Saturday, November 15, 2014

US Tax Policy And Inequality 1979-2011

The impartial Congressional Budget Office released a report on income inequality and tax policy over a 33 year period.  Tim Taylor does an excellent job of describing the results.  He includes a few graphs, which can be enlarged to view more clearly, that illustrate the changes over 33 years.

His first point provides a dramatic illustration of the importance of understanding the difference between using an average or the median to describe the central tendency in the data.  The average income in the US is $80,600.  That looks great compared to any other nation.  On the other hand, the median income is only $49, 800.  That is because the very high incomes at the top of the distribution have a powerful effect on the average.  For example, if Bill Gates walked into a room, the average income in that room would skyrocket.  The median is a much better measure of the central tendency when the data are dramatically skewed in any direction.  The most frequently used measure  used to compare the well being of nations is per capita income.  That is an average, and it is much better to use median income per capita to get a more accurate measure of central tendency.  Moreover, the difference between the average and the median increases as the data are skewed in any direction.  It is a good way to determine distributional changes over time.

We frequently break distributions down into five quintiles, each of which contains 20% of the distribution.  The bottom four quintiles realized a gain of 16% in income over the 33 year period.  The top quintile had 56% increase in its income.  Taylor is not terribly concerned with that difference because some of it can be explained as a return on skill.  When we look only a the top 1%, however, it is hard to explain the pattern as a return on skill.  The income pattern for the top 1% rises and falls with stock prices.  Obviously, it is not explained by rises and falls in the skill of the top 1%.  Conservative economists, like Greg Mankiw at Harvard, claim that the income gains made by the top 1% are the result of a rising premium that the market places on skill.  Therefore, it would be a mistake to make an effort to alter the natural force of the labor market.  Mankiw is a very smart economist but he would have a very difficult time explaining the pattern that the CBO data describe so well.  The top 1% receives much of its income from stock ownership and that market is much more volatile than the premium that the labor market places on skill.

Tax policy is used by most nations to moderate the unequal distribution of market income.  The US has a moderately progressive federal tax system much like that of other nations.  Over 33 years changes in tax policy have reduced the overall federal tax rate for the top 1% from 33% to 29%.  That group has seen its income rise much more than other groups and its average tax rate has been reduced by 4%.  Each of the other income groups, which have progressively higher tax rates has seen their average tax rate decline by only 1%.  It is pretty clear that the top 1% have had more influence on the federal tax rate than other income groups.  Moreover, cutting taxes for the top 1% has not had much of an effect on the incomes of the remaining income groups.  In fact, cutting the tax rate for the top  may have been a factor in causing the income share of the top 1% to accelerate much faster than all of the groups below the top 1%.  Much of its growth in income has come from gains in capital income which is taxed at lower levels than wage income.  The data illustrate that changes in market income are driving the growth in income inequality.  Tax policy has had only a modest effect on reducing the distribution of after tax income.  Moreover, federal tax income has declined for all income groups over the 33 year period.  That has had a powerful effect on the ability of government to provide public services without borrowing money.  Politicians love to cut taxes and its easier to maintain federal spending by selling US treasuries than by collecting the needed income via taxes.

There are a variety of government programs which redistribute tax income to lower income groups.  All income groups receive some income from government programs.  For example, Medicare provides healthcare benefits to all senior citizens independent of their income.  On of the odd results that we observe is that US citizens in the bottom 20% receive the lowest share of federal income redistribution.  Moreover, total amount of income redistributed by federal programs has been declining.  That is why those with low incomes in most other rich countries are much better off that low income citizens in the US.  They redistribute more income to their citizens than the richest country in the world. 

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