Top Marginal Tax Rates Research Articles

Politics and income taxes: Progress and progressivity

AbstractThis paper begins with a survey of the literature on the political economy approaches to labor income taxation. We focus on recent progress made by examining in detail the specific properties of nonlinear taxes derived in the context of voting. Next, we present new results on the existence of a majority voting equilibrium that unifies work in the standard framework. Finally, we discuss how recent theoretical results help us uncover empirical patterns from the last 50 years in the US tax system, namely, a sharp decrease in top marginal tax rates, the rise of the Earned Income Tax Credit, and increased progressivity in the middle of the income distribution.

International Tax Planning: Taxation of Professional Athletes—Stickhandling Through the Maze

Recent changes in Canadian tax laws have important implications for many professional athletes relocating to Canada from the United States or other countries. At the federal level, proposed changes to the alternative minimum tax, foreign-income reporting requirements, and a broad range of other taxes have introduced complexity and potential traps for the unwary. At the provincial level, the five provinces with a National Hockey League team have raised their top marginal tax rates over the last 10 years. Because the financial stakes can be high, understanding the tax laws and the tax-planning opportunities for professional athletes has become more important than ever. This article addresses some key income tax issues and planning opportunities for professional athletes earning income from the provision of cross-border services in Canada and the United States.

Fundamentals of Institutional Quality and Economic Freedom

ABSTRACT: Social scientists have extensively studied the causes of good institutions, including the origins of economic freedom. Results concerning the causes of different kinds of institutions are often similar, often concluding that the geography, environment, and culture are important factors. However, a recent political economy framework suggests that certain dimensions of economic freedom, namely specific dimensions of the size of government (government consumption, transfers and subsidies, and the top marginal tax rate), differ systematically from other dimensions of liberalization. This paper explores these arguments by constructing an index of a set of consensus predictors of institutional quality: ethnic fractionalization (predicts negatively), the natural log of the population size (negatively), absolute latitude (positively), natural resource rents (negatively), the presence of the country in the Americas (negatively), British legal origins (positively), the presence of the country in Eurasia (positively), and island geography (positively). The countries with the “best” fundamentals for institutional quality are Iceland, Ireland, Malta, Finland, and Cyprus, while the five with the “worst” fundamentals are Angola, Nigeria, Chad, Burkina Faso, and Ghana. It then takes this index of “fundamentals” of institutional quality and shows that, although they predict economic liberalism as a whole (as measured by the Economic Freedom of the World index) as they would predict other measures of institutional quality, they predict oppositely (i.e., corresponding to larger governments) for the dimensions of the size of government listed above. The result is congruent with the predictions of the political economy model. Additionally, this result is not contingent on the inclusion of any one of the “fundamental” variables, although natural resource rents and absolute latitude appear to be the most important variables. Countries with considerably more economic freedom than would be predicted by their fundaments include Peru, Singapore, the United States, Chile, and Canada; should deviations from fitted values be seen as presaging future movements in institutions, these countries are the most likely to see upcoming declines. The aforementioned political economy model implies that these findings are the result of complexities involved in the interaction between state capacity and different dimensions of economic liberalization.

Reducing poverty in the UK to mitigate energy poverty by the 10% and LIHC indicators: What tax changes are needed, and what are the consequences for CO2 emissions?

Energy poverty is driven by four factors: poverty; high energy prices; energy-inefficiency; and specific household characteristics. Increasingly refined definitions of energy poverty (and/or vulnerability) identify types or locations of households most likely to be suffering it. But there is also a place for a different approach, considering poverty reduction directly, as poverty is a necessary component within all energy poverty definitions. This paper investigates how high the UK's top marginal tax rates would need to be, to provide funds to lift low-income UK households above the poverty threshold as defined by the low-income-high-cost (LIHC) and 10% energy poverty indicators. It finds that the increased top tax rates would still be in line with those of other European OECD countries. Using recent and new research on income elasticities of CO2 emissions, it then estimates the net direct effects on CO2 emissions of this redistribution. For both scenarios the most likely effect is a small reduction in net CO2 emissions. Further, indirect downward pressures on CO2 emissions due to reduced income among the highest earners are likely to lead to yet more favourable outcomes for net CO2 emission reduction.

