Labor Supply and the strongEconomic Recoverystrong Tax Act of 1981.pdf

This PDF is a selection from an out-of-print volume from the National Bureau of Economic Research Volume Title: Empirical Foundations of Household Taxation Volume Author/Editor: Martin Feldstein and James Poterba, editors Volume Publisher: University of Chicago Press Volume ISBN: 0-226-24097-5 Volume URL: /books/feld96-1 Conference Date: January 20-21, 1996 Publication Date: January 1996 Chapter Title: Labor Supply and the Economic Recovery Tax Act of 1981 Chapter Author: Nada Eissa Chapter URL: /chapters/c6235 Chapter pages in book: (p. 5 - 38) 1 Labor Supply andtheEconomic Recovery TaxAct of 1981 Nada Eissa 1.1 Introduction U.S.personal incometax rates changeddramatically duringthe 1980s,espe- cially atthe top of the income distribution. In 1980,the top marginal tax rate (atthe federallevel) was70percent.TheEconomicRecoveryTaxAct of 1981 (ERTA) reduced that rate to 50 percent, and the Tax Reform Act of 1986 (TRA86) reduced it furtherto28percent. A dominantmotivationfor the initial law was to alleviate the disincentives for individuals to supply labor and to save that were generated by the high marginal tax rates. For labor supply, ERTA pursued this goal by introducing a deduction for the secondary earner in the household and, more generally, by reducing marginal tax rates by 23 percent within eachtax bracket. By providinglargeand potentially exogenous variation in marginal tax rates, these tax lawsprovide fertile ground for analyzingthe responsiveness of indi- vidual behavior to taxes. Evidence suggests that individual behavior did re- spond tothe incentives in these tax laws. Lindsey (1987) and Navratil (1994) use tax return data and find thatthe marginal tax rate reductions in ERTAhad a significanteffect ontaxable income. Feldstein (1993)and Auten and Carroll (1994)findsimilar results for TRA86.Burtless (1991)and Bosworth and Burt- less (1992) study the labor su