Tax Progressivity and the Rise in Inequality

April 20, 2008

Income inequality in the United States has increased sharply since the 1970s. How much of this is due to reduced tax progressivity?

A key element of the rise in inequality has been the dramatic jump in incomes among the top 1% of the population. According to calculations from IRS data by Thomas Piketty and Emmanuel Saez (available here), this group’s share of total income more than doubled during the 1980s and 1990s.

This is due in part to the fact that in recent decades taxes have done less to reduce the top 1%’s income share. The following chart shows the pretax and posttax income share of this group from 1960 to 2001, according to the Piketty-Saez calculations. Between 1960 and 1979, its posttax income share was 70% of its pretax share. In the period from 1980 to 2001 that increased to 84%.

(Note: The Piketty-Saez data end in 2001, so they don’t reflect the Bush tax cuts. Calculations by the Congressional Budget Office suggest that from 2002 to 2005 the top 1%’s posttax income share was 85% of its pretax share, very similar to what the Picketty-Saez data indicate for 1980-2001. I don’t use the CBO data here because they go back only to 1979.)

What effect has this had on inequality?

The chart makes clear that most of the rise in the top 1%’s posttax income share is due to the increase in its pretax share rather than to changes in tax progressivity. The next chart offers another way to see this. The solid line in the chart shows the top 1%’s share of after-tax income since 1960. The dashed line shows what the top 1%’s share of income would have been had taxes reduced it to the same degree as in the 1960s and 1970s. It’s lower, but not massively so. Changes in taxation have mattered, but they have not been the main reason for the rise in the top 1%’s income share.

If reducing inequality is an aim of the next administration, increasing the progressivity of our tax system would surely help. But this is only one piece of the puzzle.

8 Responses to “Tax Progressivity and the Rise in Inequality”

  1. oyfe Says:

    While its all very interesting and features graphs the actual taxation of the people of the United States is actually unlawful in that there is no law that requires individuals to pay tax.

    The IRS is a massive fraud. Have a look into that one when you get a chance.

    OYFE*

  2. Goldilocksisableachblonde Says:

    ” If reducing inequality is an aim of the next administration, increasing the progressivity of our tax system would surely help. But this is only one piece of the puzzle. ”

    Puzzle ? C’mon , is it really so hard to explain the factors that have led to increased inequality in the U.S. ?

    How about a minimum wage that has gone from an inflation-adjusted level of over $9.50/hr in 1968 to the much-reduced level of today ? The minimum wage sets a floor that tends to lift the wages of even those well above the minimum.

    What about the de-unionization of the workforce , especially in the private sector , as well as the lax , or nonexistent , enforcement of the remaining weak labor laws we still have ?

    How about crony capitalism run amok , with military subcontractors looting the Treasury , K-Street lobbyists engaging in legalized bribery , CEOs and BODs and compensation consultants sleeping together , and so on , ad nauseum ?

    What about unfair “free” trade deals ? Tax incentives for companies that offshore jobs ? The flood of illegals in recent years , and the whiny cries by the likes of Bill Gates for more H1-B visas for high-skilled immigrants , because he knows they’ll accept lower pay than natives with the same skillsets ?

    You even fail to include another obvious ramification to the reduced tax progressivity issue — CEOs and other heads of businesses will be more inclined to lavish themselves with excessive pay when they are taxed at low marginal rates than at high marginal rates , since there is a calculus that occurs that determines where the next dollar of compensation would yield the most benefit , and CEOs are not interested in plumping up the gov’t balance sheet. More money will naturally ‘trickle down’ at high marginal rates.

    I’m dismayed to see the best and brighest of economics bloggers and talking heads still debating about how the problem may be simply one of education or advanced skills. Hogwash !! How do you explain the lack of such extreme inequality in other advanced nations ?

    I’ll tell you how. Look at the factors I’ve mentioned above in those other countries and you’ll find that there are different policies in place that counteract inequality. There’s more than one way to skin this cat , after you’ve made the decision that the cat needs skinning. Are we getting close to that point , or do we need another full-blown Depression to teach us once again that a healthy middle class is a handy thing to have around ?

    This ain’t brain surgery , folks.

  3. reason Says:

    Umm…
    Money makes money. Look at a graph of wealth inequality first.

