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The Role of Taxes in Mitigating Income Inequality across the U.S. States
Abstract
This paper examines the role that federal and especially state tax policies play in mitigating income inequality. The results show that the tax code reduces income inequality considerably in all states. All of this income compression is attributable to federal taxes, as state taxes, on average, widen the after-tax income distribution slightly Nevertheless, there is very substantial cross-state variation in the impact of state tax policies. The paper further documents that the mitigating influence of taxes on income inequality has risen since the early 1980s, with the increase at the state level due mostly to changes to the tax code.
... However, deductions for salaried taxpayers such as social security contributions contribute the most in reducing income inequality. Cooper et al. (2015) confirmed that exemptions for food and clothing from some states' sales tax narrows the after tax income distribution. ...
... This is in line with both the optimal and tax incidence theories that an increase in PIT will reduce income inequality due to their progressive nature whiles an increase in VAT will lead to an increase in income inequality due to its regressive nature. Iosifidi and Mylonidis (2017) and Cooper et al. (2015) also confirm that consumption taxes represented by VAT in our study worsens income inequality whiles direct taxes comprising PITs and corporate taxes ameliorate income inequality. Notes: ***, **, * represent significance at p < 0.01, p < 0.05 and p < 0.1, respectively. ...
Purpose
This study aims to determine how taxes can be used to bridge income inequality gap in sub-Saharan Africa (SSA).
Design/methodology/approach
A panel data set of 36 SSA countries was analysed using generalised method of moments.
Findings
The results suggest that an increase in direct taxes relative to indirect taxes has a positive significant impact on income inequality. This is mostly due to the progressive nature of direct taxes as compared to indirect taxes.
Originality/value
This research contributes to the scant literature on how specific tax components affect income inequality, especially in developing countries.
... Although USA redistributes less than other wealthy democracies, tax policy plays an outsized role; in fact, USA is the only rich country where the impact of taxation is as important as direct government transfers in reducing income inequality (Joumard et al. 2012). This effect is typically attributed to the US federal income tax, yet recent evidence suggests that nearly one-third of the mitigating effect of US tax policy on the growth of market inequality since 1980 has been due to state tax policy (Cooper et al., 2015). At the same time, state and local governments spend more than $3 trillion per year on education, will result in an increase in the dollar-weighted average marginal tax rate despite no change in state income tax policy. ...
... Amidst the backdrop of increased antipathy toward income taxation among elites (Steinmo, 2003) and the general public (Campbell, 2009) since 1980, income taxation has nevertheless been an active area of policy-making as the states have embraced the income tax code as a tool to promote economic growth as well as a site for redistribution via direct income transfers (through refundable tax credits such as the EITC). This, in turn, fuels substantial variation in the effect of state tax codes on income inequality: in some states taxes serve to reduce income differences between rich and poor, whereas in other states tax policy actually exacerbates market inequality (Cooper et al., 2015). Analyzing the social correlates of state income taxation, therefore, has the potential to yield novel insights into the politics of redistribution (Kelly, 2009) and welfare state dynamics (see Bartels, 2005). ...
This article examines the social correlates of US state income tax policy-making between 1980 and 2008. We focus on the three factors the existing research suggests that are relevant to redistributive policy-making: income structure, left power resources and racial composition. We employ a holistic measure of state income taxation—the dollar-weighted average marginal tax rate—that captures both the overall level of taxation as well as the distribution of tax incidence, key determinants of the redistributive effect of income tax policy. Our analyses examine within-state changes over time as estimated using both actual and fixed income distributions, which enables us to isolate real changes in tax policy from shifts in the income distribution. We find evidence that increases in the percentages of Black and Hispanic residents are associated with a decrease in average marginal tax rate on wage income. We situate these findings within the broader literature on the social determinants of redistributive policy-making.
... Contrary to reality labor force participation was found effecting positively to income inequality which means with the participation of the labor force income inequalities are increasing. Cooper et al. (2015) analyzed the role of tax policies and their effect on mitigating income inequalities. This paper concluded that tax reduces income inequalities substantially in all states. ...
