Tax policy and economic inequality in the United States

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Tax policy and economic inequality in the United States discusses how tax policy affects the distribution of income, distribution of wealth, and income inequality in the United States. Income inequality can be measured before- and after-tax; this article focuses on the after-tax aspects. Income tax rates applied to various income levels and tax expenditures (i.e., deductions, exemptions, and preferential rates that modify the outcome of the rate structure) primarily drive how market results are redistributed to impact the after-tax inequality. After-tax inequality has risen in the United States markedly since 1980, following a more egalitarian period following World War II.

Contents

After a quarter-century of declining inequality following World War II, income inequality increased in the late 1960s and accelerated after 1980. Inequality in wealth and income grew markedly between 1980 and 2009 in the United States. [1] [2] [3]

Overview

U.S. pre-tax and after-tax income share of top 1% households from 1979-2013, for commonly cited data series (CBO and Piketty-Saez ) U.S. Income Share of Top 1%25 of Households CBO & P-S 1979-2011.png
U.S. pre-tax and after-tax income share of top 1% households from 1979–2013, for commonly cited data series (CBO and Piketty-Saez )
U.S. share of income earned by top 1% households in 1979, 2007, and 2014 (CBO data). The first date (1979) reflects the more egalitarian pre-1980 period, 2007 was the peak inequality of the post-1980 period, and the 2014 number reflects the Obama tax increases on the top 1% along with residual effects of the Great Recession. Top 1 pct share of income 1979 2007 2014.png
U.S. share of income earned by top 1% households in 1979, 2007, and 2014 (CBO data). The first date (1979) reflects the more egalitarian pre-1980 period, 2007 was the peak inequality of the post-1980 period, and the 2014 number reflects the Obama tax increases on the top 1% along with residual effects of the Great Recession.
Total effective tax rates (includes all taxes: federal+state income tax, sales tax, property tax, etc) for the richest Americans declined by 2018 to a level beneath that of the bottom 50% of earners, contributing to economic inequality. Analysis by economists Emmanuel Saez and Gabriel Zucman. 1960- Tax rates of richest versus low income people - US.svg
Total effective tax rates (includes all taxes: federal+state income tax, sales tax, property tax, etc) for the richest Americans declined by 2018 to a level beneath that of the bottom 50% of earners, contributing to economic inequality. Analysis by economists Emmanuel Saez and Gabriel Zucman.

Tax policy is the mechanism through which market results are redistributed, affecting after-tax inequality. The provisions of the United States Internal Revenue Code regarding income taxes and estate taxes have undergone significant changes under both Republican and Democratic administrations and Congresses since 1964. Since the Johnson Administration, the top marginal income tax rates have been reduced from 91% for the wealthiest Americans in 1963, to a low of 35% under George W Bush, rising recently to 39.6% (or in some cases 43.4%) in 2013 under the Obama Administration. [8] [9] Capital gains taxes have also decreased over the last several years, and have experienced a more punctuated evolution than income taxes as significant and frequent changes to these rates occurred from 1981 to 2011. Both estate and inheritance taxes have been steadily declining since the 1990s. Economic inequality in the United States has been steadily increasing since the 1980s as well and economists such as Paul Krugman, Joseph Stiglitz, and Peter Orszag, politicians like Barack Obama and Paul Ryan, and media entities have engaged in debates and accusations over the role of tax policy changes in perpetuating economic inequality.