  4. VRE Says:

    Do you really think the top 1% would have worked as hard for their pre-tax income with 70% marginal tax rates? That’s a brave assumption you make in the second graph

  5. pushmedia1 Says:

    GiaBB, what data are you looking at? Real minimum wage and unionization would increase the wages of the low end of the wage spectrum (in theory, assuming the inefficiencies they produce aren’t too large). The professor pointed out in the post that most of the increase in inequality is coming from increasing wages at the top. This isn’t occurring at the expense of the bottom as wages are increasing there too, just not at the same rates as the top.

    In other words, your mechanisms make sense if we’re talking about reductions in wages at the bottom. That’s not what the data show us.

    Also, your other mechanisms don’t explain the increased wages at the top either. Kaplan and Rauh did some accounting and found CEO pay doesn’t account for much of the increase. There’s just not enough of them to make a difference. BTW, the Top 500 CEOs make less money than the top 25 hedge fund managers.

    Trade “deals,” at their worst, enrich those that work in export industries at the expense of those that work in import industries. There’s many people of all income levels that work in both those sorts of industries. I’m not sure why rich people as a whole would benefit one way or the other (except in the sense that everyone, eventually, benefits from trade). On the other hand, I can think of why highly skilled people (e.g. college graduates) would benefit from trade if we specialize in exporting products that take a lot of skill to produce.

    Immigration has been shown to have minimal, if any, impact on native Americans’ wages (see Borjas or Peri/Ottaviano). This is because immigrants tend to do different jobs (or perform different tasks in the same jobs) than natives.

  6. joe Says:

    In other comment sections of other blogs regarding the increase in inequality, I have suggested that in order to get a grip on the reasons, one merely needs to look at changes in our economic structure over the last few decades. Change in economic structure caused the change in income equality. Why ignore a plausible and simple explanation like decrease in demand equals lower price and simultaneously an increase in supply equals lower price. The price being wages in both cases. Relatively less firms of a bigger size equals less demand for skilled labor. (i.e. big box stores, national chains, or how about that change which now allows banking across state lines.) Could the implication of this change mean there might be less demand? The implications of containerized cargo and fax machines equals a bigger labor pool, i.e greater supply of labor. Why ignore these two big changes in our economic structure and look for solutions to inequality and the demise of the middle class elsewhere.

    Here’s the most simple point (and my plea to look at what is right in front of our noses as opposed to tamgential areas) Allowing businesses to get larger and at the same time engaging in freer trade has been a net detriment to income equality and the condition of the middle class in this country. Simply put, consumer prices have risen but wages have not kept up. No those cheap products from the far east and the economies of scale from large organization have not improved the standard of living of most Americans but have made a few of us rich beyond any level concievable just a few decades ago. I would submit that reactions and adjustments to these big reasons for the increase inequality are where we should be concentrating our efforts, though I am not adverse to also looking at other more marginal areas.

    One more thought as to what is philosophically fair and proper, when it was to capital’s advantage, tariffs were patriotic, now when globalization makes offshoring advantageous, tariffs are an impingement on even more sacred freedom. Also the first preriquisite to a free market is many buyers and sellers (i.e. competition). If we are going to set the system up in a way that the winner takes all, then to what means are we going to resort to pursue victory. If the loser gets nothing then there will be no limits. I thought we were trying to build a civilization, not a jungle.


  7. [...] by Matt Zeitlin on April 28, 2008 Lane Kenworthy has a fantastic series of graphs showing how nearly all of the incrase in inequality has been due to the top 1% having a huge increase in [...]


  8. I find Tim Worstall’s explanation for the rise and fall of the income shares of the top 1 percent in the Piketty-Saez calculations plausible. Those guys are the lucky winners in the financial market sweepstakes. If one scales the DJA by an index of nominal GDP, it tracks the peaks and valleys before the 1940s and after the 1970s very, very well. But not the 30 year period in the middle. What would explain that? My hunch is consistent with several of the comments here: high marginal taxes greatly influenced income recognition during this period. That is, we are talking about tax avoidance and evasion and, perhaps, some real effects as well, depressing the reported income, although not necessarily the resources, of folks in the top income percentile. Indeed, if we look at consumption rather than income data, we don’t find the same discontinuities between the 1970s and the 1980s and 1990s we see in reported incomes.

    One possible implication of this line of analysis is that real pre-tax ‘income’ distributions may not have changed very much in the last 100 years: but, given financial markets as sluggish as those of the 1970s, the top 1 percent’s share of pre-tax income would return to the lower levels some might prefer (I would still expect the top 25 hedge fund managers to outperform the top 500 executives).


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