NCPA - National Center for Policy Analysis

Marginal Tax Rates With An Economic Purpose

August 28, 2000

Since higher income earners have more discretion over the amount, timing and form of their income, they are more responsive to changes in marginal tax rates. Consequently, say economists, the government would realize the most tax revenue if marginal tax rates were lower on higher income earners rather than higher, as they are under a progressive tax system.

Here are some of the highlights of the study by Jonathan Gruber of the Massachusetts Institute of Technology and Emmanuel Saez of Harvard University, published by the National Bureau of Economic Research.

  • An optimal tax system -- one that takes advantage of taxpayers' response to marginal rates in order to raise the most revenue -- would tax high-income people at marginal rates as low as 5 percent and lower-income people at rates as high as 51 percent.
  • The responsiveness to changes in marginal rates of high income earners is about one-third greater than middle-income earners.
  • Since Ronald Reagan slashed marginal tax rates, people in higher income brackets have responded by working longer and harder -- producing more taxable income.

They suggest a more efficient tax system would be one in which lower-income earners receive a cash grant from government that is rapidly taxed away as income rises, with lower marginal rates at higher income levels.

Source: Jonathan Gruber and Emmanuel Saez, "The Elasticity of Taxable Income: Evidence and Implications, "NBER Working Paper No. 7512, January 2000, National Bureau of Economic Research, 1050 Massachusetts Avenue, Cambridge, Mass. 02138; Editorial, "Marginal Madness," Wall Street Journal, August 28, 2000.

 

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