DO TAXPAYERS REALLY RESPOND TO 

CHANGES IN TAX RATES? 

EVIDENCE FROM THE 1993 TAX ACT

by

Robert Carroll

U.S. Department of the Treasury

OTA Working Paper 79 November 1998

OTA Papers is an occasional series of reports on the research, models, and datasets developed to 

inform and improve Treasury's tax policy analysis. The papers are works in progress and subject to 

revision. Views and opinions expressed are those of the authors and do not necessarily represent 

official Treasury positions or policy. OTA Papers are distributed in order to document OTA analytic 

methods and data and invite discussion and suggestions for revision and improvement. Comments 

are welcome and should be directed to the authors. 

Office of Tax Analysis 

U.S. Treasury Department 

Washington, DC 20220 

I thank Jim Cilke for help in the development of the data and tax calculators, and Pete Sailer for 

help in the development of the occupation codes. I also thank David Cutler, Martin Feldstein, 

Austan Goolsbee, David Joulfaian, Doug Holtz-Eakin, Erik Larson, Bruce Meyer, Mark Rider, 

Karl Scholz, Joel Slemrod, Jerry Tempalski, and participants in the 1998 UNC Tax Conference, 

Harvard-MIT Public Finance Seminar, and 1997 NBER Summer Institute Seminar in Public 

Finance for many helpful comments on earlier versions of this paper. Views expressed do not 

necessarily represent the views or policies of the Department of the Treasury. Remaining errors 

are my own. 
ABSTRACT 

An emerging literature in public finance has found taxable income to be responsive to tax 

rates. The high elasticities reported by this literature suggest that both a large deadweight loss is 

associated with the current progressive income tax and the higher income tax rates enacted in 

1993 may not have produced additional revenues. This paper estimates the responsiveness of 

taxpayer incomes to the higher tax rates enacted in 1990 and 1993 and simulates the effect of the 

estimated behavioral response on revenues from the 1993 Act. In contrast to the previous 

literature, this paper uses a panel consisting of annual tax returns and a panel that spans a period 

when tax rates increased. This paper also uses a proxy of taxpayers’ permanent income to 

estimate the permanent taxable income response holding a variety of taxpayer characteristics 

constant. The findings indicate a taxable income elasticity with respect to taxpayers’ net-of-tax 

rate of about 0.4, below the elasticities reported by most earlier studies, but above zero. 

Simulations indicate that the higher individual income tax rates under the 1993 Tax Act may have 

reduced the static revenue gain by as much as 39 percent. The reduction in the static revenue 

gain, however, could have been as little as 13 percent depending on whether the behavioral 

response reduced aggregate income or reflected reshuffling of income from high-tax to low-tax 

activities. 

Robert Carroll

Office of Tax Analysis

Room 4014, Main Treasury Bldg

15th & Pennsylvania Avenue, NW

Washington, DC 20220

ROBERT.CARROLL@DO.TREAS.GOV
Do Taxpayers Really Respond to Changes in Tax Rates? 

Evidence from the 1993 Tax Act 

“A tax may either take out or keep out of the pockets of the people a great deal more than 

it brings into the public treasury ... [I]t may obstruct the industry of the people, and discourage 

them from applying to certain branches of business which might give maintenance and 

employment to great multitudes.” Adam Smith, The Wealth of Nations 

I. Introduction 

An emerging literature in public economics attempts to estimate the overall response of 

taxpayers’ incomes to tax rate changes. Whether and to what extent taxpayers alter their incomes 

in response to changes in tax rates figured heavily in the debate over whether to increase federal 

income tax rates in 1993. Some argued that the higher tax rates would not produce the revenues 

forecast by government economists and would result in a significant deadweight loss because 

taxpayers would respond by reducing their taxable incomes (Feenberg and Feldstein, 1993). 

Reports of the recent surge in federal individual income tax receipts, however, has cast in doubt 

the possibility of a substantial behavioral response following the 1993 Act. 

Most of the research on the taxable income response has used the tax rate reductions of 

the 1980s as so-called “natural experiments” where the differential effects of exogenous policy 

changes are used to estimate the tax-induced behavioral response. These studies focus on a 

taxpayer’s taxable income because changes in taxable income will reflect a broad range of possible 

behavioral responses including changes in labor supply and participation, savings and portfolio 

allocation, the form of compensation, the timing of income and deductions, and tax evasion and 

avoidance. Also, taxable income is most closely related to tax liability and revenue and, according 

to Feldstein (1995), the dead-weight loss of tax changes. This research has generally found 

evidence of a substantial behavioral response reporting elasticities of taxable income with respect 
2 

to the net-of-tax rate sometime exceeding one (Lindsey, 1987; Feldstein, 1995a; Navratil, 1994; 

Auten and Carroll, 1997). 

These findings, however, have been cast in doubt by the claim that the substantial rise in 

taxpayer incomes during the 1980s, although coincident with the tax rate reductions, may simply 

have been the result of longer term trends affecting the overall distribution of income, but 

unrelated to the tax changes (Goolsbee, 1997; Auerbach and Slemrod, 1997; Gravelle, 1993). 

The large elasticities reported by these studies may, therefore, have been the result of the spurious 

correlation between the income changes and the longer term trends having little or nothing to do 

with changes in tax rates. Two recent papers by Goolsbee (1997) and Sammartino and Weiner 

(1997), which avoid this criticism by focusing on a period where tax rates increased, suggest that 

most of the behavioral response associated with the 1993 Act can be attributed to changes in the 

timing of income and deductions rather than a permanent response. 

In this paper, I present evidence that the taxable income response associated with the 1993 

Tax Act is substantially larger than previous studies of the 1993 Act indicate, but below the 

estimates reported by the earlier research of the tax rate reductions of the 1980s. Similar to 

earlier research, this paper compares the income changes of higher income taxpayers to the 

income changes of moderate income taxpayers in the presence of the change in the relative 

taxation of these two groups. But, unlike earlier research, this paper uses a proxy of taxpayers’ 

permanent tax rates and the exogenous policy shift in the tax rate schedule to estimate their 

permanent response. Distinguishing between the permanent and transitory response is important, 

because, as shown elsewhere, there can be significant differences between permanent and 

transitory responses. Finally, this paper uses a new panel of annual tax returns spanning both the 
3 

tax rate increases in 1990 and 1993. Unlike most previous studies, this panel contains many high 

income returns, and, by focusing on annual income changes, includes both periods with and 

without changes in tax rates. 

Focusing on the 1990 and 1993 Acts also offers other advantages for estimating the 

responsiveness of taxpayers to tax rates changes relative to the studies of the tax reforms of the 

1980s. First, the 1990 and 1993 Acts increased tax rates primarily on high income taxpayers, but 

not taxpayers with low and moderate incomes. Because the change in after-tax incomes of many 

taxpayers facing the higher rates were small even though their marginal tax rates were 

significantly increased, income effects are likely to be less important in influencing behavior 

relative to earlier reforms. Second, the 1986 Tax Reform Act not only decreased marginal tax 

rates for most taxpayers, but also increased capital gains tax rates, raised taxes on corporations 

relative to other business organizational forms, and involved significant changes in the tax base. 

In contrast, the 1993 Act involved no change in the statutory rate on capital gains realizations, 

and changes in the tax base and in the relative advantage of pass-through status were considerably 

less significant compared to earlier tax reforms. Finally, as pointed out by Slemrod (1994), the 

tax planning opportunities and technologies used by taxpayers to evade or avoid taxes may vary 

significantly over time and responses may also depend on the direction of the tax change. 

The findings reported below indicate a tax-induced behavioral response that is positive and 

significant, but considerably smaller than reported elsewhere. The estimate of the gross income 

elasticity with respect to the tax price (or net-of-tax rate) is about 0.3, while the taxable income 

elasticity is closer to 0.4. These estimates are generally robust to alternate specifications. Also, 

based on simulations of the higher individual income tax rates enacted as part of the 1993 Tax 
4 

Act, the tax-induced behavioral response may have reduced the static revenue gain by as much as 

39 percent or as little as 13 percent. The exact magnitude of the “revenue offset” depends on the 

extent to which the reduction in taxable income by taxpayers facing the higher tax rates was 

shifted to lower taxed activities or taxpayers, or resulted in a reduction in aggregate taxable 

income. 

Section II of the paper describes the major features of the 1990 and 1993 Acts. Section 

III describes trends in reported income from the panel developed for this paper. Section IV 

presents the empirical model and data used to estimate the permanent response of taxpayers’ 

incomes to changes in taxpayers’ net-of-tax rate. The results are presented in Section V, and 

Section VI concludes the paper. 