Does Taxing Business Owners Affect Employees? Evidence From A Change in the Top Marginal Tax Rate

Abstract Debates about the taxation of business owners often center on the distributional effects of these taxes, particularly the degree to which they affect workers. Drawing on a new linked owner-firm-worker data set created from U.S. administrative tax records, I analyze how an increase in the top marginal tax rate faced by business owners affected the earnings of their employees. I use panel difference-in-differences methods to compare the earnings of workers in similar firms but whose owners were differentially exposed to the tax increase. I estimate that 11–18 cents per dollar of new business income tax liability was passed through to employee earnings. I find no change in employment in response to the tax increase. The responses were generally associated with lower earnings growth, not changes in workforce composition. The burden was not borne equally by all workers. Essentially all of the workers’ share of the burden was borne by those in the top 30% of the earnings distribution, highlighting that the ultimate distributional effects of the policy depend not only on the share of the burden borne by workers but on the shares borne by different types of workers. Furthermore, since the owners bore the majority of the burden, the policy resulted in a decrease in after-tax earnings inequality between top-bracket owners and lower-bracket workers. I discuss the implications of the findings for the mediating labor market mechanisms and for welfare analyses of income taxation using a marginal value of public funds framework.

Tax progressivity and taxing the rich in developing countries: lessons from Latin America.

This article discusses the challenges and potential policy choices for levying progressive taxes and taxing the rich in Latin America, a region known for its high-income inequality, limited tax-collection capacity, and low share of taxes collected from personal income and wealth. Factors such as high exemption thresholds, low top marginal tax rates, and limited administrative capacity undermine the redistributive ability and revenue collection of the tax systems in the region. Moreover, the income composition for the top percentiles largely comes from capital, and the effective tax rates they face are often low due to the preferential treatment of capital income and wealth. After discussing the evidence of how the rich in Latin America respond to progressive taxes on income and wealth and changes in enforcement policy, we provide some insights on potential policy choices to tax them effectively. These may include broadening the income tax base by lowering the number of exempt and non-taxable income items and the statutory exemption thresholds, reevaluating preferential tax rates on capital income, monitoring foreign income, addressing the abuse of tax treatment by business earners, and enhancing tax administration capacity. Additionally, wealth taxes may complement the tax system with updates to property registers and scrutiny of foreign assets.

Summaries of Articles

Summaries of Articles

The taxation of employment income in African countries: Findings from a new dataset

AbstractThis study presents new evidence on the taxation of employment income in African countries. Utilising a unique dataset, we summarise trends in the policy design of personal income taxes and other mandatory contributions between 1995 and 2020. We analyse tax rates, thresholds and reform patterns, before comparing cross‐country effective tax rates and the progressivity of employment income taxes. We find that, inter alia, reform is infrequent, top marginal tax rates are lower than in the OECD and in 25% of African countries, an individual earning a wage equal to the PPP$1.90/day poverty line would be liable to pay income tax.

Turning out for redistribution: the effect of voter turnout on top marginal tax rates

I investigate the impact of voter turnout on top marginal tax rates in OECD countries between 1974 and 2013. I find that higher turnout leads to higher taxes for top earners, a result broadly consistent with the median voter theorem. Using novel survey data, I confirm that individuals in all but the wealthiest income bracket prefer higher taxes on the rich more than they prefer greater government spending in the economy. In line with these preferences, I find that turnout has a significantly negative effect on top income shares but no effect on the size of government or on public welfare expenditure. An instrumental variables approach confirms my findings. Overall, the paper is the first of its kind to link turnout to measures of redistribution that affect top earners and to preferences for redistribution.

On the connection between cultural values and personal income taxation

The article explores the relationship between Hofstede’s cultural dimensions and personal income taxation, as it is, what was never done in the scientific literature. It briefly describes the current level of scientific discourse and history of thought development in this problem field, forming the theoretical basis for substantiating the assumed relationship. Using theoretical reasoning as well as comparative quantitative methods (logistic and linear regression analysis), the paper shows the connection between some of Hofstede’s cultural dimensions (power distance, individualism) and the establishment of progressive income taxation and top marginal tax rates. It is found that lower scores of power distance are associated with progressive income taxation, as well as higher tax rates. In addition, some potential mechanisms underlying this relationship are discussed. It is emphasized that cultural values can have two levers of influence on tax policy (bottom-up and top-down), since both the politicians responsible for designing tax systems and the citizens who shape the redistribution demand carry the national cultural values. The sample under study includes 115 countries at different levels of economic development.

