How Tax Policy Is Related To Income Inequality

This article is part of a series of articles in The Boston Review on what to do about rising income inequality. The three economists, who wrote this article have done a lot of good work on both rising income inequality and tax policy. They found that tax policies in rich countries have been very different but that they have had no effect on economic growth. All of the rich countries have had similar growth in per capita GDP under widely different tax policies. Moreover, the US and the UK cut the top marginal tax rates and they experienced growing income inequality. Between 1975 and 2008, the top marginal tax rate in the US was cut by 35% and the top 1%'s share of income increased by 10%. Neither Germany or France reduced their top tax rates, and they saw no increase in the share held by the top 1%. The tax cuts in the US may have encouraged CEO's in the US to seek higher wages from their boards.

The two major objections to increasing the top rate on high income earners are considered by the authors and they do not find an economic argument against them. They estimate that supply side effects on top wage earners may reduce their incentives to work and the top rate could be raised to 57% without a loss in tax income from supply side effects. Tax avoidance may also increase if the top tax rate is increased. That is no a problem if the well known tax loopholes are closed prior to a tax increase.

The major problem with raising the top rates is not economic, it is political. It depends on whether to public believes that the growth in income inequality is due to rent seeking behavior or to higher productivity. The top 1% has the ability to influence public opinion on this critical issue. This may limit the effort to use tax policy to deal with rising income inequality.