Surprise! When the rich get richer, taxes go lower

As you're probably aware, the share of income in the U.S. held by the top one percent has grown considerably in recent decades. The latest data by inequality experts Thomas Piketty and Emmanuel Saez estimates that the top one percent has gone from taking home a low of 8.87 percent of total income in 1975 to taking 19.82 percent in 2011. And it was even higher pre-crisis; their 2007 share was 23.5 percent.

But what you may not know is that this was far from a universal phenomenon. Other Anglophone nations, like the UK, Canada, Australia, New Zealand and Ireland, experienced gains for top earners (albeit smaller ones than in the United States), but Japan, France and Germany barely saw any change.

In a new paper with Facundo Alvaredo and Anthony Atkinson, Piketty and Saez look at how these different countries changed their tax policies as inequality grew. The answer, perhaps unsurprisingly, is that countries where inequality grew the most also saw the biggest cuts in top marginal tax rates for wealthy earners:

How to interpret this is a difficult question to answer. Alvaredo, Atkinson, Piketty and Saez note University of Michigan tax expert Joel Slemrod's explanation that lower rates reduced incentives for tax avoidance, which likely led top earners to report more income than they normally would. However, this doesn't jibe with the fact that when you include capital gains income, a major avoidance mechanism, the increase in income shares barely changes at all.

Lawrence Lindsey and Martin Feldstein have argued that cuts in rates led to increased economic activity among top earners, leading to more growth and income. That's the conventional supply-side story. But you could also tell a story where lower tax rates increased the after-tax income of the rich, and that in turn increased their political power, which produced still lower rates.

 

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Dylan Matthews · May 28, 2013