Read time: 5 mins
Based on Revisiting taxes on high incomes, published December 2023.
Increasing the progressivity of income taxes (by raising income tax rates across the board) would raise revenue but would also increase the financial burden on much of the population. ANU expertise suggests that a different approach – targeting only top earners – works best. As they’re a small part of the economy and their behaviour is relatively unresponsive to tax changes, raising rates for this group alone could be the least painful way to raise revenue.
Read time: 5 mins
Based on Revisiting taxes on high incomes, published December 2023.
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Tax increases on very high-income earners would be more likely to maximise revenue than increasing tax progressivity across the board.
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ANU researchers demonstrated this by factoring in top income earners who are relatively unresponsive to taxation changes. These workers’ salaries are inflated by temporary favourable conditions, meaning they’re less likely to work or save less in response to the shock of increases.
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When these workers represent a significant proportion of the top one per cent of earners, taxing this group raises the most revenue.
Higher taxes on the top one per cent of earners would be a more effective way to maximise government revenues than increasing the progressivity of taxes overall, new ANU research has shown.
Investigating optimal marginal tax rates under a variety of potential conditions, ANU experts showed that the ‘best’ way to maximise revenue varies depending on who the richest people in an economy are, how they earn their money, and what rate of tax they already pay. Any time these variables changed, substantial differences emerged in researchers’ predictions of output and government revenues.
The researchers began by distinguishing between two types of workers in the top percentile of earners and contrasted their different behaviours.
The first type are ‘superstars’. These are workers whose incomes are very high due to a favourable and temporary labour income draw. This group doesn’t react much to changes in the tax rate due to the temporary nature of the shocks they face. Instead, superstars tend to keep working and saving even with higher tax rates, potentially because of the role that luck has played in their remuneration levels.
The second group are ‘entrepreneurs’. In contrast to superstars, these workers have high and persistent productivity and react to higher taxes by working and saving less.
Using a benchmark economy in which ‘superstar’ workers make up much of the top one per cent of earners, researchers calculated the optimal tax rate for its highest earners for raising revenue. It was around 54 per cent, which is higher than calculations with more entrepreneurs in the top one per cent.
Their work highlighted the strength of the relationship between the composition of the top one per cent and the optimal way to raise revenue. They found that when more superstar workers are in the highest earning group, the higher the top group’s optimal marginal tax rate is.
Finally, they applied the new top-earner tax rate to the population and compared how much revenue it raised to what could be achieved by increasing tax progressivity. They found that because this would impose higher taxes on many more households, applying a higher tax rate on just the highest earners performed best at raising revenue.
The research suggests that a detailed understanding of the composition of the top one per cent of earners is critical to policy-making. Exploring policy options that respond to this information is important for maximising revenue.
"When the top percentile of earners is mostly composed of ‘superstar’ workers who have very favourable but temporary labour incomes, these people keep working and saving even with higher tax rates."
