Aggregate and Distributional Effects of Increasing Taxes on Top Income Earners

Research Area: Financial Markets
Researcher: Bettina Brüggemann,
Jinhyuk Yoo
Date: Jan 2015
Abstract:

The macroeconomic implications of raising taxes on top income earners are in the focus of the IMFS Working Paper No. 94 by Bettina Brüggemann of Goethe University and Jinhyuk Yoo, IMFS and Bank of Korea, demonstrating that such a tax increase leads to less inequality in both wealth and income but, on the other hand, has negative effects on the aggregate economy. The study also shows that the aggregate gain in welfare is sizable mainly due to a higher degree of distributional equality.

 

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. (22.07.15)

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