The Reality of Raising Taxes at the Top, Part 1: Would Tax Hikes Shrink Taxable Income?

April 25, 2012 at 4:25 pm

This blog series, based on a major new CBPP report, will look at the different ways in which raising taxes on high-income people might affect economic growth, starting with its impact on their taxable income.

Opponents often argue that raising taxes on high-income households would hurt economic growth.  But as our new report shows, recent research doesn’t support that claim.  In fact, tax increases of the sort policymakers are considering would likely benefit the economy over the long run if we use the savings to reduce deficits.

With that in mind, and after decades of sharp increases in income inequality and dramatic tax cuts for upper-income people, there’s an overwhelming case for raising taxes on high-income people as part of a balanced deficit-reduction package that shares the load with middle- and low-income Americans.

We discussed these findings with two noted tax experts — the Tax Policy Center’s co-director, William Gale, and Syracuse University’s Daniel Patrick Moynihan professor of public affairs, Leonard Burman — on a conference call for journalists this morning.  You can listen to their presentations here.

First, let’s look at the impact of higher taxes on taxable income.  Opponents often note that high-income taxpayers report less income to the IRS after their taxes go up.  That’s true – they do. But, as an important study by tax economists Joel Slemrod and Alan Auerbach found, the main reason isn’t that these people are working, saving, or investing less in response to the tax hikes. Instead, it’s mostly because they are adopting various tax avoidance strategies to minimize their taxable income, like arranging to receive their income in the form of capital gains or carried interest rather than ordinary income (which is taxed at higher rates).

To be sure, increased tax avoidance has some economic costs, since resources spent on avoiding taxes could otherwise be spent on more productive activities.  But those costs are likely nowhere near as large as if it were true that when tax rates go up, high-income people work, save, and invest much less.

Moreover, policymakers can limit tax avoidance — and make the tax code more economically efficient — by scaling back the code’s many deductions, credits, and other targeted tax breaks.

Our next installment will look at how raising taxes at the top might affect how much high-income people work.

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More About Chye-Ching Huang

Chye-Ching Huang

Chye-Ching Huang is a tax policy analyst with the Center’s Federal Fiscal Policy Team, where she focuses on the fiscal and economic effects of federal tax policy. You can follow her on Twitter @dashching.

Full bio | Blog Archive | Research archive at CBPP.org

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