Behavioral Responses to Tax Rates: Evidence from TRA86

Martin Feldstein

NBER Working Paper No. 5000
Issued in January 1995
NBER Program(s):Public Economics

This paper uses the experience after the Tax Reform Act of 1986 to examine how taxes affect three aspects of individual taxpayer behavior: labor supply, total taxable income, and capital gains. The substantial sensitivity of married women's labor supply implies that the efficiency of the tax system could be increased significantly by reducing the marginal tax rates of these women relative to their husbands' marginal tax rates. More generally, the sensitivity of taxable income to the net of tax share implies that lower marginal tax rates would involve much less revenue loss than is traditionally assumed and would bring a much more substantial reduction in the deadweight loss of the tax system. The sharp fall in the real value of realized capital gains since the 1986 rise in tax rates on capital gains confirms earlier research indicating the substantial sensitivity of capital gains realizations to tax rates. A comparison with projections by the Treasury and Congressional Budget Office made in 1988 shows that the current official model greatly understates the sensitivity of capital gains to tax rates.

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Document Object Identifier (DOI): 10.3386/w5000

Published: American Economic Review, AEA Papers and Proceedings, Vol.85, No.2, May 1995.

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