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It's Not About the Money: Why Natural Experiments Don't Work on the Rich

  • Austan Goolsbee

An influential literature on the effects of marginal tax rates on the behavior of the rich has claimed that the elasticity of taxable income with respect to the net of tax share is very high possibly exceeding one. These high estimated elasticities imply that cutting taxes on the rich does not lose much revenue possibly increases it and that progressivity generates a large amount of deadweight loss. To identify this elasticity, these studies have conducted natural experiments' comparing the rich to other income groups and assuming that they are the same except for changes in their tax rates. This paper tests the natural experiment assumption using alternative data on the compensation of a panel of several thousand corporate executives and finds it to be false. Relatively, the very rich have incomes which trend upward at a faster rate are more sensitive to economic conditions, and are more likely to be in a form whose timing can be shifted in the short run. Interpreted broadly, these facts might reduce existing elasticity estimates by as much as 75%. The paper also suggests ways of improving existing methods.

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File URL: http://www.nber.org/papers/w6395.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 6395.

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Date of creation: Feb 1998
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Publication status: published as Slemrod, J. (ed.) Does Atlas Shrug? The Economic Consequences of Taxing the Rich. Cambridge: Harvard University Press, 2002.
Handle: RePEc:nbr:nberwo:6395
Note: PE
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  1. Heckman, James J, 1993. "What Has Been Learned about Labor Supply in the Past Twenty Years?," American Economic Review, American Economic Association, vol. 83(2), pages 116-21, May.
  2. Austan Goolsbee, 1997. "What Happens When You Tax the Rich? Evidence from Executive Compensation," NBER Working Papers 6333, National Bureau of Economic Research, Inc.
  3. David M. Cutler & Lawrence F. Katz, 1991. "Macroeconomic Performance and the Disadvantaged," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 22(2), pages 1-74.
  4. Feenberg, D.R. & Poterba, J.M., 1992. "Income Inequality and the Incomes of Very High Income Taxpayers: Evidence from Tax Returns," Working papers 92-16, Massachusetts Institute of Technology (MIT), Department of Economics.
  5. Martin Feldstein, 1995. "Tax Avoidance and the Deadweight Loss of the Income Tax," NBER Working Papers 5055, National Bureau of Economic Research, Inc.
  6. Levy, Frank & Murnane, Richard J, 1992. "U.S. Earnings Levels and Earnings Inequality: A Review of Recent Trends and Proposed Explanations," Journal of Economic Literature, American Economic Association, vol. 30(3), pages 1333-81, September.
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