Wednesday, December 13, 2006

Marginal Tax Rates in the US

Here is a graph of the top marginal tax rate in the US tax system over the past century or so.

A couple of things to notice:
- the decrease of the highest marginal tax rate during the 1920s and the subsequent increase of that rate during the Great Depression

- the decline in the highest marginal tax rate over the past few decades

Richard Posner argues that this decrease in the highest marginal tax rate helps explain the increasing income inequality in the United States:
What are the causes, and what are the effects, of this trend in the income (and of course wealth) of the highest-earning segment of the distribution? Part of it is reduced marginal tax rates, because high marginal tax rates discourage risk-taking. Consider two individuals: one is a salaried worker with an annual income of $100,000 and good job security, and the other is an entrepreneur with a 10 percent chance of earning $1 million in a given year and a 90 percent chance of earning nothing that year. Their average annual incomes are the same, but a highly progressive tax will make the entrepreneur's expected after-tax income much lower than the salaried worker's. Many of the people at the top of the income distribution are risk takers who turned out to be lucky; the unlucky risk takers fell into a lower part of the distribution.
Economist Greg Mankiw adds:
Has the fall in top marginal tax rates over the past several decades in fact encouraged people to pursue higher-risk career paths, thereby exacerbating inequality in ex post incomes? As far as I know, this hypothesis has not received much attention in the empirical literature on income inequality.
(Source: Greg Mankiw's Blog)

1 comment:

Anonymous said...

First off I think it's pretty crazy that the marginal tax rate has been up as high as 90%. I have to agree that high marginal taxes would cause a decrease in risk taking in business. As for the fact that the decrease in marginal tax rates continues to create a more uneven distribution of income, I think that is true. When marginal taxes are at 90% people don't get alot of money for all the work they do, so they are less inclined to go after jobs that might have a higher payout. If less of your money is being payed to taxes there is a higher payoff for and people go after risky jobs.
- james c