This paper investigates the impact of income inequality and economic growth on tax revenues within the context of six SAARC countries, using panel data from 1990 to 2021. By applying various econometric models, including Pooled Ordinary Least Squares (POLS), Fixed Effects (FE), Random Effects (RE), and Pooled Mean Group (PMG), the study evaluates the relationship between tax-to-GDP ratios and key variables like GDP, income inequality (GINI), economic freedom, and employment. Results from the Random Effects model indicate that income inequality negatively affects tax revenues, while GDP growth, economic freedom, and employment have positive and significant impacts. The PMG model further supports these findings, revealing long-term equilibrium relationships. This research contributes to understanding the economic determinants of tax buoyancy in developing countries, highlighting policy implications for balancing income redistribution and economic efficiency.
... The result has been wide crossstate variability in the structure of social welfare systems. State-to-state variation in welfare state characteristics is now greater than across many countries (Bruch et al., 2018b) and the inequality-reducing effects of state tax systems vary considerably (Cooper et al., 2015). Thirty-two states, including the District of Columbia, supplement the federal EITC with additional EITClike policies (Urban Institute and Brookings Institution, 2022). ...
Building off the success of the federal earned income tax credit (EITC), states have developed earned income credits to supplement the incomes of the working poor. In 2016, a distinctive change to the Oregon Earned Income Credit (OEIC) targeted additional resources to families with young children. Using a unique data set and static estimates, we found that the OEIC yielded proportional decreases in child and young child poverty of 1.8 and 2.6%, respectively. By simulating alternative OEIC policies, we also found that significant increases to OEIC rates or takeup would be required to more aggressively reduce child poverty.
... Tennessee lacks a broad-based income tax and instead relies on higher sales taxes -the secondhighest combined state and local sales tax rate in the nation -for state funding. 2,3 Tennessee provides $2.5 billion annually in tax incentives to businesses, the fourthhighest business tax incentive rate in the nation. 4 Yet both Nashville and the State of Tennessee struggle to maintain balanced budgets and fund government operations. ...
The City of Nashville has grown rapidly in the past decade, bringing with it increased opportunity for the city, but also growing pains via displacement, gentrification, and congestion. This paper grapples with the dilemmas we have as planners when working in a place that we love and balancing nostalgia with desire for improvements in our communities.
... Finally, although states have always had considerable flexibility in policy design and administration, especially with respect to cash welfare, the 1996 reforms facilitated a substantial increase in state policy variation, particularly for programs affected by PRWORA (Bruch, Meyers, & Gornick, 2018). This trend has also continued throughout the decade in a wide range of explicit and implicit family policy domains, including state Medicaid (Buettgens, Holahan, & Recht, 2015;Courtemanche, Marton, Ukert, Yelowtiz, & Zapata, 2016;Rose, 2015) and EITC expansions (Cooper, Lutz, & Palumbo, 2015;Williams, 2015), cash benefits (Schott, Pavetti, & Floyd, 2015;Stanley & Floyd, 2016), prekindergarten programs (Bartik & Hershbein, 2018;Friedman-Krauss, Barnett, & Nores, 2016), and paid family leave (Isaacs, Healy, & Peters, 2017). ...
Prior Journal of Marriage and Family decade‐in‐review articles have grappled with the definition and role of family policy for research and policy practice while emphasizing its value to both. In this article, we begin with a broad conceptualization of family policy that encompasses actions intended to achieve explicitly stated goals for families (explicit policies) and those that affect families without an explicitly stated goal for doing so (implicit policies), which we believe provides a solid framework for guiding and understanding both research and practice in the field. Second, we review major U.S. policy initiatives in the past decade and their documented and potential effects on families. Third, we describe several key aspects by which contemporary families have become more diverse and complex. Fourth, we discuss the implications of ongoing family complexity for public policies. We conclude with a discussion about future research and policy development in the context of contemporary family complexity.