II. The 1990 and 1993 Tax Acts 

Both the 1990 and the 1993 Acts increased individual income tax rates. The 1990 Act 

increased income tax rates for higher income taxpayers by: (1) increasing the top tax rate from 28 

percent to 31 percent, (2) phasing-out personal exemptions (PEP), and (3) limiting itemized 

deductions (Pease). The Act also increased the AMT rate from 21 percent to 24 percent and 

increased the cap on wages subject to the 1.45 percent tax (2.9 percent including both the 

employee and employer share) for Hospital Insurance (Part A of Medicare) from $53,400 to 

$125,000 for 1991. 

The 1993 Act increased income taxes on higher income taxpayers by adding a new 36 

percent rate bracket for joint filers with incomes exceeding $140,000 (indexed) and single filers 

with incomes exceeding $115,000 (indexed) and a 10 percent surtax for high income taxpayers 
5

with incomes exceeding $250,000 (indexed) in 1993. The surtax had the effect of adding a new 

39.6 percent top statutory rate. The 1993 Act also permanently extended the phase-out of the 

personal exemption and the limitation on itemized deductions, increased the single 24 percent 

AMT rate to a two tiered AMT with a maximum rate of 28 percent, and, effective in 1994, 

repealed the cap on wages subject to the 1.45 percent tax (2.9 percent including both the 

employee and employer share) for Hospital Insurance (Part A of Medicare).1 

Estimated tax price elasticities from the 1990s are important because the tax rate increases 

in 1990 and 1993 move in the opposite direction of the rate reductions of the 1980s. The 

literature on income dynamics has considered the influence of long-term trends affecting the shape 

of the income distribution over several decades. This literature has, for example, considered the 

role played by numerous nontax factors including increased international trade, technological 

change, changing returns to human capital, and the declining strength of unions.2 Determining 

whether high income taxpayers responded to the 1990 and 1993 tax rate increases by lowering 

their incomes will also help determine whether the substantial elasticities estimated from the tax 

reductions of the 1980s result from a spurious correlation between the tax reductions and the 

longer term trends affecting the shape of the income distribution, but having nothing to do with 

the tax rate reductions. 

Recent data indicate that the widening gap between the share of income reported by high 

1

The 1993 Act also made moving expenses deductible above the line instead of as an itemized 

deduction, increased the fraction of Social Security benefits includable in income from 50 percent to 85 

percent for higher income taxpayers, and expanded the EITC for low income workers. The top statutory 

corporate tax rate was increased from 34 percent to 35 percent and the deduction for wages paid to highly 

compensated employees was restricted to $1 million. 

2

See, for example, the series of articles by Gottschalk (1997), Johnson (1997), Topel (1997), and 

Fortin and Lemieux (1997). 
6

and low income taxpayers has continued. The change in the shape of the income distribution has 

been at least one source of the rise in government receipts and falling deficits during the past 

several years. These trends, depicted in Table 1, might seem at odds with the notion that 

taxpayers reduced their incomes in response to rate increases of the 1990s. Indeed, Table 1 

shows that the income share reported by taxpayers with incomes over $200,000 rose between 

1989 and 1995 from 13.0 percent to 14.0 percent.3 

Table 1 also shows, however, that the average real incomes of taxpayers in the top income 

class fell during this period. The decline in average incomes between 1989 and 1995 suggests that 

movement of taxpayers from lower to higher income classes, rather than the rise in the incomes of 

taxpayers already classified as high income may explain the rising income shares of the high 

income. Although not shown in Table 1, the number of taxpayers with incomes over $200,000 

rose by 15 percent, from 0.812 million in 1989 to 0.933 million in 1995. Although these data 

point to income mobility as a possible explanation for the changes in the overall shape of the 

income distribution between 1989 and 1995, they are only suggestive because the same taxpayers 

are not followed over time. 

3

These tabulations are based on an inflation-adjusted, constant law income concept to abstract 

from changes in the tax base and inflation. Constant law income is calculated by adding to and subtracting 

from a taxpayer’s total income the income items included or excluded in selected years because of statutory 

changes in the definition of a taxpayer’s total income. Adjustments are made by adding: (1) tax-exempt 

interest income, (2) untaxed pension benefits, (3) disallowed passive losses, (4) foreign income exclusion, 

and (5) depreciation in excess of straight-line depreciation, and subtracting: (1) Social Security benefits, 

(2) moving expenses, (3) unreimbursed employee business expenses, and (4) alimony paid. This income 

concept is similar to the concept used by the Statistics of Income Division for tabulations published in 

Individual Income Tax Returns, Publication 1034. 
7

III. Trends from a Panel of Tax Returns 

The panel developed for this paper is constructed from tax returns common to the Statistic 

of Income (SOI) Individual Income Tax files from 1989 through 1995.4 The age, industry, and 

occupation of taxpayers are also included in these data.5 This paper uses annual data from 1989 

through 1995 to include periods both with and without tax changes, an important source of 

independent variation not incorporated into earlier studies of the tax rate reductions of the 1980s, 

which tend to compare data from a year before the tax change to a year after the tax change. The 

use of annual data is also important because income may be temporarily high or low in any single 

year and there is evidence of substantial year-to-year shifting of income and deductions in years 

immediately preceding and following the tax changes (see, for example, Parcell (1996), Platt 

(1997), and Goolsbee (1997)).6 

This panel includes a large number of high income tax returns because the stratified 

sampling procedure used for SOI Individual Tax Files over samples tax returns with high incomes. 

4

The SOI Individual Income Tax Files are annual stratified random samples of over 100,000 

individual tax returns filed in each year. See IRS (1989) for a description of the 1989 sample procedure. 

Taxpayers who do not file on a calendar year basis (i.e., fiscal year filers), or whose tax return is for a year 

other than 1989 or 1995 are excluded from the panel. Taxpayers with two or more tax returns for a filing 

year, perhaps because of transcription errors of Social Security numbers during editing, are also excluded. 

5

The tax return data are supplemented with the age of the taxpayer using a match file provided by 

the Social Security Administration. The occupation classifications are based on the taxpayer-provided 

occupation description on the signature line of Form 1040 and the industry of a taxpayer's employer from 

W-2 Forms. 

6

Some income shifting from 1991 into 1990 occurred because of the higher income tax rates 

taking effect in 1991 and the increase in the wage cap for Health Insurance (Medicare) taxes to $125,000. 

Most of the transitory shifting of income around the 1993 Act involved the shifting of wages and bonus 

income from 1993 into 1992 as a result of the higher individual income tax rates taking effect in 1993, and 

additional shifting of wages and bonus income from 1994 into 1993 to avoid the repeal of the wage cap for 

Health Insurance (Medicare) taxes in 1994. Data for 1995 are probably the first year of data not 

influenced by income shifting. 
8

The selection of tax returns for the panel, however, depends on whether a tax return is sampled 

for each of the annual SOI Individual Tax files from 1989 through 1995. The sampling procedure 

used for the annual SOI files has the effect of including in the panel all taxpayers who remain in 

the same sample strata or move to a sample strata with a higher sampling rate. Taxpayers who 

move to a sample strata with a lower sampling rate have a lower probability of remaining in a 

subsequent SOI Individual Tax File and being included in the panel and are, therefore, 

underrepresented. This paper relies on a weighting procedure suggested by Hausman and Wise 

(1981) and Hinkins et al (1988) that corrects for the endogenous sample selection by weighting all 

observations by the inverse of the effective selection probability (i.e., the maximal weight over the 

years included in the panel). Weighting the data by the maximal weight compensates for the 

underrepresentation of taxpayers with income declines.7 

7

The panel is constructed from the overlap or intersection of the 1989 through 1995 SOI Individual 

Tax Files. For illustrative purposes, however, the weights can be derived for a two year panel without 

loss of generality for longer overlap panels. In the case of, for example, an overlap panel drawn from the 

1989 and 1990 SOI files, the probably that a taxpayer would be drawn into the panel is given by the law of 

conditional probabilities as, 

P 89 _ 90 / Pi 

89 @ Pi 90*Pi 89 

The probability that a taxpayer is sampled in 1989, Pi 

89 , depends on 1989 income and tax schedules. 