Tax expenditures (i.e., deductions, exemptions, and preferential tax rates) represent a major driver of inequality, as the top 20% get roughly 50% of the benefit from them, with the top 1% getting 17% of the benefit. [10] For example, a 2011 Congressional Research Service report stated, "Changes in capital gains and dividends were the largest contributor to the increase in the overall income inequality." [11] CBO estimated tax expenditures would be $1.5 trillion in fiscal year 2017, approximately 8% GDP; for scale, the budget deficit historically has averaged around 3% GDP. [12]

Scholarly and popular literature exists on this topic with numerous works on both sides of the debate. The work of Emmanuel Saez, for example, has concerned the role of American tax policy in aggregating wealth into the richest households in recent years while Thomas Sowell and Gary Becker maintain that education, globalization, and market forces are the root causes of income and overall economic inequality. The Revenue Act of 1964 and the "Bush Tax Cuts" coincide with the rising economic inequality in the United States both by socioeconomic class and race. [13] [14] [15] [16] [17]

Changes in economic inequality

Real incomes change for top 1%, and each 20% 1979-2011. After tax household income in the US.svg
Real incomes change for top 1%, and each 20% 1979-2011.
US Share of Income Taxes Paid by Income Level v1.png

Income inequality

Economists and related experts have described America's growing income inequality as "deeply worrying", [19] unjust, [20] a danger to democracy/social stability, [21] [22] [23] and a sign of national decline. [24] Yale professor Robert Shiller, who was among three Americans who won the Nobel prize for economics in 2013, said after receiving the award, "The most important problem that we are facing now today, I think, is rising inequality in the United States and elsewhere in the world." [25]

Inequality in land and income ownership is negatively correlated with subsequent economic growth. A strong demand for redistribution may occur in societies where a large section of the population does not have access to the productive resources of the economy. Voters may internalize such issues. [26] High unemployment rates have a significant negative effect when interacting with increases in inequality. Increasing inequality harms growth in countries with high levels of urbanization. High and persistent unemployment also has a negative effect on subsequent long-run economic growth. Unemployment may seriously harm growth because it is a waste of resources, generates redistributive pressures and distortions, depreciates existing human capital and deters its accumulation, drives people to poverty, results in liquidity constraints that limit labor mobility, and because it erodes individual self-esteem and promotes social dislocation, unrest and conflict. Policies to control unemployment and reduce its inequality-associated effects can strengthen long-run growth. [27]

Gini coefficient

The Gini Coefficient, a statistical measurement of the inequality present in a nation's income distribution developed by Italian statistician and sociologist Corrado Gini, for the United States has increased over the last few decades. The closer the Gini Coefficient is to one, the closer its income distribution is to absolute inequality. In 2007, the United Nations approximated the United States' Gini Coefficient at 41% while the CIA Factbook placed the coefficient at 45%. The United States' Gini Coefficient was below 40% in 1964 and slightly declined through the 1970s. However, around 1981, the Gini Coefficient began to increase and rose steadily through the 2000s.

Wealth distribution

Wealth, in economic terms, is defined as the value of an individual's or household's total assets minus his or its total liabilities. The components of wealth include assets, both monetary and non-monetary, and income. [28] Wealth is accrued over time by savings and investment. Levels of savings and investment are determined by an individual's or a household's consumption, the market real interest rate, and income. Individuals and households with higher incomes are more capable of saving and investing because they can set aside more of their disposable income to it while still optimizing their consumption functions. It is more difficult for lower-income individuals and households to save and invest because they need to use a higher percentage of their income for fixed and variable costs thus leaving them with a more limited amount of disposable income to optimize their consumption. Accordingly, a natural wealth gap exists in any market as some workers earn higher wages and thus are able to divert more income towards savings and investment which build wealth.