Radically reducing UK energy poverty by the 10% and LIHC indicator through progressive fiscal policy: What would it cost, who would pay, and what are the consequences for CO2 emissions?

Energy poverty is driven by four factors: poverty; high energy prices; energy-inefficiency; and specific household characteristics. Increasingly refined definitions of energy poverty (and/or vulnerability) identify types or locations of households most likely to be suffering it. But there is also a place for considering poverty reduction directly, as poverty is a component within all energy poverty definitions. This paper investigates how high the UK's top marginal tax rates would need to be, to provide funds to lift low-income UK households above the poverty threshold as defined by the low-income-high-cost (LIHC) and 10% energy poverty indicators. It finds that the increased top tax rates would still be in line with those of other European OECD countries. Using recent research on income elasticities of CO2 emissions, it then estimates the net effects on CO2 emissions of this redistribution. For the 10% scenario the worst-case is a net 0.7% increase and, the best-case is a small reduction. For the LIHC scenario the worst-case increase is 2.21% and best-case increase is 0.7%. Indirect downward pressures on CO2 emissions due to reduced income among the highest earners are also likely to lead to further favourable outcomes for net CO2 emission reduction.

THE PARALLEL MARCH OF THE GINIS How does taxation relate to inequality, and what can be done about it?

THE PARALLEL MARCH OF THE GINIS How does taxation relate to inequality, and what can be done about it?

Breaking Wagner's Law: Which Countries Have the Most Limited Government?

Which countries have the world's smallest and the world's largest governments? One-fifth of the Economic Freedom of the World index is a subindex scoring the size of government for countries across the world. This subindex is inclusive of the three dimensions of government spending, the top marginal tax rate, and the government ownership of the economy. Measured in this manner, the “smallest” governments are, generally, weak or fragile states. This paper recognizes Wagner's law, the empirical regularity that wealthier countries tend to spend more as a percentage of gross domestic product (GDP). It then performs a novel adjustment to the size of government data to account for Wagner's law, re-scores and re-ranks the countries, and explores the results.

Nexus Between Tax Structure and Income Inequality in India

This study empirically examines the long-run effect of tax structure on income inequality in India. It considers annual time-series data from 1980 to 2019. The unit root and Johansen cointegration tests substantiate a long-run relationship between tax variables and income inequality. We employ Fully Modified OLS (FMOLS) and Dynamic OLS (DOLS) techniques for the baseline analysis. For a robustness check, we utilize the Canonical Cointegration Regression (CCR) technique. The results show that the top marginal tax rate (TMTR) reduces income inequality, whereas customs duty (CD) significantly increases income inequality. Personal income tax (PIT), corporate income tax (CIT), and excise duty (ED) have no significant association with income inequality. In addition, GDP per capita significantly reduces income inequality, whereas GDP per capita squared aggravates income inequality, reflecting the absence of the Kuznets hypothesis in India. Human capital measured by mean years of schooling (MYS) also significantly worsens income inequality. Our results suggest that the Indian government should increase TMTR and reduce customs duty (CD) in order to improve income distribution.

Estimating the elasticity of taxable income: Evidence from top Japanese taxpayers

This study aims to estimate the elasticity of taxable income (ETI) with regard to the net-of-tax rate, precisely in terms of potential for the margin arising from the behavioral response. We use panel data from top Japanese taxpayers in Tokyo during 1986–1989 and focus on the tax policy changes caused by the 1987–1989 comprehensive tax reform, which substantially reduced the top marginal tax rates. It is found that the ETI with regard to the net-of-tax rate is approximately 0.158–0.226, considerably lower than those for the United States and many European countries. One possible reason for the small ETI estimates is the absence of the behavioral response in terms of choice of deductions in this study.

