But we rarely look at the numbers on the other side of the tax equation: not the top rates, but rather the levels of income at which they kick in. This is an extremely important distinction, particularly at the top of the income distribution. There’s very little difference between families at the 50th and 51st percentiles of the income spectrum, for instance. But the difference in income between the top 1 percent and the top 0.1 percent — or 0.01 percent — is massive.
In 2014, for instance, you needed to make about $478,000 to be part of the 1 percent in the United States. You’d need five times as much income — about $2 million — to make it to the 0.1 percent. And the price of entry for the top 0.01 percent — the 1 percent of the 1 percent — was $10 million.
Given the huge differences, one might reasonably expect that we tax those top incomes very differently as well. But a brief glance at the tax brackets in place for the 2014 tax year shows that’s not the case. That year the top rate kicked in at about $430,000 for a head of household. Beyond that it didn’t matter how much you made — $430,000, $4.3 million, or $43 million — it was all the same as far as the tax man was concerned. The progressivity of the U.S. tax system stalled out at the top percentile of income.
To find out, I’ve plotted the upper limit of the top tax bracket against the income thresholds for the 1 percent, the 0.1 percent and the 0.01 percent going back to 1913.
That’s . . . interesting, but it’s not exactly useful. We can see that the top tax bracket was well above the 0.01 percent income threshold in the 1930s, but that’s about it. Nominal incomes have grown so much since then, particularly in the past 40 years, that it obscures what’s happening on the left side of the chart. To get around this I’ll switch the y-axis to a logarithmic scale, which will stretch everything out to make it easier to see the differences between the trendlines while keeping the overall relationship between them the same.
That’s much better, and it shows something interesting: From 1913 until about 1970, the top tax bracket was set well above 1 percent income threshold, and for most of that period above the 0.1 percent and 0.01 percent thresholds as well. What that means, practically speaking, is that the tax code was sensitive to the extreme differences you see at the very top of the income spectrum. The top 0.01 percenters were taxed at higher rates than the 0.1 percent, who in turn were taxed higher than the 1 percent.
But right around 1970, that starts to change. The top tax bracket stalls out at about $180,000 just as the uppermost income thresholds creep past it. By 1980, the tax brackets top out at the 0.1 percent income threshold, and several years later, they drop even further: By 1982, the top rate kicks in at $62,000, well under the 1 percent income threshold of $86,000.
Those bills essentially put in place our tax equilibrium. There’s a big difference between making $500,000 and $50 million a year: You might call it the difference between “rich” and “ultrarich.” But today, the IRS treats those levels of income the same, subjecting them to a 37 percent tax and no more.
Many economists believe that several decades of relatively low tax rates on top earners have contributed to the skyrocketing income inequality we observe today. As a 2012 Congressional Research Service report noted, the top tax rate cuts of the postwar decades “appear to be associated with the increasing concentration of income at the top of the income distribution,” while having “little association with saving, investment, or productivity growth.”
Among many policymakers, there’s a growing realization that income inequality is a significant problem. Federal Reserve Chairman Jerome H. Powell called income inequality the nation’s greatest economic challenge.
One way to address inequality would be to raise tax rates at the top of the income spectrum: “a more progressive tax system would reduce income inequality if nothing else changes,” as the Tax Policy Center has noted. To do that, policymakers may need to break with recent precedent and return to a system with differential rates at the very top of the income distribution.