NCPA - National Center for Policy Analysis

Extra Bonus From Lowering Marginal Tax Rates

March 28, 2000

Harvard University professor Martin Feldstein -- an adviser to Gov. George W. Bush's campaign -- says Bush's tax plan will achieve benefits beyond those claimed by the candidate. That's because the plan explicitly assumes that taxpayers will not change their behavior at all in response to lower marginal tax rates.

Feldstein says their behavior will change -- and that will make up for much of the revenue lost through lower tax rates.

Here's how he sees that happening:

  • Lower marginal rates encourage people to work and earn more taxable income -- and since the Bush plan has an extra reduction in the marginal rate for the lower-earning member of a married couple, the incentive to work is increased even further.
  • Since high marginal rates encourage employers and employees to seek more non-taxable fringe benefits in lieu of cash, lowering rates would discourage this practice and shift more compensation to the form of taxable cash.
  • High marginal rates also encourage taxpayers to seek tax deductible expenses for things like mortgage expense and greater write-offs for business expenses like travel and entertainment -- so lowering rates would allow individuals to spend money on things they really prefer.
  • Feldstein points out that relatively small changes in the form of compensation and in tax deductions and business expenses can have a big impact on taxable income and tax revenues.

In fact, the Office of Management and Budget estimates the revenue loss from such legal avoidance practices at more than $400 billion a year -- not including such choices as nicer working conditions. That equals 40 percent of personal income tax revenue.

With no change in taxpayer behavior, the Bush plan is estimated to cost $135 billion in lost revenue. But if human factors are taken into consideration, that figure drops to $90 billion a year.

Source: Martin Feldstein, "Bush's Tax Plan Is Even Better than the Campaign Says," Wall Street Journal, March 28, 2000.


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