The Incentive Effects of Marginal Tax Rates: Evidence from the Interwar Era
This paper uses the interwar period in the United States as a laboratory for investigating the incentive effects of changes in marginal income tax rates. Marginal rates changed frequently and drastically in the 1920s and 1930s, and the changes varied greatly across income groups at the top of the income distribution. We examine the effect of these changes on taxable income using time-series/cross-section analysis of data on income and taxes by small slices of the income distribution. We find that the elasticity of taxable income to changes in the log after-tax share (one minus the marginal rate) is positive but small (approximately 0.2) and precisely estimated (a t-statistic over 6). The estimate is highly robust. We also examine the time-series response of available indicators of investment and entrepreneurial activity to changes in marginal rates. We find suggestive evidence of an impact on business formation, but no evidence of an important impact on other indicators.
We are grateful to Alan Auerbach, Raj Chetty, Amy Finkelstein, Patrick Kline, and Emmanuel Saez for helpful comments and suggestions, to Maria Coelho, Jeanette Ling, and Priyanka Rajagopalan for research assistance, and to the National Science Foundation and the Center for Equitable Growth for financial support. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
“The Incentive Effects of Marginal Tax Rates: Evidence from the Interwar Era” (with David H. Romer), American Economic Journal: Economic Policy, forthcoming. citation courtesy of