The probability that a taxpayer is also sampled in 1990, Pi 

90 * Pi 89 , depends on both 1989 and 1990 

income and tax schedules. This sampling probability is one if the taxpayer’s income rose or remained the 

same between 1989 and 1990, assuming all other stratification criteria were unchanged. If the taxpayer’s 

income, however, declined, this sampling probability will be less than one, assuming all other stratification 

criteria are unchanged. Thus, whether a taxpayer is sampled in 1990 is conditional on being sampled in 

1989 and depends on both their 1989 and 1990 characteristics (i.e., income and tax schedules). The 

appropriate weight is the inverse of the probability that a taxpayer is sampled in both years (i.e., the inverse 

of the product of these two probabilities shown in the above equation), which can be calculated as the 

maximum of the 1989 and 1990 Individual Tax File sampling weights. An appendix providing a detailed 

description of the sampling design of the SOI Individual Tax Files and the construction of the weights used 

in this paper is available upon request. 
9

Table 2 presents tabulations from the panel where taxpayers are classified based on their: 

(1) 1989 income, (2) 1995 income (in 1989$), and (3) average income from 1989 through 1995 

(in 1989$). These tabulations are restricted to particular taxpayers because of data limitations and 

to abstract from taxpayer characteristics that are not likely to be related to tax-induced behavioral 

responses, but that affect a taxpayer’s reported income.8 For example, the analysis is restricted 

to joint filers with the same marital status in all years to avoid fluctuations in income related to 

marriage, or family dissolution due to divorce or death of spouse.9 To abstract from the effect of 

the two Acts on retirement decisions, taxpayers who are over age 55 in 1989 (and 61 in 1995) are 

excluded. Taxpayers under age 25 in 1989 are excluded because income changes for many of 

these taxpayers reflect the completion of schooling and entry into the work force.10 

Taxpayers who are on the alternative minimum tax (AMT) in any year are also excluded. 

Although these taxpayers had relatively low marginal tax rates (e.g., in 1989 the AMT rate was 

21 percent), the 1990 and 1993 Acts substantially increased the AMT rate, first to 24 percent in 

1991 and then to a maximum 28 percent in 1993. The 1993 Act also increased the AMT 

exemption amounts somewhat. Taxpayers with AMT liability tend to have average tax rates that 

8

In most cases, the sample restrictions are based on 1989 characteristics because the post-tax 

change characteristics can be affected by how a taxpayer responded to the tax changes and, therefore, can 

be endogenous in a way pre-tax change value are not. For example, whether a taxpayer is subject to the 

AMT in 1995 will, in part, depend on how the taxpayer responded to the 1990 and 1993 Acts. 

Nevertheless, in robustness tests presented below these sample restrictions are relaxed or are applied 

symmetrically based on characteristics in each year. 

9

Tax returns with a change in their secondary Social Security number are also excluded because 

the household is no longer composed of the same individuals, which may indicate the taxpayer divorced and 

remarried between 1989 and 1995. 

10Taxpayers who are identified as deceased, retired, or as students based on information from each 

taxpayer's self-described 1993 occupation are also excluded. The construction of the occupation codes is 

discussed in greater detail below. 
10

are high relative to other taxpayers. Deleting AMT taxpayers avoids the difficulty of 

distinguishing between differences in the effect of marginal tax rate changes and average tax rate 

changes.11 

The first panel in Table 2 shows that the share of income reported by high income 

taxpayers in 1989 declined over the period. The share of income reported by taxpayers reporting 

more than $200,000 fell from 14.5 percent to 12.7 percent between 1989 and 1995. The drop in 

the income share for this group between 1989 and 1990 is likely the result of the 1990-91 

recession. The continued drop off between 1990 and 1991 could also be the result of the 

recession or income shifting from 1991 into 1990 as a result of the rise in the top statutory rate 

from 28 percent to 31 percent under the 1990 Act. The decline in the income share between 1992 

and 1993 is consistent with income shifting due to the higher individual tax rates enacted in the 

1993 Act. The continued drop off between 1993 and 1994 is consistent with income shifting 

because of the repeal of the wage cap on Medicare (Part A) taxes enacted in the 1993 Act, but 

not going into effect until 1994. The large jump in the income share between 1994 and 1995 is 

likely the result of income being shifted from 1994 into 1993. The 1995 data are probably the 

first year of data following the 1993 Act that exclude the effects of income shifting. 

Changes in the income share reported by lower and moderate income taxpayers in the 

panel show small increases. The trends in Table 2 suggest the possibility of a significant 

behavioral response since the 1990 and 1993 Acts almost exclusively lowered the net-of-tax rates 

11In addition, the 1990 and 1993 Acts directly increased the tax rate on capital gains realizations 

for some taxpayers subject to the AMT. That is, the tax rate on capital gains realizations for taxpayers 

subject to the AMT was first increased from 21 percent to 24 percent by the 1990 Act and then to either 26 

percent or 28 percent by the 1993 Act depending on a taxpayer’s tentative alternative minimum taxable 

income. 
11 

on higher income taxpayers and this group had large declines in their real incomes both in 

absolute terms and relative to low and moderate income taxpayers. 

The trend from the panel data does, at first glance, seem at odds with the rising income 

share of the high income in the cross-sectional data presented in Table 1. The tabulations from 

the cross-sectional data and panel data, however, could tell a story consistent with both a 

significant tax-induced behavioral response by high income taxpayers and the recent surge in 

individual income tax receipts, if the income gains of low and moderate income taxpayers more 

than offset the income reductions of the highest income taxpayers. 

The trends in the first panel of Table 2, however, could also be the result of reversion to 

the mean where, rather than a long-run response to the tax change, high income taxpayers are 

merely reverting back to more typical levels of income. That is, incomes in the several years prior 

to the tax rate increases could simply include significant transitory income. 

In contrast to the first panel in Table 2, the second panel classifies taxpayers according to 

their income in 1995 (deflated back to 1989 levels). The share of income reported by taxpayers 

with incomes over $200,000 reported a substantially greater share of income in 1995 (18.9 

percent) than in 1989 (13.4 percent). Although this may not be surprising since classifying 

taxpayers based on their 1995 income includes taxpayers who “moved up” to the higher income 

classes, these differences point to the interpretive difficulty of drawing conclusions from 

tabulations that classify taxpayers based on either initial or ending incomes, which may include 

temporary shocks or transitory components of income that can distort longer term trends. 

The third panel of Table 2 presents tabulations that classify taxpayers based on their 

average income over the entire period. These tabulations should mitigate the effects of transitory 
12

changes and mean reversion in income. Some research has indicated that the transitory 

component in earnings dies off in roughly three years (Gottschalk, 1997). Also, inter-year shifting 

of income would have no impact on groupings based on average income because these effects net 

out. When the groupings are based on a taxpayer’s average income the income share of the top 

class rises somewhat from 13.7 percent in 1989 to 15.8 percent in 1995. 

The results from the panel data presented in Table 2 strongly suggest that groupings based 

on 1989 annual income likely suffer from reversion to the mean where taxpayers with temporarily 

high incomes in 1989 moved to more “normal” levels of income in 1995. Groupings based on 

1989 income alone would overstate the income decline of the high income class. Since taxpayers 

in this income class are likely to have faced the higher rates under the 1990 and 1993 Acts, the 

estimated tax price elasticity would likely be biased upwards. Similarly, reversion to the mean 

would have the opposite effect if groupings were instead based on 1995 incomes. That is, income 

gains would be overstated and the elasticity biased downwards. The use of taxpayers’ average 

income presents itself as a more plausible approach and serves as the basis for estimating the tax 

price elasticity in the empirical model presented below. 

IV. Empirical Model 

The empirical model can be viewed as a reduced form where income is assumed to be 

influenced by four factors, 

yit ' "o % "1(1&Jit) % $ Xi % 4i % (t % git (1) 

where yit is the ith taxpayer’s reported income at time t, "o is a constant term, (1-Jit) is a 
13

taxpayer’s tax price or net-of-tax rate, Xi is a matrix of individual characteristics that do not 

change over time, but whose relationship to income may have changed, 4i represents an individual 

effect (i.e., individual characteristics that do not change over time), and (t represents a time effect 

(i.e., factors that change over time, but do not vary across individuals). The tax rate is determined 

by, 

Jit ' f Zit , yit (2) 

where the tax function, f , is a nonlinear function of income and taxpayer characteristics, Zi , 

including filing status, deductions, exemptions, and credits. 

The individual effect is eliminated from the model through first differencing. Even after 

first-differencing, however, taxpayer characteristics that do not change over time, but whose 

relationship to income may have changed, remain in the model. A taxpayer’s age, for example, 

can serve as a proxy for life cycle effects. Differences in regional and industry growth, or returns 

to human capital may also influence a taxpayer’s potential for income growth, although the 

taxpayer did not move, and continued to work in the same industry or occupation. 

Differences in the asset holdings of individuals may also explain differences in income 

growth, even if portfolios are unchanged. Taxpayers who receive a large fraction of their income 

from financial assets may have a different pattern of income growth than taxpayers who receive, 

for example, only wage income. Similarly, taxpayers who hold primarily business assets may have 

different potential for income growth than taxpayers who hold primarily financial assets, 

depending on differences in the rates of return to these assets. The matrix of taxpayer 

characteristics given by Xi

 is intended to control for as many of these nontax factors as the tax 
14

return data allow. Separate year dummies are included to estimate the time effect.

