August 27, 2008
Economic Benefits of Reducing Top Income Tax Rates Included Higher Taxable Income
Washington, DC, August 27, 2008 - Recent research on tax relief enacted in 2001 and 2003 shows that taxable income increased when top tax rates were cut. Though not sufficient to "pay for themselves," an exaggerated claim often made for tax cut proposals, the rate cuts in the top two brackets did induce taxpayers to report enough extra taxable income to offset between 25 and 40 percent of the static revenue loss.
In Tax Foundation Fiscal Fact No. 141, "The 2001 and 2003 Tax Relief: The Benefit of Lower Tax Rates," Tax Foundation Vice President for Economic Policy Robert Carroll, Ph.D., says this analysis is important when evaluating the tax proposals of the presidential candidates.
"Absent any action from Congress, the top tax rate will rise back to 39.6% when the 2001 and 2003 tax relief sunsets at the end of 2010," Carroll explains. "That would end an eight-year rate reduction that helped spur the economy in the longer term by improving the incentives to work, produce and save, and by reducing other economic distortions associated with high tax rates."
Carroll points out that if taxpayers had not responded at all to the lower tax rates, their tax cut would have been about $29.7 billion in 2005 (the static revenue loss to the federal government). But, because the lower tax rates induced taxpayers to increase their taxable incomes by roughly 3 percent, the tax cuts only cost the Treasury about $18.5 billion.
"That means an estimated 25-to-40 percent of the static revenue loss was offset by the tax-induced increase in the tax base," says Carroll.
Listing specific taxpayer responses that would account for the surge in taxable income, Carroll cites taxpayers working harder and longer hours, taking riskier and higher-paying jobs, choosing entrepreneurship over wage-earning, shifting compensation from nontaxable fringe benefits to taxable wages, or relying less heavily on tax deductible consumption such as debt-financed home ownership.
"Sound tax policy seeks to let household and business decisions be based more on economic merit, not tax considerations," says Carroll, and each of these behavioral responses would boost taxable income."
Carroll's analysis can be found at http://www.taxfoundation.org/publications/show/23534.html.
The Tax Foundation is a nonpartisan, nonprofit organization that has monitored fiscal policy at the federal, state and local levels since 1937.
###
To set up an interview to discuss analysis of the 2001 and 2003 tax relief packages or any of the presidential candidates' tax policies, please contact Matt Moon, the Tax Foundation's Manager of Media Relations, at (202) 464-5102.