The wealth gap in the United States is large and the large majority of net worth and financial wealth is concentrated in a relatively very small percentage of the population. Sociologist and University of California-Santa Cruz professor G. William Domhoff writes that "numerous studies show that the wealth distribution has been extremely concentrated throughout American history" and that "most Americans (high income or low income, female or male, young or old, Republican or Democrat) have no idea just how concentrated the wealth distribution actually is." [29] In 2007, the top 1% of households owned 34.6% of all privately held wealth and the next 19% possessed 50.5% of all privately held wealth. Taken together, 20% of Americans controlled 85.1% of all privately held wealth in the country. [30] [31] In the same year, the top 1% of households also possessed 42.7% of all financial wealth and the top 19% owned 50.3% of all financial wealth in the country. Together, the top 20% of households owned 93% of the financial wealth in the United States. Financial wealth is defined as "net worth minus net equity in owner-occupied housing." [30] In real money terms and not just percentage share of wealth, the wealth gap between the top 1% and other portions of the population is immense. The average wealth of households in the top 1% of the population was $13.977 million in 2009. This is fives times as large as the average household wealth for the next four percent (average household wealth of $2.7 million), fifteen times as large as the average household wealth for the next five percent (average household wealth of $908,000), and twenty-nine times the size of the average household wealth of the next ten percent of the population (average household wealth of $477,000) in the same year. Comparatively, the average household wealth of the lowest quintile was -$27,000 and the average household wealth of the second quintile (bottom 20-40th percentile of the population) was $5,000. The middle class, the middle quintile of the population, has an average household wealth level of $65,000. [32]

According to the Congressional Budget Office, the real, or inflation-adjusted, after-tax earnings of the wealthiest one percent of Americans grew by 275% from 1979 to 2007. Simultaneously, the real, after-tax earnings of the bottom twenty percent of wage earnings in the United States grew 18%. The difference in the growth of real income of the top 1% and the bottom 20% of Americans was 257%. The average increase in real, after-tax income for all U.S. households during this time period was 62% which is slightly below the real, after-tax income growth rate of 65% experienced by the top 20% of wage earners, not accounting for the top 1%.[ citation needed ]} Data aggregated and analyzed by Robert B. Reich, Thomas Piketty, and Emmanuel Saez and released in a New York Times article written by Bill Marsh shows that real wages for production and non-supervisory workers, which account for 82% of the U.S. workforce, increased by 100% from 1947 to 1979 but then increased by only 8% from 1979–2009. Their data also shows that the bottom fifth experienced a 122% growth rate in wages from 1947 to 1979 but then experienced a negative growth rate of 4% in their real wages from 1979–2009. The real wages of the top fifth rose by 99% and then 55% during the same periods, respectively. [33] Average real hourly wages have also increased by a significantly larger rate for the top 20% than they have for the bottom 20%. Real family income for the bottom 20% increased by 7.4% from 1979 to 2009 while it increased by 49% for the top 20% and increased by 22.7% for the second top fifth of American families. [34] [35] As of 2007, the United Nations estimated the ratio of average income for the top 10% to the bottom 10% of Americans, via the Gini Coefficient, as 15.9:1. The ratio of average income for the top 20% to the bottom 20% in the same year and using the same index was 8.4:1. According to these UN statistics, the United States has the third highest disparity between the average income of the top 10% and 20% to the bottom 10% and bottom 20% of the population, respectively, of the OECD (Organization for Economic Co-operation and Development) countries. Only Chile and Mexico have larger average income disparities between the top 10% and bottom 10% of the population with 26:1 and 23:1, respectively. Consequently, the United States has the fourth highest Gini Coefficient of the OECD countries at 40.8% which is lower than Chile's (52%), Mexico's (51%), and just lower than Turkey's (42%).

Tax structure

A 2011 Congressional Research Service report stated, "Changes in capital gains and dividends were the largest contributor to the increase in the overall income inequality. Taxes were less progressive in 2006 than in 1996, and consequently, tax policy also contributed to the increase in income inequality between 1996 and 2006. But overall income inequality would likely have increased even in the absence of tax policy changes." [11] Since 1964, the U.S. income tax, including the capital gains tax, has become less progressive (although recent changes have made the federal tax code the most progressive since 1979). [36] The estate tax, a highly progressive tax, has also been reduced over the last decades. [37]

A progressive tax code is believed to mitigate the effects of recessions by taking a smaller percentage of income from lower-income consumers than from other consumers in the economy so they can spend more of their disposable income on consumption and thus restore equilibrium. [38] This is known as an automatic stabilizer as it does not need Congressional action such as legislation. It also mitigates inflation by taking more money from the wealthiest consumers so their large level of consumption does not create demand-driven inflation. [38]