Measuring the Permanent Response. Obtaining a consistent estimate of the tax-induced

behavioral response is the primary concern of this paper. As shown in equation (2), however, a

taxpayer's actual tax price is endogenous to the amount of income and deductions reported. As

taxable income falls, a taxpayer's tax rate may also fall despite the rate increases under the 1990

and 1993 Acts. The endogeneity of the tax price can be addressed by constructing a synthetic tax

price that is conditional on income at a particular point in time. Such a synthetic tax price will be

correlated with the endogenous variable (i.e., a taxpayer’s actual tax price), but uncorrelated with

the error term because it only includes variation in the tax price due to the statutory changes in the

tax code.

In addition to endogeneity, however, a taxpayer’s actual tax rate will be composed of both 

a permanent tax component, Jp, and a transitory tax component, μt , given by, 

Jt ' J

p % μt (3) 

Since this paper is interested primarily in taxpayers’ permanent response to tax rate changes, an 

instrumental variables approach similar to Burman and Randolph (1994) and Randolph (1995) is 

used.12 An appropriate instrument is one that is correlated with Jt , but not μt

. A taxpayer’s tax 

rate calculated based on his permanent income only includes variation due to exogenous shifts in 

the tax rate schedule (and other statutory changes) and removes the influence of the transitory 

component of income on Jt . 

12It is unlikely that the estimated tax price elasticity is fully long-run because the effects of the tax 

rate changes on capital formation and other slowly changing factors are not likely to be fully realized even 

by 1995. 
15

Permanent income is proxied by a taxpayer’s seven year average income (i.e., 1989 

through 1995). Next, this proxy for permanent income is used to calculate a taxpayer’s tax rate in 

each year based on his average characteristics. This synthetic tax rate is used to construct the 

difference in the natural logarithm of a taxpayer’s tax price, which is then used as an instrument to 

estimate fitted values of Jt, which are used in place of a taxpayer’s actual tax price in the first 

differenced version of equation 1. 

The synthetic tax price used in this procedure has two important attributes. First, because 

it is based on a taxpayer’s permanent income, it is based on a single value of a taxpayer’s income. 

Therefore, year-to-year fluctuations in income will not influence this “synthetic” tax price and it 

will only capture exogenous changes in tax rates due to shifts in the rate schedule and other 

statutory tax changes. This attribute is similar to the use of initial income to group taxpayers in 

the difference of difference calculations of Feldstein (1995), and the instruments developed by 

Auten and Carroll (1997) and Moffitt and Wilhelm (1997), which rely on taxpayer characteristics 

at a single point in time, albeit in the initial period.13 

Second, the tax price is based on a taxpayer’s permanent income, rather than annual 

income. As suggested by Table 2, reversion to the mean is prevalent in the data used by this 

paper.14 The use of a single year of income on which to calculate the synthetic tax price would 

13Other papers have also calculated synthetic tax rates to capture exogenous changes in tax rates 

and identify tax-induced behavioral responses. For example, see Eissa (1995), and Carroll et al (1996). 

14Moffitt and Wilhelm (1997) discuss a somewhat different approach for controlling for reversion 

to the mean that conditions the change in income on income in the initial period. Moffitt and Wilhelm point 

out, however, that this alternate approach creates some difficulty because, depending on the specification, 

income in the initial period could enter the model twice, first through the synthetic tax rate and second 

through conditioning the income change on initial income. In addition, it is not clear how this approach 

controls for reversion to the mean associated with the level of ending income. 
16

likely result in substantial bias in the estimated tax price elasticity. Observed changes in income 

may reflect changes in the transitory component of income that either have little to do with the tax 

changes or reflect year-to-year shifting of income and deductions that, although attributable to the 

tax change, are transitory in nature. A synthetic tax price based on a taxpayer’s permanent 

income removes individual transitory effects because it is uncorrelated with transitory variations in 

individuals income, thereby allowing consistent estimation of the permanent response.15 Similar to 

Burman and Randolph (1994), aggregate transitory effects are removed by including time 

dummies. 

The Data. The panel data described above and used for the tabulations shown in Table 3 are used 

to estimate equation 1. Tax returns with incomes below $50,000 (1989$), however, are excluded 

from the panel used for estimation. This sample exclusion defines the set of taxpayers who are 

included in the control group (i.e., those taxpayers with no tax change) from which the tax price 

elasticity is identified. The judgment is that taxpayers with incomes below $50,000 are not a 

suitable control group for taxpayers facing the higher tax rates under the 1993 Act.16 With 4,233 

tax returns in the panel spanning seven years, 25,398 observations are used for estimation after 

first differencing. All results are weighted using the weighting procedure described above. The 

mean and standard deviation of the dependent and independent variables are presented in Table 3. 

The dependent variable is gross income, defined as a taxpayer’s total income (in 1995, 

15While is would also be desirable to separately estimate the transitory response, another 

instrument that is correlated with a taxpayer’s actual tax rate, but uncorrelated with their permanent tax 

rate would be needed. 

16Other problems with including low income taxpayers are that many low income taxpayers drop 

out of the sample over time and the tax rates faced by these taxpayers were substantially changed because 

of changes to the earned income tax credit (EITC) in 1993. Excluding low income taxpayers also helps 

abstract from the behavioral effects of the EITC and temporary shocks to income due to unemployment. 
17

Form 1040, line 22).17 Although this income concept includes capital gains realizations, the 

results presented below are not sensitive to the exclusion of capital gains from income. The 

change in the natural logarithm of annual income is calculated after deflating income in each year 

to 1989 levels using the consumer price index (CPI). A taxpayer’s taxable income, after adjusting 

for statutory changes in the tax base, is used as the dependent variable in an alternative 

specification also presented below. 

The net-of-tax rate is defined as one minus a taxpayer’s Federal marginal tax rate and is 

analogous to a taxpayer’s “tax price.”18 The marginal tax rates incorporate both the features of 

the individual income tax and the effect of increases in the cap on wages subject to the tax for 

Health Insurance (Part A of Medicare) included in both the 1990 and 1993 Acts. Tax rates are 

calculated using detailed tax calculators designed to capture the major features of the individual 

income tax and changes to the wage cap for health insurance tax (Medicare Part A) occurring in 

both 1990 and 1993. Descriptive statistics for a taxpayers’ actual tax price in 1989 and 1995 are 

shown in Table 3. 

The ability to control for differences between taxpayers is important because a key 

assumption in studies that use shifts in the tax schedule to identify behavioral responses is that 

groups facing different changes in their relative taxation are suitable control groups. Failure to 

control for taxpayer characteristics that may explain differences in their income growth may result 

17Unlike earlier tax reforms, the 1990 and 1993 Acts made relatively few changes to the tax base. 

Although the 1993 Act increased the fraction of Social Security benefits subject to tax for high income 

taxpayers, this change in the tax base has no effect on the results reported below because elderly taxpayers 

are excluded from the panel. 

18The tax calculators were adapted for use with panel data from the U.S. Treasury Department’s 

Individual Tax Simulation Model. 
18

in spurious correlation between these omitted influences and tax rate changes, and bias the 

estimated tax price elasticity.19 This assumption is perhaps more extreme in the case of the 1993 

Act because, unlike the tax rate reductions of the 1980s, the 1993 Act only increased the tax rates 

of the highest income taxpayers. 

Taxpayer wealth is likely to influence a taxpayer’s ability to alter portfolios and labor 

arrangements in response to tax changes. Tax return data, however, provide no direct measure of 

a taxpayer’s wealth. Taxpayers may also exhibit income changes that are completely unrelated to 

tax induced behavioral responses if they happen to hold assets that provide above average returns. 

For example, taxpayers could experience low income growth simply because they happen to hold 

short-term interest-bearing assets when interest rates fall or corporate equity when corporate 

earnings fall. Or, to the extent financial assets produce greater returns than labor, taxpayers with 

greater holdings of financial assets would tend to exhibit higher income growth. The sum of a 

taxpayer’s dividend and interest income is used as a proxy for individual holdings of financial 

assets to control for a taxpayer’s potential for income growth arising from these holdings.20 

A dummy variable is included to indicate whether a taxpayer reports income from a sole 

proprietorship, partnership, or subchapter S corporation. This variable may reflect ownership of 

business assets, entrepreneurship skills, education and the propensity for risk-taking. Also, the 

income growth of taxpayers with holdings of business assets are likely to reflect the extent to 

19Relatively high (low) income growth may, for example, result simply because a taxpayer holds a 

large (small) amount of assets with high returns. In the case of taxable interest income, movements in 

interest rates would tend to have a greater impact on the income growth of taxpayers who hold a 

disproportionate share of short-term interest yielding assets prior to the tax change, than taxpayers who do 

not, holding portfolio allocations constant. 

