Monday, May 4, 2009

Effects of higher taxes on the rich?

Bob Williams of the Tax Policy Center writes about the proposal to raise the top bracket of the British income tax from 45% to 50%:

Actor Michael Caine talks of moving to America and a British soccer coach warns that his sport will collapse as the best players go elsewhere.

The concerns are real but overstated. Sure, some people will adjust what they do to avoid high taxes, and a few will decamp for places that tax less. Some will hire lawyers and accountants to turn earnings into gains to cut their tax bills. But will a 5-percentage-point rise in the top rate lead to massive behavioral change?

Research here in the U.S. says no. The econometrics are tricky, and teasing out responses to changing tax rates in a big and complex economy confounds easy analysis. But the bottom line is consistent across many studies: Rich people have temporary changes in income when their taxes are altered but they don’t last long. Instead, they respond to higher taxes by shifting income across time or re-characterizing income into forms that face less tax, such as capital gains. Long-run behavioral changes (moving abroad, reducing labor supply, etc.), however, are relatively small.

The top U.S. tax rate has bounced around a lot over the past few decades, dropping from 50 to 28 percent, climbing back to 39.6 percent, and then falling again to 35. Incomes followed different paths after each change, sometimes rising sharply after rate cuts and other times rising after rate hikes. Similarly, incomes have fallen after both rate cuts and rate increases. Despite assertions to the contrary, there’s been no clear pattern.

Further reading:

Linking tax changes income and revenue

Taxable Income Responses to 1990s Tax Acts: Further Explorations

The Elasticity of Taxable Income with Respect to Marginal Tax Rates: A Critical Review

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