Personal Income Taxes in the Middle East and North Africa: Prospects and Possibilities

With the exception of a few North African countries, personal income taxes (PITs) play little or no role in the Middle East and North Africa (MENA), often yielding less than 2 percent of gross domestic product (GDP) in revenue. This paper examines how PITs have evolved in recent decades, and what they might look like in the next 20 years. Throughout the region, top marginal tax rates on labour and business income of individuals have declined substantially, a trend that mirrors reductions in advanced and developing economies. Taxation of passive capital income has changed very little, and the revenue contribution from this source remains low throughout the region, averaging less than 1 percent of GDP and concentrated in oil-importing non-fragile states. Social security contributions (SSCs) have increased in importance in nearly all MENA countries, and some countries have introduced additional payroll taxes and levies. The combination of reduced marginal tax rates, light taxation of income from capital and business activities, and increases in SSCs has resulted in income tax systems that create disincentives to work and incentives for informality, and contribute little to government revenue and income redistribution. Given differences in economic and political structures, demographics, and starting points, the path to PIT and SSC reforms will vary across the region. Countries with relatively mature PIT/SSC systems, where revenue performance has improved in the past two decades, will increasingly need to balance revenue and equity objectives against efficiency objectives (in particular, labour market incentives and informality). Countries without a PIT will have to weigh whether a consumption tax/SSC system that mimics a flat tax on labour income is sufficient to diversify revenue away from oil, and whether to adopt PITs to address rising income and wealth inequality. Finally, fragile states, which face more political volatility and have weaker fiscal institutions than non-fragile states, will have to focus on simplicity of tax design and collection to be able to raise revenue from PITs.

Institutional and Political Determinants of Statutory Tax Rates: Empirical Evidence from Sub-Saharan Africa

ABSTRACT This paper investigates the extent to which institutional and political factors explain statutory tax rates in sub-Saharan Africa (SSA). In particular, it examines the effect of regulatory quality, political accountability, political fragmentation, the electoral cycle, and ideological orientation on corporate income tax (CIT) rates as well as top marginal personal income tax (PIT) rates during 1990–2017. Different from advanced economies, our results suggest that in SSA institutional (structural) factors are more important than political (conjunctural) ones. Better institutions (proxied by higher regulatory quality) are associated with lower tax rates, whereas weak political accountability (proxied by longer government tenures) and greater fragmentation (linked to polarization) lead to higher tax rates. The electoral cycle is weakly associated with higher CIT, and contrary to findings in advanced economies, the ideological orientation of the government does not appear to influence statutory tax rates in SSA.

Progressivity and redistributive effects of income taxes: evidence from India.

We analyse the progressivity and redistributive effects of India’s income tax system utilizing Income Tax Department data for 2011–18. By fitting Lorenz and tax concentration curves to these data, we find that despite exhibiting high levels of progressivity, the redistributive effects of income taxes remain modest amongst tax assessees and miniscule within the adult population. We also find that plugging the gap between statutory and actual average tax rates will do little to improve redistributive effects, and lowering income thresholds for top marginal tax rates offers greater redistributive and revenue potential than reducing exemption limits or increasing top marginal tax rates.

Higher Taxes at the Top: The Role of Entrepreneurs

This paper computes optimal top marginal tax rates in Bewley-Huggett-Aiyagari–type economies that include entrepreneurs. Consistent with the data, entrepreneurs are overrepresented at the top of the income distribution and are thus disproportionately affected by an increase in the top marginal income tax rate. The top marginal tax rate that maximizes welfare is 60 percent. While average welfare gains are positive and similar across occupations along the transition, they are larger for entrepreneurs than for workers in the long run, and this occupational gap in welfare gains after the tax increase widens with increasing income. (JEL D11, D21, D31, H21, H24, L26)

Designing, Not Checking, for Policy Robustness: An Example with Optimal Taxation

Economists typically check the robustness of their results by comparing them across plausible ranges of parameter values and model structures. A preferable approach to robustness—for the purposes of policymaking and evaluation—is to design policy that takes these ranges into account. We modify the standard optimal income tax model to include the policymaker’s subjective uncertainty over parameter values, and we characterize robust optimal policy as that which maximizes expected social welfare. After calibrating uncertainty over the elasticity of taxable income from past empirical work and novel survey data on economists’ beliefs, we compare the implied robust optimal marginal tax rates to the alternative benchmark policy based on the best point estimates of relevant parameters. Our results suggest that robust optimal marginal tax rates are typically more progressive than in benchmark analyses, raising top marginal tax rates by between 5 and 7 percentage points, and generating modest expected welfare gains. Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.