20Both capital gains and tax-exempt interest are excluded from this variable. The tax return data 

only contain a taxpayer’s capital gains when realized, not accrued. 
19

which returns to business investments generally were above or below average income growth. 

Age and age squared are included to control for life cycle effects. The number of children 

(up to a maximum of 6) and a dummy variable indicating whether a taxpayer has any children 

away from home but still claimed as dependents are also included. Dependent children away from 

home are typically in college and may limit the ability of a taxpayer to respond to changes in tax 

rates because income is already being used to cover college expenses. Regional dummies are also 

included to capture the different opportunities for income growth that existed in different regions 

during this period. 

This paper considers whether differences in earnings growth by industry may explain 

income growth. Categorical variables developed from the principal activity code on taxpayers’ 

Schedule C’s (sole proprietorship) forms, taxpayers’ W-2 information returns, and data from the 

IRS’s Business Master File are included to control for different earnings potential based on the 

principal business activity of employers.21 As shown in Table 4, income growth varied widely 

during this period according to the employer’s principal industry. 

Including occupational dummy variables for the categories listed on Table 5 allows 

consideration of whether occupations with higher educational content or requirements also 

experience higher income growth, all else equal. As shown in Table 5, income growth of 

taxpayers varied considerably across occupation categories.22 Returns to human capital may have 

21These data were developed by the Statistics of Income Division of the IRS from a number of 

different sources including the principal business activity code reported by sole proprietors on their 

Schedule C forms and firms’ industry information obtained by matching employees W-2 information 

returns to their respective employers business tax return from the IRS’s Business Master File. 

22Taxpayer reported occupation descriptions were classified using the Standard Occupation 

Classification (SOC) system (see Clark, Reilly, and Sailer, 1989). The returns in the panel were classified 

by the Statistics of Income Division of the IRS using information from both a taxpayer's occupation 
20

changed differently for individuals in certain occupations because of differences in relative labor 

productivity or differences in demand, perhaps due to technological changes or increasing 

international competitiveness. After excluding lower income taxpayers from the sample, CEOs 

and other senior executives, doctors and other health-related occupations, and managers and 

junior executives, experienced the highest income growth. Taxpayers with unclassifiable 

occupation codes and blue collar workers had the smallest increase in real incomes. 

Income growth, however, could also vary across occupations because some occupations 

may offer greater flexibility to alter work effort or portfolios than others. For example, doctors, 

lawyers, and the self-employed have considerable flexibility to alter their work schedules and 

compensation arrangements in response to the tax rate changes. If the occupation variables 

control for this tax-related effect, inclusion of these variables could bias the estimated elasticity 

for the tax variable downwards (Feldstein, 1996).23 

V. Estimation Results 

Estimates for the determinants of income growth are reported in Table 6. Two income 

measures are used for the dependent variable: (1) gross income, and (2) adjusted taxable income. 

All equations are estimated using weighted least squares. The synthetic tax price based on a 

taxpayer’s permanent income is used as an instrument in all the specifications presented. The 

description in 1993 and the industry classification of a taxpayer's employer obtained from W-2 Forms. 

SOC classifications were aggregated into occupational groups reflecting education and skill levels, and, in 

some cases, type of employer (government) and industry (doctors and other health related services). 

23These variables also may control for transitory changes in income to the extent that, for example, 

the self-employed tend to have very volatile income and executives may tend to have very high income for 

relatively short periods. 
21

“taxes only” specification (i.e., columns 1 and 3) is presented to illustrate the effect of including 

nontax factors (i.e., columns 2 and 4) on the estimated tax price elasticity. 

The “taxes only” specification in columns (1) and (3), which only includes a constant term, 

the difference in the natural logarithm of the tax price (i.e., 1-J), and the year dummies, is similar 

to earlier research that excludes non-tax factors from the model (for example, see Feldstein 

1995a, Navratil 1994, and Lindsey 1987). The estimated tax price elasticity for this specification 

is 0.26 (s.e.=0.09) for the gross income equation and 0.31 (s.e.=0.11) for the taxable income 

equation. Both of these estimates are well below results reported elsewhere.24 The coefficient for 

the 1990-91 year dummies are negative, perhaps reflecting the downturn in the business cycle. 

The 1992-93 year dummies are also negative, perhaps reflecting income shifting from 1993 into 

1992. 

In the fully specified model reported in columns (2) and (4), the coefficient for the proxy 

for financial wealth is positive, implying that income grew more slowly for those with greater 

holdings of interest and dividend yielding assets, all else equal, but statistically insignificant. The 

signs of the coefficients for age and age squared are jointly significant and imply that income 

growth declines with age. The coefficient for the entrepreneurship dummy is positive in both 

specifications, but not statistically different from zero. 

The coefficients for the number of children and the dummy variable for college age 

children are positively related to income growth in both specifications, but not statistically 

different from zero. The positive sign on the dummy variable for college age children is 

24In an earlier version of this paper, a two year panel including only tax returns for 1989 and 1995 

was used. The tax price elasticities estimated using a specification comparable to the difference of 

differences calculations reported by Feldstein (1995) and the model used by Auten and Carroll (1998) were 

somewhat higher than the elasticities reported by these earlier studies. 
22 

inconsistent with the view that taxpayers with college age children are liquidity constrained. The 

regional and industry dummy variables are jointly significant indicating that a taxpayer's income 

growth is influenced by regional economic performance and industry. 

Some of the coefficients for the occupation dummies are statistically different than zero 

and suggest that changes in returns to human capital were an important factor explaining income 

growth. Taxpayers in occupations with high educational content, particularly CEOs and other 

executives, and managers and junior executives, experienced the greatest income growth during 

this period (all else constant), in contrast to taxpayers in occupations with relatively less 

educational content (all else constant). The effects of occupation, however, must be interpreted 

with care. In addition to a taxpayer's human capital, occupation may also reflect taxpayers' 

flexibility for rearranging affairs in response to changes in tax rates. 

The estimated tax price elasticity is 0.32 with a standard error of 0.10 for the gross income 

equation including the nontax factors. The estimated tax price elasticity rises to 0.38 (s.e=0.12) 

for the taxable income equation. The tax price elasticity for the taxable income equation is 

expected to be higher than in the gross income equation because changes in a taxpayer’s taxable 

income include behavioral responses associated with a taxpayer’s deductions or adjustments to 

income, while gross income would not. 

The inclusion of the nontax factors increases the estimated tax price elasticity somewhat. 

Even though occupation is an important factor explaining income growth, including occupation in 

the model does not appear to affect the estimated tax price elasticity. In an alternative 

specification that excludes the occupational variables, the tax price elasticities comparable to 

those reported in columns (3) and (4) are 0.31 (s.e.=0.09) and 0.35 (s.e.=0.11). 
23

Alternative Specifications. A number of assumptions were made above concerning the choice of 

the sample and model specification. Estimates using alternative sample exclusions and 

specifications are presented below and summarized in Table 7 to access the robustness of the 

results. 

The sample excludes taxpayers with incomes below $50,000. This sample restriction 

defines the control group used to identify the tax price elasticity as primarily taxpayers with 

incomes above $50,000, but below the rate thresholds for their higher tax rates enacted by the 

1990 and 1993 Acts; that is, the group facing no change in marginal tax rates.25 This exclusion is 

tightened by excluding all taxpayers with incomes below $75,000, instead of $50,000, which 

reduces the sample size to 3,503. This change in the sample increases the estimated tax price 

elasticities somewhat (gross income: coef.=0.48 (s.e.=0.12); taxable income: coef.=0.56 

(s.e.=0.14)). 

In the sample used for Table 6, AMT taxpayers are excluded because they are, in effect, 

subject to a completely different, but parallel income tax with a different rate structure and tax 

base. Nevertheless, adding these taxpayers back to the sample increases the sample to 4,739 

taxpayers, and the estimated elasticities fall slightly (gross income: 0.29 (s.e.=0.09); taxable 

income: 0.33 (s.e.=0.11), suggesting that the results are not very sensitive to this sample 

restriction. 

Both the gross income and taxable income measures used for Table 6 include capital gains 

income. The 1990 and 1993 Acts, however, changed the relative taxation between interest and 

25Intertemporal variation in tax rates and differences between the income changes of taxpayers in 

the 36 percent and 39.6 percent tax bracket should also help identify the tax price. 
24 

dividend income and capital gains income by increasing rates on ordinary income and either 

lowering (i.e., 1990 Act) or keeping the maximum rate on capital gains fixed (i.e., 1993 Act). 

Consequently, the change in relative taxation may have induced taxpayers to rearrange their 

portfolios to hold more assets that yield tax favored capital gains, rather than income taxed at 

regular rates. The effect of such portfolio reallocations on the estimated tax price elasticities is 

considered by excluding capital gains from both the gross income and taxable income measures. 

