Principal investigator: Bruno Benevit
Original title: Tax Cuts for Whom? Heterogeneous Effects of Income Tax Changes on Growth and Employment
Authors: Owen Zidar
Location of the Intervention: United States
Period: 1950 - 2011
Sector: Tax Savings
Primary Variable of Interest: Employment level
Type of Intervention: Tax shocks
Methodology: OLS
Summary
Income taxation involves discussions from various perspectives, usually related to tax justice, efficiency, or potential conflicts between both aspects. Within the context of efficiency, the different effects of income taxation on different social strata in the economy is a commonly addressed topic. In this sense, this study examined how tax changes in the United States affected aggregate economic activity using post-war data. The results indicated that growth in employment levels was positively affected by cuts in income taxation, with larger effects associated with cuts for low-income groups and small effects for the top 10% wealthiest group.
- Policy Problem
Taxation has the potential to cause distortions within an economy, raising concerns about its impacts. Therefore, taxing different population groups can have distinct effects on various aspects of an economy. On the one hand, it can be argued that tax changes favoring the high-income segment of the population are the most effective way to induce prosperity, diffusing positive effects from top to bottom. On the other hand, lower-income groups have higher marginal propensities to consume and disincentives to work due to income-based benefits, suggesting that tax cuts for this group could lead to greater economic activity in terms of consumption and labor supply.
In this sense, one can verify a trade-offs between the taxation of groups with different income levels. By focusing on the overall impacts of tax changes for different groups, it is possible to analyze the heterogeneous effects on consumption and its supply-side effects, as well as its consequences for economic activity as a whole.
- Policy Implementation Context
In the context of the United States, the population share of states belonging to the wealthiest 10% nationally shows great heterogeneity among the federative entities, varying between 3,9% and 15,48% of the state population.
Regarding the tax trajectory in the country, the social groups prioritized in relation to income taxation have varied over time. Taxpayers who saw the largest proportional tax cuts in the early 1980s and 2000s were those with higher incomes. Conversely, in the early 1990s, higher income earners faced tax increases, while taxpayers with low to moderate incomes received tax cuts.
Between 1950 and 2010, the author demonstrated that tax changes for different income groups in the United States frequently occurred simultaneously (ZIDAR, 2019). Furthermore, tax increases have been rare since the 1980s, especially for the bottom four quintiles of gross national income. It was also observed that the magnitudes of tax changes for the top 10% were greater in terms of share of production due to the increased income concentration of this population segment. Additionally, previous tax increases for the bottom 90% occurred primarily through increases in payroll taxes before 1980.
- Evaluation Details
This study constructed a time series of tax changes over the period from 1950 to 2011 using two strategies. For the calculation of tax shocks for the period from 1950 to 1960, changes in marginal rates available in the Income Statistics tables were considered (Income Statistics – SOI).
For the calculation for the period between 1960 and 2011, the author used the TAXSIM Tax Simulator program (National Bureau of Economic Research's Tax Simulator) to calculate shocks based on individual income tax return data. For each tax change, a measure was constructed considering income and deductions in the year prior to the tax change, as well as the old and new tax tables. In order to avoid the impact of behavioral changes resulting from tax changes, tax data from the previous year were used. Both measures were aggregated for each taxpayer in the 50 US states, considering income groups such as the poorest 90% and the richest 10% according to adjusted gross income (Adjusted Gross Income – AGI) national.
To verify the real effects of the tax changes, the price index of American Chamber of Commerce Researchers Association – ACCRA is a price index formulated using the approach of Moretti (2013), defined from the combination of real estate market prices and the national Consumer Price Index (CPI).
- Method
To estimate the dynamic effects of fiscal changes for different income brackets in the states, event study methodologies, distributed lag models, and models for identifying the 2-year effect were adopted. At the state level, impacts on employment, employment-to-population ratio, nominal GDP, and real GDP were verified. Regarding national variables, the impact on GDP, investment, residential investment, consumption, durable goods consumption, and non-durable goods consumption was observed.
