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The Effect of Increased Tax Rates on Taxable Income and Economic Efficiency: A Preliminary Analysis of the 1993 Tax Rate Increases

In: Tax Policy and the Economy, Volume 10

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  • Martin Feldstein
  • Daniel Feenberg

Abstract

The 1993 tax legislation raised marginal tax rates to 36 percent from 31 percent on taxable incomes between $140,000 and $250,000 and to 39.6 percent on incomes above $250,000. This paper uses recently published IRS data on taxable incomes by adjusted gross income class to analyze how the 1993 tax rate increases affected taxable income, tax revenue, and economic efficiency. Our estimates are based on a difference-in-difference procedure comparing growth of taxable incomes among taxpayers with AGIs over $200,000 to the growth of incomes of lower income taxpayers. We use the NBER TAXSIM model to adjust for interyear differences in the composition of the two taxpayer groups. The results show that high income taxpayers would have reported 7.8 percent more taxable income in 1993 than they did if their tax rates had not increased. Because of the high threshold for the increase in tax rates, this decline in taxable income caused the Treasury to lose more than half of the extra revenue that would have been collected if taxpayers had not changed their behavior. The deadweight loss caused by the higher marginal tax rates (including the effects on labor supply and on consumption of goods and services favored by deductions and exclusions) is approximately twice as large as the $8 billion in revenue raised by the 1993 tax rate. Several possible statistical biases could cause the estimated effect of the tax changes to either underestimate or overestimate the true long-run effect. The paper concludes with a discussion of these problems and of plans for future analysis.
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Suggested Citation

  • Martin Feldstein & Daniel Feenberg, 1996. "The Effect of Increased Tax Rates on Taxable Income and Economic Efficiency: A Preliminary Analysis of the 1993 Tax Rate Increases," NBER Chapters, in: Tax Policy and the Economy, Volume 10, pages 89-118, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberch:10900
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    1. Daniel R. Feenberg & James M. Poterba, 1993. "Income Inequality and the Incomes of Very High-Income Taxpayers: Evidence from Tax Returns," NBER Chapters, in: Tax Policy and the Economy, Volume 7, pages 145-177, National Bureau of Economic Research, Inc.
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    Cited by:

    1. Soren Blomquist & Anil Kumar & Che-Yuan Liang & Whitney K. Newey, 2014. "Individual heterogeneity, nonlinear budget sets, and taxable income," CeMMAP working papers 21/14, Institute for Fiscal Studies.
    2. Carina Neisser, 2021. "The Elasticity of Taxable Income: A Meta-Regression Analysis [The top 1% in international and historical perspective]," The Economic Journal, Royal Economic Society, vol. 131(640), pages 3365-3391.
    3. Todd B. Walker & Shu-Chun Susan Yang & Eric M. Leeper, 2008. "Fiscal Foresight: Analytical Issues," 2008 Meeting Papers 786, Society for Economic Dynamics.
    4. Soren Blomquist & Anil Kumar & Che-Yuan Liang & Whitney K. Newey, 2022. "Nonlinear Budget Set Regressions for the Random Utility Model," Working Papers 2219, Federal Reserve Bank of Dallas.
    5. Kodama, Naomi & Yokoyama, Izumi, 2015. "How the 2003 Social Insurance Premium Reform Affects Firm Behavior," CIS Discussion paper series 650, Center for Intergenerational Studies, Institute of Economic Research, Hitotsubashi University.
    6. Martin S. Feldstein, 1997. "The Costs and Benefits of Going from Low Inflation to Price Stability," NBER Chapters, in: Reducing Inflation: Motivation and Strategy, pages 123-166, National Bureau of Economic Research, Inc.
    7. Segura III, Jerome, 2016. "A Regional Tale of Two Income Taxes," Journal of Regional Analysis and Policy, Mid-Continent Regional Science Association, vol. 46(2), December.
    8. Engen, Eric M. & Skinner, Jonathan, 1996. "Taxation and Economic Growth," National Tax Journal, National Tax Association;National Tax Journal, vol. 49(4), pages 617-642, December.
    9. KODAMA Naomi & YOKOYAMA Izumi, 2017. "Labor Market Impact of Labor Cost Increase without Productivity Gain: A natural experiment from the 2003 social insurance premium reform in Japan," Discussion papers 17093, Research Institute of Economy, Trade and Industry (RIETI).
    10. Charles Yuji Horioka, 2014. "The Life and Work Of Martin Stuart (“Marty”) Feldstein," UP School of Economics Discussion Papers 201410, University of the Philippines School of Economics.
    11. Bull, Nicholas & Lindsey, Lawrence B., 1996. "Monetary Implications of Tax Reforms," National Tax Journal, National Tax Association, vol. 49(3), pages 359-79, September.
    12. Austan Goolsbee, 1999. "Evidence on the High-Income Laffer Curve from Six Decades of Tax Reform," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 30(2), pages 1-64.
    13. Eric M. Leeper & Todd B. Walker & Shu-Chun Susan Yang, 2008. "Fiscal Foresight: Analytics and Econometrics," CAEPR Working Papers 2008-013, Center for Applied Economics and Policy Research, Department of Economics, Indiana University Bloomington.
    14. Emmanuel Saez & Joel Slemrod & Seth H. Giertz, 2012. "The Elasticity of Taxable Income with Respect to Marginal Tax Rates: A Critical Review," Journal of Economic Literature, American Economic Association, vol. 50(1), pages 3-50, March.
    15. Benjamin Russo, 2009. "Innovation and the Long‐Run Elasticity of Total Taxable Income," Southern Economic Journal, John Wiley & Sons, vol. 75(3), pages 798-828, January.
    16. James E. Long, 1999. "The Impact of Marginal Tax Rates on Taxable Income: Evidence from State Income Tax Differentials," Southern Economic Journal, John Wiley & Sons, vol. 65(4), pages 855-869, April.
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    More about this item

    JEL classification:

    • H24 - Public Economics - - Taxation, Subsidies, and Revenue - - - Personal Income and Other Nonbusiness Taxes and Subsidies
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation

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