1. E VIDENCE ON THE E CONOMIC E FFECTS OF T AXES J ON B AKIJA P ROFESSOR OF E CONOMICS, W ILLIAMS C OLLEGE J UNE 21, 2012 1

2. CROSS-COUNTRY EVIDENCE ON TAXES AND ECONOMIC GROWTH: REASONS FOR SKEPTICISM Not even close to an experiment Reverse causality –Business cycle fluctuations cause tax revenue to change –Demand for government increases with income –Tax administration improves with higher income Effect of government size on growth should differ depending on quality of government –Scandinavian countries have: Large progressive governments Well-designed, well-administered, economically efficient policies 2

3. So many other factors affect economic growth –We don’t have good control variables for them all –Econometric estimates are very sensitive to reasonable changes in the set of control variables –Controlling for a variable that is a channel through which government affects growth makes estimates worse instead of better! Selection bias –If you select only countries that are rich today, you leave out all the countries with small governments that did not grow CROSS-COUNTRY EVIDENCE ON TAXES AND ECONOMIC GROWTH: REASONS FOR SKEPTICISM 3

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8. 8 Source: author's calculations based on data from Piketty and Saez (2003, updated in 2012 at http://elsa.berkeley.edu/~saez/TabFig2010.xlshttp://elsa.berkeley.edu/~saez/TabFig2010.xls), Saez (2004), and IRS Statistics of Income Bulletin, Spring 2012.

9. Skill-biased technical change Globalization “Superstar” theory Executive compensation issues Pay (e.g. stock options) tied to booming financial market asset prices Shifting of income from corporate to personal tax base Changes in tax avoidance and evasion –Costly, but can be addressed by tax reform and enforcement IS RISING INEQUALITY EVIDENCE OF THE RICH RESPONDING TO BETTER INCENTIVES CAUSED BY TAX CUTS? REASONS FOR SKEPTICISM 9

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14. If entirely a real behavioral response to incentives If mostly due to other factors (Piketty, Saez, & Stantcheva’s position) Percentage change in income caused by a one percent increase in net-of-tax share 0.440.2 Deadweight loss per dollar of additional revenue raised in top bracket $0.95$0.28 Revenue-maximizing top marginal tax rate 60%79% IMPLICATIONS OF CROSS-COUNTRY RELATIONSHIP BETWEEN CHANGE IN TOP PERSONAL INCOME TAX RATE AND CHANGE IN TOP 1% INCOME SHARE Source: author’s calculations based on Piketty, Saez, and Stantcheva (2012) Note: “net-of-tax-share” is one minus the marginal tax rate. 14