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 et al. (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].