Industrial Insight

raising taxes on the rich? | April 22, 2011

http://economics21.org/commentary/taxation-and-taxable-income

Taxation and Taxable Income

e21 Staff Editorial | 04/20/2011

For these reasons, it should be no surprise that the reduction in tax rates has resulted in substantial increases in the amount of taxable income reported by the rich. This has increased the top 1%’s share of pretax income, which has, ironically, led some to argue for higher taxes on the rich. The graph below plots the top marginal tax rate against the share of pretax income reported by the top 1% (from CBO). The correlation is –0.55: as the tax rate applied to the highest income falls, the amount of income (and share of total income) reported by this group increases on a predictable basis.

The only real exception to this rule came in the 1990s, as top marginal rates increased even as the top 1%’s share of income grew. Yet, this too was likely tax-related, as the reduction in capital gains tax rates to 18% led to larger and more frequent realizations. Since income includes only realized capital gains, lower tax rates on this form of income can increase taxable income simply by increasing the number and frequency of realizations. While this can improve the economy’s efficiency if positions that would have been held purely for tax purposes are liquidated, again, increases in taxable income can result even when the economic gains are not present.

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