... Most such work focuses on the impact of tax policy on inequality in the United States by comparing pre-tax inequality to post-tax inequality (Piketty and Saez, 2007; 3 Documents de travail du Centre d'Economie de la Sorbonne -2016.32 Debacker et al., 2013;Bargain et al., 2015;Cooper et al., 2015). For instance, Piketty and Saez (2007) and Debacker et al. (2013) show a positive effect of the federal tax system in the reduction in income inequality in the United States. ...
Over the past two decades, research on the impacts of a diverse range of public policies and income inequality has seen rapid growth. Despite the large number of publications to date, there remain important lacunae in our understanding of how policy interventions might help to reduce income inequality. This paper aims to fill this void by providing a systematic literature review of 270 publications that examine four key policy areas: (1) tax policy, (2) social benefits, (3) labour market interventions, and (4) education policy. We describe patterns of empirical findings and implications drawn from the reviewed publications. The strengths and weaknesses of the existing literature are also discussed, along with potential future research avenues.
State governments have a long history of providing income tax relief to their elderly constituents. Our research investigates the current distributional and revenue effects of these tax breaks, as well as the economic status of the elderly, and explores how these measures have changed since 1990. Using data from the 1990 Integrated Public Use Microdata Series and the 2013 American Community Survey, combined with the TAXSIM calculator, we calculate current state income tax liabilities and revenues and simulate the effects of removing all age-related tax breaks. Our analyses reveal that the economic well-being of the elderly has grown substantially relative to the nonelderly and that state tax breaks primarily benefit the middle- and upper-income elderly. Revenue costs of these tax breaks have also grown substantially, and their modest and mixed effects on income equality, measured by changes in the Gini, cast doubt on equity as a justification.
Direct income supports have long been known to substantially reduce the extent and depth of poverty. Evidence suggests that they can also bolster children's opportunities to succeed and enhance long-term mobility. A growing body of research, for example, links income from 2 related tax credits for working families—the Earned Income Tax Credit and the Child Tax Credit—to benefits for children in those families, such as improved birth weight, better school outcomes, and increased rates of employment in adulthood. Similarly, the introduction of food stamps has been found to improve not only the birth weight of infants given access to the program but also their educational achievement, as well as indicators of health, well-being, and self-sufficiency decades later. These are striking research results for income support that is not typically thought of as improving children's health or education. The mechanisms through which these income supports lead to such benefits are likely varied and complex, but emerging research suggests that helping families with children afford basic necessities can reduce the added stress of financial difficulties, preventing downstream neuroendocrine and biochemical changes that affect children's longer-term outcomes. These findings have important implications for policy makers. Research suggests that potential weakening of the safety net would not only substantially increase poverty, but also have damaging long-term effects on children. Policy makers should reject funding cuts and instead strengthen the safety net, which this analysis suggests could reduce poverty further and also enhance children's opportunities to succeed.
This paper reviews the current evidence on the incidence of the corporate tax from Harberger-type general equilibrium models, with special attention to the open economy. The analysis identifies the major drivers of the results from open-economy models and compares estimates from four major studies that have examined corporate tax incidence in an open economy. Adjusting estimates from the studies to reflect central empirical estimates of key elasticities suggests that capital bears the majority of the corporate tax burden. The paper also presents an alternative method, based on the new view of property tax incidence, for allocating the corporate tax burden that distinguishes between the global effects of corporate taxes and excise effects that vary among nations.