Event studies were used to verify the impact of a 1% GDP increase in taxes on outcomes for those with adjusted gross income (AGI) in the bottom 90% nationally and for those with AGI in the top 10% nationally. Initially, the outcome variables analyzed included measures of employment, nominal GDP, inflation, and real GDP. Subsequently, in order to explain the mechanisms associated with tax shocks, another set of outcome variables was examined, comprising measures associated with the labor market and the level of state consumption.
The distributed lag model adopted a specification to identify how tax changes in the top 10% and bottom 90% groups according to the AGI affected economic activity. Therefore, the effect of tax changes in each year and in its two preceding years (changes that occurred in the years) was considered. ,
e
Based on this model, the impacts at the state and national levels were verified. The model for identifying the 2-year effect considered a measure of the difference in the outcome variable between the years.
e
divided by the value of the outcome variable for the year.
, that is, the percentage change over 2 years after a given tax change.
Both models considered fixed time and state effects, as well as covariates related to spending on social programs in each state and, for the national-level analysis, the effect of tax changes not associated with income or payroll. Finally, robustness tests were conducted considering different specifications in the covariate vector of the models, incorporating other measures of cyclicality, macroeconomic indices, and regional trend variables.
- Main results
The results of the event studies indicated the presence of trends in the employment level and the employment-to-population ratio at the state level that precede tax changes for the most vulnerable social strata. Specifically, a 1% change in state GDP in taxes for the population comprising the bottom 90% of the AGI implies a change approximately 4 percentage points lower 3 years later compared to the level of both employment measures in the year prior to the tax change. This effect diminishes after 4 years, remaining approximately 3 percentage points below the level prior to the tax change. No significant effects were identified for changes in the top 10% of the AGI. Regarding the impacts on economic activity, the results indicated that the tax changes impacted both nominal GDP and price indices (ACCRA and Moretti) by 8% and 6% in the year following the tax changes, respectively. Again, the magnitudes of these effects were reduced 3 years after the changes.
Regarding the effects of the lag models, estimates from both models pointed to a reduction of approximately 3,5% in the employment-to-population ratio after a 1% change in the state's GDP in taxes for the population comprising the bottom 90% of the AGI. Furthermore, tax changes of the same scale for this group also imply a reduction in nominal and real GDP, ranging from 5,3% to 9,2%. As previously observed, no significant effects were identified for changes in the top 10% of the AGI.
In terms of national implications, tax changes resulted in reductions of 3,8% and 1,1% after tax changes for the populations comprising the bottom 90% and top 10% of the AGI, respectively. However, these effects were not statistically significant, nor were the coefficients associated with the impacts on aggregate consumption and residential investment. Additionally, an impact on the macroeconomic aggregate of investments was observed, although with weak significance.
Finally, the results regarding the mechanism analysis indicate that labor market activity decreases after tax changes for the bottom 90%. Labor force participation rates decrease by about 3 percentage points 3 and 4 years after a tax change, while hours worked by workers who work at least 48 weeks decrease by about 2% immediately after the tax change. An increase in real wages was also observed after tax changes for the bottom 90%.
- Lessons in Public Policy
This article examined how income tax changes affected economic activity in the United States, with an emphasis on the dynamic differences in taxation for different social strata. Through various models considering the lagged effects of tax changes and the cyclicality of economic activity, the estimated effects indicated that macroeconomic aggregates are more sensitive to tax changes on the poorest 90% according to gross income.
In general, the results of this article do not confirm the hypothesis of loss of efficiency resulting from taxing the wealthiest. This evidence provides new insights for policymakers, suggesting caution regarding the existence of a mechanism for... trade-offs between equity and tax efficiency in the short and medium term.
References
MORETTI, E. Real Wage Inequality. American Economic Journal: Applied Economics, v. 5, no. 1, p. 65–103, 1 Jan. 2013.
ZIDAR, O. Tax Cuts for Whom? Heterogeneous Effects of Income Tax Changes on Growth and Employment. Journal of Political Economy, v. 127, no. 3, p. 1437–1472, jun. 2019.
