Monday, October 25, 2010

Tax Rate Increases Worsen the Distribution of Income

A growing body of academic literature suggests that uneven distribution of economic gains may be troublesome for democracy.  Using IRS data, Professors Thomas Piketty (Paris School of Economics) and Emmanuel Saez (UC Berkeley) plot the share of pre-tax income flowing to the top 1% of earners between 1913 and 2008.  The graph (Figure 2) shows that the share peaked in 1928 at 24%, after which it underwent a steady decline to 9% in 1975 (with some ups and downs along the way in the 1930s and 1940s).

The share accruing to the top 1% remained steady during 1976-80.  It then rose to 16% in 1988 at the end of Reagan’s presidency.  After falling slightly to just over 14% under President George H.W. Bush, it shot up sharply under President Clinton, peaking at 22%.  The dot-com bust reduced it to 17% in 2003, thereafter rising to 23% in 2007, settling at 21% in 2008 at the end of Bush’s second term.

Taking the starting and ending points of the Clinton and Bush presidencies, the share of income flowing to the top 1% under Clinton rose 57%; under George W. Bush, it actually fell.

Why are these gains and losses important?  Some commentators have argued that President Bush’s tax-rate reductions worsened the distribution of income by giving tax breaks to the top 2%.  In fact, the top 1% did worse at the end of the Bush’s presidency.

In stark contrast, the top 1% flourished under President Clinton.  Recall that two new rates of 36% and 39.6% were added to the previous rates of 15%, 28%, and 31% in the Clinton years.  On this evidence, it’s hard to argue that restoring the Clinton rates is required to improve the distribution of income.

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