THE EFFECT OF MARGINAL TAX RATES ON TAXABLE INCOME - A PANEL STUDY OF THE 1986 TAX-REFORM ACT

This paper uses a Treasury Department panel of more than 4,000 taxpayers to estimate the sensitivity of taxable income to changes in tax rates on the basis of a comparison of the tax returns of the same individual taxpayers before and after the 1986 tax reform. The analysis emphasizes that the response of taxable income involves much more than a change in the traditional measures of labor supply. The evidence shows an elasticity of taxable income with respect to the marginal net-of-tax rate that is at least one and could be substantially higher. The implications for recent tax rate changes are discussed.