This change in the definition of the dependent variable has only a modest effect on the estimated 

tax price elasticities, lowering the gross income elasticity slightly to 0.26 (s.e.=0.11) and 

increasing the taxable income elasticity slightly to 0.40 (s.e.=0.16). 

As mentioned above, the tax price incorporates the changes in the wage cap used for the 

Medicare (HI) Part A tax. These changes increase the marginal tax rate faced by employees by 

1.45 percentage points from the employee share of the tax. Depending on the incidence of the 

employer share of this tax, however, the increase in the marginal tax rate could be as high as 2.9 

percentage points. In an alternate specification, the tax price is first recalculated to incorporate 

both the employee and employer share of this tax. This modification lowers the estimated tax 

price elasticities somewhat (gross income: coef.=0.27 (s.e.=0.09); taxable income: coef.=0.31 

(s.e.=0.11)). The lower elasticity obtained when including both portions of the HI tax is expected 

because a larger change in a taxpayer’s tax price will be observed for a given income change. 

Instead, if the HI tax is entirely removed from the tax price, the estimated elasticities rise 

somewhat (gross income: coef.=0.33 (s.e.=0.10); taxable income: coef.=0.40 (s.e.=0.11)). 

In summary, these results indicate that the estimated tax price elasticity is positive, but 

substantially smaller than reported by studies relying on the tax reductions of the 1980s for 
25 

identification of the tax price elasticity. This qualitative result does not change after making a 

number of alternative assumptions about the sample, the dependent variable, and the specification 

of the tax price. 

Implications for Revenue. The tax price elasticities estimated above are used to simulate the 

behavioral response associated with the higher tax rates under the 1993 Act and its effect on 

revenues. The taxable income elasticity with respect to the net-of-tax rate, 0.38, is used because 

it reflects the various types of behavioral responses affecting both income and deductions and is 

therefore appropriate for analyzing the impact of the response on revenues. All of the simulations 

presented below are at 1993 incomes and use the U.S. Treasury’s Individual Income Tax Model. 

First, the static effect of the 36 percent and the 39.6 percent tax rates are simulated by 

comparing taxable income and tax liability before the 1993 Act to taxable income and tax liability 

after the 36 percent and 39.6 percent rates are imposed. As shown in Table 8, before the 

imposition of the two new tax rates, taxpayers reported taxable income of $2,453.0 billion and tax 

liability of $471.6 billion. Assuming no taxpayer behavior, the two new tax rates would have 

increased tax liability to $488.6 billion resulting in a static revenue gain of about $17.0 billion. 

Second, the taxable income elasticity (0.38) is applied to the percentage change in 

taxpayers’ net-of-tax rate to estimate the tax-induced change in taxable income (net of capital 

gains). The tax-induced behavioral response reduces taxable income by $17.4 billion to $2,435.6 

billion and tax liability falls by $6.6 billion to $482.0. The net change in liability after the 

simulated tax-induced behavioral response is $10.4 billion implying a revenue offset relative to the 

static revenue gain of 39 percent. 

This estimate of the revenue offset, however, assumes that the tax-induced behavioral 
26

response reduces aggregate taxable income, rather than shifting income to activities that are still 

taxed, albeit at a lower rate. For example, although a reduction in labor supply by high income 

taxpayers would lower their taxable incomes, some economic activity could be shifted to 

taxpayers who, on average, face a lower tax rate. High income doctors might reduce the number 

of patient visits as they adjust their labor/leisure choice, but the patients, whose need for medical 

care remains unchanged, may seek medical care provided by doctors or other health care 

practitioners who, on average, face a lower marginal tax rate. Similarly, the change in the relative 

taxation of income earned by businesses organized in the corporate versus noncorporate form 

might cause a shift towards earning income by businesses in the corporate form. In both of these 

examples, the reduction in taxable income by taxpayers facing the higher tax rates is, at least 

partly, matched by a rise in the taxable income by other taxpayers or other taxable activities.26 

Indeed, when estimating the revenue effects of tax changes government economists typically 

assume that gross domestic product, as well as other macro-economic aggregates, are held 

constant. That is, feed-back effects are not incorporated. 

Although determining whether the behavioral response takes the form of a reduction in 

aggregate income or reshuffling of economic activity between high and low tax activities is an 

issue beyond the scope of this paper, this is a key issue for linking the behavioral response to the 

revenue offset. To highlight the importance of this issue, the revenue offset is recalculated in the 

lower panel of Table 8 with the additional assumption that the $17.4 billion reduction in taxable 

income by taxpayers facing the higher tax rates shown in the top panel is shifted to other activities 

26Some “shifted” income could be taxed at a zero rate. For example, taxpayers subject to the 

higher tax rates could also rearrange their portfolios to hold more tax-exempt bonds, which are subject to a 

zero tax rate. In this case, reshuffling results in a commensurate increase in a non-taxed activity, rather 

than a reduction in economic activity. 
27 

or taxpayers, and taxed, on average, at a 25 percent rate. With this additional assumption the 

offset to the static revenue gain falls from 39 percent to 13 percent. The choice of the appropriate 

tax rate depends to what extent the behavioral response takes the form of reshuffling from high to 

low tax activities or a reduction in income. 

VI. Conclusion 

An important question in the public finance literature and among policy makers is how 

taxpayers respond to changes in tax rates. The answer to this question would help policy makers 

evaluate the apparent tradeoff between progressive tax rates and efficiency. This paper estimates 

the elasticity of a taxpayer’s gross income and taxable income with respect to changes in his netof tax rate or tax price. Rather than focusing on particular types of behavior, this elasticity 

provides an overall measure of responsiveness of taxpayers to tax rate changes. 

This paper uses a panel of taxpayers spanning the tax increases enacted as part of the 1990 

and 1993 Acts to consider to what extent taxpayers change their incomes in response to changes 

in tax rates. Focusing on a period of rising tax rates is important because it avoids the criticism of 

earlier research that observed changes in taxpayer incomes are merely the result of long-term 

trends of increasing income inequality that have little to do with changes in tax rates. This paper 

finds evidence of tax-induced behavioral responses with a gross income tax price elasticity of 0.3 

and the taxable income tax price elasticity of nearly 0.4. These tax price elasticities suggest a 

smaller response than earlier studies of the tax rate reductions in the 1980s, but a response that is 

positive and significantly different from zero. This result suggests that the tax rate increases in the 

1990 and 1993 Tax Acts resulted in lower reported incomes of taxpayers facing the higher rates. 

Simulations of the behavioral response indicate that the higher individual income tax rates 
28 

under the 1993 Act may have reduced the static revenue gain by as much as 39 percent or as little 

as 13 percent depending on whether the behavioral response reduced output or reflected a 

reshuffling from high-tax to low-tax activities. Additional research that isolates the type of 

taxpayer behavior associated with the 1993 Act would be helpful for determining the appropriate 

revenue offset. 
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Table 1

Distribution of Constant Law Income From Cross-Sections of Income Tax Returns

Constant Law Income 1/ 

(in thousands of 1989 dollars) 1989 1990 1991 1992 1993 1994 1995

Percent Distribution 

Under 0 

0-10 

10-20 

20-30 

30-50 

50-75 

75-100 

100-200 

200-1,000 

Over 1,000 

Total 

Over 200

Over 200 (Adjusted) 2/

Average Incomes 

Under 0 

0-10 

10-20 

20-30 

30-50 

50-75 

75-100 

100-200 

200-1,000 

Over 1,000 

All Taxpayers 

Over 200

Over 200 (Adjusted) 2/

-1.5% -1.6% -1.7% -1.5% -1.5% -1.5% -1.4% 

4.7% 5.0% 5.2% 5.1% 5.2% 5.1% 5.1% 

11.8% 11.8% 12.3% 12.0% 12.2% 12.4% 12.1% 

13.0% 13.6% 14.0% 13.6% 13.6% 13.5% 13.2% 

24.8% 24.9% 25.0% 24.4% 24.2% 24.0% 23.2% 

17.9% 17.8% 17.6% 17.4% 17.4% 17.3% 16.8% 

7.7% 7.4% 7.5% 7.3% 7.5% 7.3% 7.5% 

8.6% 8.5% 8.5% 8.6% 8.9% 9.1% 9.5% 

8.2% 8.1% 7.8% 8.3% 8.1% 8.3% 8.9% 

4.8% 4.6% 3.6% 4.7% 4.3% 4.4% 5.1% 

100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 

13.0% 12.6% 11.4% 13.1% 12.5% 12.7% 14.0% 

13.0% 12.6% 11.4% 12.5% 12.6% 13.1% 14.0% 

(in 1989 dollars) 

-64,335 -59,226 -60,410 -53,932 -51,995 -56,229 -54,333 

4,825 4,892 4,909 4,976 4,949 4,962 4,967 

14,694 14,714 14,682 14,690 14,650 14,646 14,690 

24,669 24,687 24,674 24,692 24,648 24,610 24,677 

38,764 38,726 38,666 38,700 38,634 38,732 38,772 

59,926 59,887 59,841 60,083 59,884 59,904 60,073 

85,339 85,238 85,298 85,499 85,311 85,067 85,341 

132,175 132,193 131,150 131,926 132,586 132,891 132,227 

354,040 358,662 339,633 355,304 350,278 347,455 349,803 

2,624,133 2,550,992 2,400,091 2,626,181 2,542,332 2,576,744 2,570,266 

29,043 28,481 27,602 28,372 28,052 28,222 28,772 

521,781 520,437 467,248 516,912 501,170 496,429 509,257 

521,781 520,437 467,248 497,526 506,677 510,033 509,257 

Source: Tabulations from SOI Individual Tax Files. 

