I estimate that the new top marginal income tax rate of 39.6% on annual income in excess of $400,000 per year will have a direct impact on about 7/10 of one percent of taxpayers. However, the income earned by these taxpayers in excess of the $400,000 threshold accounts for about 9.5% of aggregate personal income. Had President Obama prevailed in the fiscal cliff negotiations, and the marginal income tax rate increased for incomes in excess of $200,000, higher marginal rates would have directly affected about 2.6% of taxpayers. The income earned by taxpayers in excess of the $200,000 threshold accounts for about 14.7% of aggregate personal income.
Changes in marginal tax rates have incentive effects as well as indirect effects on workers and consumers not subject to the higher marginal rates. The economic debate over raising marginal tax rates on high income earners centers on the magnitude of the disincentives for work, saving, investment, and job creation caused by higher marginal tax rates. As high income earners change their behavior in response to the reduced incentives to earn income, all consumers and workers will be impacted by the new top marginal rate.
Unfortunately there have been few empirical studies that have focused on income earners directly impacted by the 39.6% marginal rate. This is because less than one in one hundred earners generate enough income to pay the new top marginal rate. Second, little information about these earners is known because most publicly available databases protect the confidentiality of survey respondents by “top coding” personal income. When the income variable in a database is “top coded” it is impossible to tell whether an individual’s annual income is $500,000 or $500 million. Finally, while the income generating activities of middle-income earners is typically summarized by annual hours of work, the productive activities of high income earners are less likely to be captured by surveys that merely report hours and weeks worked per year. High income earners engage in risk-taking and entrepreneurial activities that may be more or less responsive than hours worked to changes in marginal tax rates. In other words, although there are many economics studies measuring how the hours worked by low and middle-income earners respond to changes in marginal tax rates, these studies tell us little about how income earners will change their investment and risk-taking behavior now that the top income tax rate is 39.6% not 35%. Whatever the incentive effects of this new tax rate will be, they will be felt by all Americans not just taxpayers earning in excess of $400,000 per year.
Note: My calculations are based on the summary statistics presented by economists Emmanuel Saez and Thomas Piketty, using the 2010 Statistics of Income data from the IRS. These data are not top coded and provide the best information about high income earners. Unfortunately tax returns data have no information about how many individuals earned income in the taxpaying household, how many hours were worked, or how much risk-taking and entrepreneurial activities were taken by the household in the tax year. Saez and Piketty reported that in 2010, excluding capital gains from income, the top:
- ½ of one percent of tax returns reported annual income of $488,000 or more and accounted for 13.4% of all personal income.
- 1% of tax returns reported annual income of $336,000 or more and accounted for 17.4% of all personal income.
- 5% of tax returns reported annual income of $148,000 or more and accounted for 33.7% of all personal income.
Using these summary data, and the conditional means of income reported by Saez and Piketty, I fit a simple model for the top percentiles of the empirical distribution of personal income in order to estimate the fraction of aggregate personal income above the $200,000 and $400,000 thresholds reported above.