How much can taxes curb inequality?

The Wall Street Journal's David Wessel has an excellent piece Monday on what academic research tells us about taxes and inequality in the United States. The short version: Inequality has exploded in the past three decades. Taxes, meanwhile, have gotten more progressive — though not enough to counteract that increase in inequality.

I've made the graph below to illustrate that latter fact. The red line shows how much taxes and transfers (such as food stamps) have done to reduce inequality between 1979 and 2009. The data comes from table nine here. The blue line, meanwhile, shows how much more progressive taxes and transfers would have had to be in order to maintain 1979 levels of economic equality.

In 2009, taxes and transfers reduced inequality by 26.4 percent, around the same amount as the 24.8 percent reduction in 1979. But the tax code actually has to become more and more progressive every year to prevent inequality from growing. Taxes and transfers needed to reduce inequality by 38.2 percent in 2009 to keep it down to 1979 levels.

Is that impossible? There are certainly countries out there that are reducing their pre-tax/transfer inequality by well over 38.2 percent. According to the latest OECD figures, many European social democracies — including France, Germany, Sweden and Denmark, and many Eastern European countries, like Slovakia, the Czech Republic and Slovenia — reduced inequality by more than that through taxes and transfers:

 

But are there countries where after-tax inequality has stayed essentially flat even as pretax inequality rose? Actually, yes. The OECD's historical data is not great on this topic, but it does indicate that some (though not all) of our peer countries have increased the progressivity of their tax codes:

Japan, Britain and Italy all starting reducing inequality by more and more as the years went by, and indeed kept pace with the progressivity increases the United States would have needed to maintain 1975 level inequality. Interestingly, Sweden, Finland and Germany didn't keep pace, in part because their tax codes were already so progressive.

All of which is to say: There is a lot of room to reduce inequality through the tax code. It's not the only way. As Dean Baker argues in his latest book, "The End of Loser Liberalism," there are a lot of pretax market distortions imposed by the government that exacerbate inequality, and Matt Yglesias and Ryan Avent would be quick to tell you that housing regulations are a big part of the story. But there's a lot of room yet in the tax code for tackling the issue.

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Suzy Khimm · August 6, 2012