1/ Taxpayers are classified according to their "constant law income." Constant law income equals a taxpayer's total 

income in each year, 

minus: Social Security benefits plus: tax-exempt interest income 

moving expenses untaxed pension benefits 

unreimbursed employee business expenses disallowed passive losses 

alimony paid foreign income exclusion 

depreciation in excess of 

straight-line depreciation 

2/ Amounts are "adjusted" to reflect shifting of $15.8 billion in wages and bonus income from 1993 into 1992 and $11.4 

billion in wages and bonus income from 1994 into 1993. 
Table 2

Distribution of Income From Panel of Taxpayers

Taxpayers Classified Based on Initial Income, Ending Income and Average Income

Gross Income 

($1,000s) 1989 1990 1991 1992 1993 1994 1995

Taxpayers Classified Based on Their 1989 Incomes: 

Under 0 -0.8% 0.1% -0.2% -0.1% 0.0% 0.1% 0.2% 

0-10 0.3% 0.6% 0.6% 0.6% 0.6% 0.7% 0.7% 

10-20 2.0% 2.4% 2.5% 2.6% 2.7% 2.8% 2.8% 

20-30 5.7% 6.0% 6.2% 6.0% 6.3% 6.3% 6.3% 

30-50 25.3% 25.4% 25.7% 25.6% 25.6% 26.3% 25.5% 

50-75 27.5% 26.9% 27.4% 26.8% 26.8% 27.1% 26.4% 

75-100 13.0% 13.1% 12.9% 12.7% 12.6% 12.7% 12.7% 

100-200 12.4% 12.0% 12.3% 12.6% 12.8% 12.4% 12.7% 

200-1,000 10.4% 10.1% 9.9% 10.1% 9.7% 9.1% 9.6% 

Over 1,000 4.1% 3.4% 2.6% 3.1% 2.7% 2.5% 3.1% 

Total 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 

Taxpayers Classified Based on Their 1995 Incomes (in 1989$): 

Under 0 0.4% 0.2% 0.0% -0.0% -0.1% -0.4% -0.8% 

0-10 0.9% 0.9% 0.8% 0.7% 0.7% 0.5% 0.3% 

10-20 3.0% 2.8% 2.6% 2.5% 3.0% 2.1% 1.8% 

20-30 6.5% 6.3% 6.1% 6.0% 5.7% 5.5% 5.0% 

30-50 24.0% 24.2% 23.7% 23.0% 22.9% 22.9% 21.7% 

50-75 26.0% 25.7% 26.1% 25.8% 25.8% 26.1% 25.3% 

75-100 11.6% 11.7% 11.7% 11.6% 11.9% 12.1% 12.0% 

100-200 14.2% 14.1% 14.6% 14.6% 14.6% 15.0% 15.8% 

200-1,000 10.0% 10.8% 11.1% 11.9% 11.7% 12.4% 13.3% 

Over 1,000 3.4% 3.3% 3.3% 4.0% 3.9% 3.9% 5.6% 

Total 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 

Taxpayers Classified Based on Their Average Income (in 1989$) 1/: 

Under 0 -0.4% -0.4% -0.6% -0.7% -0.6% -0.7% -0.5% 

0-10 0.2% 0.2% 0.2% 0.2% 0.1% 0.2% 0.2% 

10-20 2.0% 1.9% 1.8% 1.8% 1.7% 1.8% 1.8% 

20-30 6.2% 6.0% 5.8% 5.8% 5.8% 5.8% 5.6% 

30-50 25.4% 25.0% 25.0% 24.4% 24.4% 24.7% 23.9% 

50-75 27.9% 27.6% 28.0% 27.7% 27.4% 27.7% 27.1% 

75-100 11.7% 11.7% 11.8% 11.8% 11.9% 11.8% 11.6% 

100-200 13.3% 13.4% 13.7% 13.5% 13.7% 14.4% 14.6% 

200-1,000 10.1% 11.0% 10.8% 11.4% 10.8% 10.8% 11.3% 

Over 1,000 3.6% 3.7% 3.4% 4.1% 4.8% 3.5% 4.5% 

Total 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 

Source: Tabulations by author. 

Note: Income defined as taxpayer's total income plus tax-exempt interest income. Sample of 

taxpayers includes joint filers between the ages of 25 and 55 in 1989 without AMT liability. Weighted 

using maximal sample weight from cross-sectional files. 

1/ Average of taxpayer's income from 1989 through 1995. 
TABLE 3 

SAMPLE MEANS AND STANDARD DEVIATIONS OF VARIABLES (n=4,233) 

Unless Indicated Otherwise, Values are for 1989 

Variables Mean 

Standard 

Deviation 

) Log of Constant Law Gross Income, 1989-1990 0.027 5.351 

) Log of Constant Law Taxable Income, 1989-1990 0.0252 6.345 

1-J89 0.697 0.511 

1-J95 0.650 0.102 

Log of Income from Financial Assets 7.519 36.065 

Entrepreneur Dummy 0.546 10.008 

Age 42.9 136.7 

Age Squared 1,890 11554 

Number of Children 1.43 22.52 

College Age Children 0.032 4.17 

Regional Dummy Variables: 

Northeast 0.056 4.624 

Mid-Atlantic 0.187 7.845 

West-North Central 0.075 5.282 

South Atlantic 0.157 7.303 

East South Central 0.048 4.305 

West South Central 0.094 5.868 

Mountain 0.048 4.303 

Pacific 0.153 7.229 

Industry Dummy Variables: 

Agriculture, Mining and Construction 0.035 3.673 

Manufacturing 0.184 7.795 

Transportation and Public Utilities 0.055 4.579 

Wholesale Trade 0.046 4.211 

Retail Trade 0.037 3.771 

Finance, Insurance and Real Estate 0.077 5.358 

Services 0.253 8.740 

Public Administration 0.095 5.894 
TABLE 4 

Income Growth by Industry Category, 1989-1995 

Occupation Category 

No Income-Based Sample 

Exclusion 

Exclude Taxpayers with 

Incomes Below $50,000 

Sample 

Real 

Income 

Growth 1/ Sample 

Real 

Income 

Growth 1/ 

Agriculture, Mining and Construction 812 3% 186 0% 

Manufacturing 1,614 12% 593 37% 

Transportation and Public Utilities 514 8% 107 22% 

Wholesale Trade 574 18% 274 35% 

Retail Trade 788 7% 223 35% 

Finance, Insurance and Real Estate 779 8% 352 19% 

Services 2,873 13% 1,555 21% 

Public Administration 750 7% 102 9% 

Industry Information Not Available or 

NEC 

2,455 6% 841 15% 

All Industries 11,159 9% 4,233 22% 

1/ Growth rates are calculated from weighted data. 
TABLE 3 (Cont.) 

