Marginal Tax Rates and Income: New Time Series Evidence*

Abstract

Using new narrative measures of exogenous variation in marginal tax rates associated with postwar tax reforms in the United States, this study estimates short-run tax elasticities of reported income of around 1.2 based on time series from 1946 to 2012. Estimated elasticities are larger in the top 1% of the income distribution but are also positive and statistically significant for other income groups. Previous time series studies of tax returns data have found little evidence for income responses to taxes outside the top of the income distribution. The different results in this article arise because of additional efforts to account for dynamics, expectations, and especially the endogeneity of tax policy decisions. Marginal rate cuts lead to increases in real GDP and declines in unemployment. There is also evidence that the responses are to marginal tax rates rather than average tax rates. Counterfactual tax cuts targeting the top 1% alone are estimated to have short-run positive effects on economic activity and incomes outside of the top 1%, but to increase inequality in pretax incomes. Cuts for taxpayers outside of the top 1% also lead to increases in incomes and economic activity, but with a longer delay.