Wealth distribution in the United States by net worth (2007). [39] The net wealth of many people in the lowest 20% is negative because of debt. [39] By 2014 the wealth gap deepened.
  1. Top 1% (34.6%)
  2. Next 4% (27.3%)
  3. Next 5% (11.2%)
  4. Next 10% (12.0%)
  5. Upper Middle 20% (10.9%)
  6. Middle 20% (4.00%)
  7. Bottom 40% (0.20%)

Policy responses

Public policy responses addressing causes and effects of income inequality include: progressive tax incidence adjustments, strengthening social safety net provisions such as Aid to Families with Dependent Children, welfare, the food stamp program, Social Security, Medicare, and Medicaid, increasing and reforming higher education subsidies, increasing infrastructure spending, and placing limits on and taxing rent-seeking. [70] Other reforms include raising the minimum wage, tax reform. [71]

Taxes on the wealthy

The Congressional Budget Office reported that less progressive tax and transfer policies contributed to an increase in after-tax income inequality between 1979 and 2007. [72] Sales taxes and payroll taxes are examples of regressive taxes that tend to have a greater impact on low-income households compared to high-income households. This indicates that more progressive income tax policies (e.g., higher income taxes on the wealthy and a higher earned-income tax credit) would reduce after-tax income inequality. As a result, progressive taxation, which imposes higher tax rates on higher-income individuals, is often seen as a mechanism to reduce income inequality by redistributing wealth to those with lower incomes. [73]

In their World Inequality Report published in December 2017, Piketty, Saez and coauthors revealed that in "Russia and the United States, the rise in wealth inequality has been extreme, whereas in Europe it has been more moderate." [74] :16 They reported that the tax system in the United States, along with "massive educational inequalities", have grown "less progressive despite a surge in top labor compensation since the 1980s, and in top capital incomes in the 2000s." [74] :10 The "top 1% income share was close to 10% in the [US and Europe] in 1980, it rose only slightly to 12% in 2016 in Western Europe [where taxation and education policies are more progressive] while it shot up to 20% in the United States." The "bottom 50% income share decreased from more than 20% in 1980 to 13% in 2016." [74] :10 In 2012, the economists Emmanuel Saez and Thomas Piketty had recommended much higher top marginal tax rates on the wealthy, up to 50 percent, 70 percent or even 90 percent. [75]

Ralph Nader, Jeffrey Sachs, the United Front Against Austerity, among others, call for a financial transactions tax (also known as the Robin Hood tax) to bolster the social safety net and the public sector. [76] [77] [78]

The Pew Center reported in January 2014 that 54% of Americans supported raising taxes on the wealthy and corporations to expand aid to the poor. By party, 29% of Republicans and 75% of Democrats supported this action. [79]

Millionaire tax


Previously, Senators Charles Schumer and Bernie Sanders advocated limiting stock buybacks in January 2019. They explained that from 2008-2017, 466 of the S&P 500 companies spent $4 trillion on stock buybacks, about 50% of profits, with another 40% going to dividends. During 2018 alone, a record $1 trillion was spent on buybacks. Stock buybacks shift wealth upwards, because the top 1% own about 40% of shares and the top 10% own about 85%. Further, corporations directing profits to shareholders are not reinvesting the money in the firm or paying workers more. They wrote: "If corporations continue to purchase their own stock at this rate, income disparities will continue to grow, productivity will suffer, the long-term strength of companies will diminish — and the American worker will fall further behind." Their proposed legislation would prohibit buybacks unless the corporation has taken other steps first, such as paying workers more, providing more benefits such as healthcare and pensions, and investing in the community. To prevent corporations from shifting from buybacks to dividends, they proposed limiting dividends, perhaps by taking action through the tax code. [80]

