High-Income Families and the Tax Changes of the 1980s: The Anatomy of Behavioral Response

The relative income gains of the affluent after the passage of the Tax Reform Act of 1986 (TRA86), which sharply lowered tax rates at high income levels, are overstated by comparing cross-sectional slices using concurrent income definitions, but they are large nevertheless. Although an index of the demand-side factors affecting inequality throughout the income distribution can explain much of the increased high-income concentration until 1985, it cannot adequately explain the post-TRA86 spurt. Thus, TRA86 is likely to have been a principal cause of the large increase in the reported personal income of the affluent. A close look at the sources of the post-1986 increases in the reported individual income of high-income households suggests that much of it represents shifting of income -- for example, from the corporate tax base to the individual tax base -- and not income creation such as additional labor supply. This distinction is critical because knowing how much the reported individual income of a particular group of people changes in response to a tax change is not a sufficient statistic for evaluating adequately its revenue consequences, incidence, and efficiency.