Top Tax Rate Reductions from the Economic Growth And Tax Relief Reconciliation Act of 2001

The Economic Growth and Tax Relief Act of 2001 led to a reduction in the top marginal income tax rate from 39.6% to 35%. Heim (2009) studies the impact of this tax change on the taxable income of those subject to the top marginal income tax rate. Hendren and Sprung-Keyser (2020) use these estimates to compute the MVPF of this policy change.

MVPF SUMMARY

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Hendren and Sprung-Keyser (2020) estimate the MVPF of top tax rate changes using the equation

where FE = \frac{-t}{1-t}*\alpha*\epsilon_{eti}, where \alpha = \frac{E[Y]}{E[Y-y|Y\geq y]} is the Pareto Parameter of the income distribution and \epsilon = \frac{d[E[y]]}{d(1-t)}\frac{1-t}{E[y]} is the elasticity of taxable income with respect to the keep rate, 1-t.

Throughout, Hendren and Sprung-Keyser (2020) measure t as the sum of the federal income tax rate and a 5% state income tax rate assumption. In practice, the reforms are discrete changes in t. To account for this, Hendren and Sprung-Keyser (2020) compute the fiscal externality above separately for the pre- and post-reform tax rates, and then take an average of the two FEs. Appendix F of Hendren and Sprung-Keyser (2020) provides further details and references.

The key additional parameter beyond the elasticity of taxable income is the Pareto parameter of the income distribution. Atkinson, Piketty, and Saez (2011) find a value of 1.66 for 2001. Heim (2009) estimates an elasticity of taxable income of 0.22. This implies an MVPF of 1.37, with a confidence interval of [0.918, 2.862].