Ultra-millionaire tax

Senator Elizabeth Warren proposed an annual tax on wealth in January 2019, specifically a 2% tax for wealth over $50 million and another 1% surcharge on wealth over $1 billion. Wealth is defined as including all asset classes, including financial assets and real estate. Economists Emmanuel Saez and Gabriel Zucman estimated that about 75,000 households (less than 0.1%) would pay the tax. The tax would raise around $2.75 trillion over 10 years, roughly 1% of GDP on average per yearuld raise the total tax burden for those subject to the wealth tax from 3.2% relative to their wealth under current law to about 4.3% on average, versus the 7.2% for the bottom 99% families. [81] For scale, the federal budget deficit in 2018 was 3.9% GDP and is expected to rise towards 5% GDP over the next decade. [82] The plan received both praise and criticism. Two billionaires, Michael Bloomberg and Howard Schultz, criticized the proposal as "unconstitutional" and "ridiculous," respectively. Warren was not surprised by this reaction, stating: "Another billionaire who thinks that billionaires shouldn't pay more in taxes." [83] Economist Paul Krugman wrote in January 2019 that polls indicate the idea of taxing the rich more is very popular. [84]

Billionaire tax

Ron Wyden introduced the S.3367 - Billionaires Income Tax Act in 2023. [85]

Infrastructure Spending

OECD asserted that public spending is vital in reducing the wealth gap. [86] Enhanced infrastructure has the potential to tackle both the root causes and the consequences of inequality. For instance, workers who face mobility constraints might benefit from upgraded public transportation systems, enabling them to commute to better-paying jobs that are located further away from their residences and to access essential services more affordably. [87]

Minimum wages

The minimum wage is significant to consider since it has been a popular public policy for decreasing poverty and redistributing income (Levin-Waldman, 2001). [88] In the United States, states have the authority to determine their own minimum wages, independent of the federal government. If there's a discrepancy between the state and federal minimum wages, the higher wage takes precedence. As of August 2022, 30 states had a minimum wage higher than the federal minimum. [89] The minimum wage reduces inequality, particularly among the lowest earners (Engelhardt & Purcell, 2021; [90] Autor & Smith, 2016 [91] ).

In February 2014, the Congressional Budget Office (CBO) analyzed the impacts on employment and family income of two options (the $10.10 option and the $9.00 option) for increasing the federal minimum wage. Both options lead to overall real income rise, with particularly positive effects on families below the poverty threshold, significantly boosting their income and reducing the number of people in poverty. In additional, under both the minimum wage increase options, families earning more than six times the poverty threshold would experience a net decrease in real income: $17 billion and 0.4% for the $10.10 option, and $4 billion and about 0.1% for the $9.00 option. These two strategies illustrate how higher minimum wages can reduce income inequality by redistributing income from wealthier to poorer households. [92]

Social Security and Medicare

Burkhauser et al. (2013) indicate that measured inequality is about 25 to 30 percent smaller if the average cost of Medicare and Medicaid benefits are added to recipients’ incomes. [93] Kaestner and Lubotsky (2016) indicated that Medicare and Medicaid reduce inequality of well-being, and government-subsidized health insurance significantly reduces income inequality. [94]

In the President proposed budget for 2025, President Biden has unequivocally stated his opposition to any reductions or compromises to the Medicare or Social Security benefits that seniors and disabled individuals have earned and paid to throughout their careers. [95]

The budget strengthens Medicare by extending the solvency of the Medicare Hospital Insurance (HI) trust fund, increasing the Medicare tax rate on incomes above $400,000, closing loopholes in existing taxes, and directing revenue from the Net Investment Income Tax into the HI trust fund. The tax rate is raised from 3.8% to 5 percent for those with incomes over $400,000. Additionally, the budget directs savings from proposed Medicare drug reforms into the HI trust fund.The budget also invests in staff, information technology, and improvements at the Social Security Administration (SSA), aiming to enhance customer service at field offices, State disability determination services, and teleservice centers for retirees, individuals with disabilities, and their families. [95]

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See also