In two counterfactual policy experiments the top marginal tax rate is increased from 35 to 70 percent. The government then redistributes the additional tax revenue among households either by decreasing all other marginal tax rates or paying a lump-sum transfer to all households. Although the tax increase only affects a small fraction of the population, this group is more likely to hold a great portion of aggregate capital, to be highly productive or both.
Brüggemann and Yoo argue that if the top income earners change their capital holdings and hours worked after the tax increase, these responses lead to macroeconomic consequences such as changes in equilibrium prices. The rest of the population will then react to these prices by adjusting their savings and labor supply. Over time, this gives rise to changes in the distribution of income and wealth. Brüggemann and Yoo come to the conclusion that increasing the top marginal tax rate decreases inequality in both wealth and income but also leads to a contraction of the aggregate economy.
Bettina Brüggemann and Jinhyuk Yoo
"Aggregate and Distributional Effects of Increasing Taxes on Top Income Earners"
IMFS Working Paper No. 94 (PDF, 768 KB)