Variables Mean 

Standard 

Deviation 

Occupation Dummy Variables, 1993: 

CEOs & Other Senior Executives 0.117 6.468 

Managers & Junior Executives 0.246 8.652 

Investors 0.001 0.571 

Lawyers 0.058 4.682 

Artists, Athletes, & Journalists 0.012 2.145 

Doctors & Other Health-Related Occupations 0.120 6.533 

Scientists, Engineers, & Computer-Related Occupations 0.120 6.525 

Other Professionals 0.029 3.348 

Sales-Related Occupations 0.105 6.163 

Clerical and Household Services Occupations 0.035 3.688 

Production Workers 0.066 4.989 

J= Federal marginal tax rate. All values are weighted. 
TABLE 5 

Income Growth by Occupation Category, 1989-1995 

Occupation Category 

No Income-Based Sample 

Exclusion 

Exclude Taxpayers with 

Incomes Below $50,000 

Sample 

Real 

Income 

Growth 1/ Sample 

Real 

Income 

Growth 1/ 

CEOs & Other Senior Executives 1,627 21% 1,194 40% 

Managers & Junior Executives 1,738 15% 721 27% 

Investors 70 6% 41 16% 

Lawyers 466 13% 338 18% 

Artists, Athletes, & Journalists 207 13% 93 39% 

Doctors & Other Health-Related 

Occupations 

1,006 21% 842 12% 

Scientists,Engineers,& Computer 

Occupations 

747 12% 217 17% 

Other Professionals 261 9% 46 18% 

Sales-Related Occupations 1,252 7% 380 17% 

Clerical and Household Services 

Occupations 

601 3% 33 3% 

Production Workers 1,768 2% 118 5% 

Occupation Information Not Available 

or NEC 

1,416 5% 210 15% 

All Occupations 11,159 10% 4,233 22% 

1/ Growth rates are calculated from weighted data. 
TABLE 6 

REGRESSION RESULTS 

Variables 

Gross Income Adjusted Taxable Income 

Taxes Only Full Model Taxes Only Full Model 

Intercept 0.027* 

(0.004) 

0.239* 

(0.059) 

0.025* 

(0.005) 

0.186* 

(0.070) 

) log of (1-J) 0.26* 

(0.09) 

0.32* 

(0.10) 

0.31* 

(0.11) 

0.38* 

(0.12) 

Year Dummies: 

1990-91 -0.012* 

(0.006) 

-0.011** 

(0.006) 

-0.012** 

(0.007) 

-0.011 

(0.007) 

1991-92 0.019* 

(0.006) 

0.019* 

(0.006) 

0.033* 

(0.007) 

0.033* 

(0.007) 

1992-93 -0.027* 

(0.006) 

-0.025* 

(0.006) 

-0.019* 

(0.007) 

-0.017* 

(0.008) 

1993-94 -0.0004 

(0.0057) 

0.0003 

(0.057) 

0.014* 

(0.007) 

0.015* 

(0.008) 

1994-95 0.0188* 

(0.0056) 

0.019* 

(0.006) 

0.029* 

(0.007) 

0.029* 

(0.007) 

Non-Tax Factors: 

Log of Income from Financial Assets 0.0008 

(0.001) 

0.0002 

(0.0013) 

Age -0.0089* 

(0.0028) 

-0.0063** 

(0.0034) 

Age Squared 0.00008* 

(0.00003) 

0.00005 

(0.00004) 

Entrepreneur Dummy 0.0033 

(0.0038) 

0.0021 

(0.0045) 

Number of Children 0.0021 

(0.0017) 

0.0029 

(0.0020) 

College Age Children 0.0017 

(0.0103) 

0.0003 

(0.0124) 

Regional Dummy Variables: 

Northeast -0.0083 

(0.0080) 

-0.0096 

(0.0096) 

Mid-Atlantic -0.0040 

(0.0055) 

-0.0047 

(0.0066) 

West-North Central -0.0031 

(0.0071) 

-0.0077 

(0.0086) 

South Atlantic -0.0027 

(0.0057) 

-0.0030 

(0.0069) 

East South Central -0.0034 

(0.0084) 

-0.0038 

(0.0101) 

West South Central -0.0069 

(0.0066) 

-0.0075 

(0.0079) 

Mountain -0.0123 

(0.0084) 

-0.0163 

(0.0101) 

Pacific 0.0015 

(0.0057) 

0.0013 

(0.0068) 
TABLE 6 (Cont.) 

Variables 

Gross Income Adjusted Taxable Income 

Taxes Only Full Model Taxes Only Full Model 

Industry Dummy Variables: 

Agriculture, Mining and Construction -0.021* 

(0.010) 

-0.020** 

(0.012) 

Manufacturing 0.010* 

(0.005) 

0.012* 

(0.006) 

Transportation and Public Utilities -0.007 

(0.008) 

-0.005 

(0.009) 

Wholesale Trade 0.003 

(0.009) 

0.003 

(0.011) 

Retail Trade 0.012 

(0.009) 

0.009 

(0.011) 

Finance, Insurance and Real Estate -0.005 

(0.007) 

-0.005 

(0.008) 

Services 0.005 

(0.005) 

0.003 

(0.006) 

Public Administration -0.004 

(0.007) 

-0.006 

(0.008) 

Occupation Dummy Variables: 

CEOs & Other Senior Executives 0.0197* 

(0.0074) 

0.0244* 

(0.0089) 

Managers & Junior Executives 0.0123* 

(0.0063) 

0.0145** 

(0.0076) 

Investors -0.0075 

(0.0574) 

-0.0266 

(0.0690) 

Lawyers 0.0072 

(0.0089) 

0.0092 

(0.0106) 

Artists, Athletes & Journalists 0.0078 

(0.0162) 

0.0020* 

(0.0195) 

Doctors & Health-Related Occupations 0.0043 

(0.0079) 

0.0078* 

(0.0095) 

Scientists,Engineers,& Computer Occupations 0.0042 

(0.0072) 

0.0014 

(0.0086) 

Other Professionals 0.0122 

(0.0095) 

0.0129 

(0.0138) 

Sales-Related Occupations 0.0095 

(0.0078) 

0.0117 

(0.0094) 

Clerical and Household Services Occupations -0.0046 

(0.0104) 

-0.0124 

(0.0125) 

Production Workers -0.0022 

(0.0084) 

-0.0024 

(0.0101) 

Note 1: Instrumental variables is used with generalized least squares. Difference in natural logarithm of 

synthetic tax price based on taxpayers’ permanent income used as instrumental variable in all specifications. 

Taxable income adjusted to reflect law in 1989. 

Note 2: Standard errors appear in parenthesis. * indicates variable is significant at the 95 percent level of 

confidence. ** indicates variable is significant at the 90 percent level of confidence. J= Federal marginal tax 

rate. Observations=(4,233*6)=25,398. 
TABLE 7 

Estimated Tax Price Elasticity Under 

Alternative Sample Exclusions and Specifications 

Specification 

Sample 

Size 

Gross Income Adjusted Taxable Income 

Taxes Only Full Model Taxes Only Full Model 

Exclude taxpayers with 

incomes below $75,000 

3,503 0.38* 

(0.11) 

0.48* 

(0.12) 

0.48* 

(0.13) 

0.56* 

(0.14) 

Include taxpayers on the 

alternative minimum tax 

4,739 0.24* 

(0.09) 

0.29* 

(0.09) 

0.29* 

(0.11) 

0.33* 

(0.11) 

Exclude capital gains 

from income 

4,233 0.21* 

(0.11) 

0.26* 

(0.11) 

0.37* 

(0.15) 

0.40* 

(0.16) 

Include both employee 

and employer portions 

of HI tax 

4,233 0.21* 

(0.08) 

0.27* 

(0.09) 

0.25* 

(0.10) 

0.31* 

(0.11) 

Exclude HI tax from tax 

price 

4,233 0.27* 

(0.09) 

0.33* 

(0.10) 

0.33* 

(0.11) 

0.40* 

(0.11) 

Note 1: Instrumental variables is used with generalized least squares. Difference in natural logarithm of 

synthetic tax price based on taxpayers’ permanent income used as instrument in all specifications. Note 2: 

Standard errors appear in parenthesis. * indicates significant at the 95 percent level of confidence. Taxable 

income is adjusted to reflect 1989 law. 
Table 8

Simulation of the Effect on Revenues 

of the Individual Income Tax Rate Changes in the 1993 Tax Act

Post-1993 Post-1993 

Pre-199 Tax Act Static Tax Act Net Revenue 

3 Tax (Static) Change (Dynamic) Behavior Effect Offset 

Act 

($ in billions) 

Behavioral Response (With No Income Shifting): 1/ 

Taxable Income 2,453.0 2,453.0 0.0 2,435.6 -17.4 -17.4 

Tax Liability 471.6 488.6 17.0 482.0 -6.6 10.4 -39% 

Behavioral Response (With Income Shifting): 2/ 

Taxable Income 2,453.0 2,453.0 0.0 2,453.0 0.0 0.0 

Tax Liability 471.6 488.6 17.0 486.4 -2.3 14.8 -13% 

Note: Simulation includes the effects of the 36 percent and 39.6 percent tax rates enacted as part of the 1993 Tax Act. The

effects of the repeal of the wage cap on Health Insurance (Medicare Part A) taxes are not included. All estimates are at 1993

incomes.

1/ Assumes that the behavioral response reduces the taxable incomes of taxpayers facing the higher rates and the "lost" income is

not shifted to other taxable activities.

2/ Assumes that the reduction in taxable income for those taxpayers facing the higher tax rates is "shifted" to other taxable

activities or taxpayers.