Wage inequality has risen dramatically in the United States since at least 1980. This paper quantifies the role that the tax policies of the federal and state governments have played in mitigating wage inequality. The analysis, which isolates the contribution of federal taxes and state taxes separately, employs two approaches. First, cross-sectional estimates compare before-tax and after-tax inequality across the 50 states and the District of Columbia. Second, inequality estimates across time are calculated to assess the evolution of the effects of tax policies. The results from the first approach indicate that the tax code reduces wage inequality substantially in all states. On average, taxes reverse approximately the last two decades of growth in wage inequality. Most of this compression of the income distribution is attributable to federal taxes. Nevertheless, there is substantial cross-state variation in the extent to which state tax policies compress the income distribution. Cross-state differences in gasoline taxes have a surprisingly large impact on income compression, as do sales tax exemptions for food and clothing. The results of the second approach indicate that the mitigating influence of tax policy on wage inequality has increased very modestly since the early 1980s. The increase is due to the widening of the pre-tax wage distribution interacting with a progressive tax structure. In contrast, legislated tax changes over this period decreased income compression somewhat.
Recent research has documented that income inequality in the United States has increased dramatically over the prior three decades. There has been less of a consensus, however, on whether the increase in income inequality was matched by an equally large increase in consumption inequality. Most researchers have studied this question using data from the Consumer Expenditure Survey (CE) and some studies have suggested that the increase in consumption inequality has been modest. Unfortunately ,there is now mounting evidence that the CE is plagued by serious non-classical measurement error, which hinders the extent to which definitive conclusions can be made about the extent to which consumption inequality has evolved over the last three decades.In this paper, we use a variety of different techniques to overcome the measurement error problems with the CE. First, we use data from the diary component of the CE, focusing on categories where measurement error has been found to be less of an issue. Second, we explore inequality measures within the CE using the value of vehicles owned, a consumption component that is considered to be measured well. Third, we try to account directly for the non-classical measurement error of the CE by comparing the spending on luxuries (entertainment) relative to necessities (food). This is similar to the recent approach taken by Browning and Crossley (2009) and Aguiar and Bils (2011). Finally, we use expenditure data from the Panel Study of Income Dynamics to explore the dynamics of alternative measures of consumption inequality. All of our different methods yield similar results. We find that consumption inequality within the U.S. between 1980 and 2010 has increased by nearly the same amount as income inequality.Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.
We assess the effects of U.S. tax policy reforms on inequality by applying a new decomposition method that allows us to disentangle mechanical effects due to changes in pre-tax incomes from direct effects of policy reforms. While tax reforms implemented under Democrat administrations, in particular the EITC reforms in the 1990s and the ARRA in 2009, had an equalizing effect at the lower half of the distribution, the disequalizing effects of Republican reforms are due to tax cuts for high-income families. As a consequence of partisan politics, overall policy effects almost cancel out over the whole time period.
This paper critically surveys the large and growing literature estimating the elasticity of taxable income with respect to marginal tax rates using tax return data. First, we provide a theoretical framework showing under what assumptions this elasticity can be used as a sufficient statistic for efficiency and optimal tax analysis. We discuss what other parameters should be estimated when the elasticity is not a sufficient statistic. Second, we discuss conceptually the key issues that arise in the empirical estimation of the elasticity of taxable income using the example of the 1993 top individual income tax rate increase in the United States to illustrate those issues. Third, we provide a critical discussion of selected empirical analyses of the elasticity of taxable income in light of the theoretical and empirical framework we laid out. Finally, we discuss avenues for future research. ( JEL H24, H31, J22)
Using internal and public use March Current Population Survey data, we analyze trends in US income inequality (1975–2004). Using a multiple imputation approach where values for censored observations are imputed using draws from a Generalized Beta distribution of the Second Kind, we find that the upward trend in income inequality significantly slowed after 1993. Our results closely match the income share trends reported by Piketty and Saez (2003) except for within the top 1 percent of the distribution. Thus, we argue that if inequality has increased substantially since 1993, such increases are confined to this very high income group.
We conduct a systematic empirical study of cross-sectional inequality in the United States, integrating data from the Current Population Survey, the Panel Study of Income Dynamics, the Consumer Expenditure Survey, and the Survey of Consumer Finances. In order to understand how different dimensions of inequality are related via choices, markets, and institutions, we follow the mapping suggested by the household budget constraint from individual wages to individual earnings, to household earnings, to disposable income, and, ultimately, to consumption and wealth. We document a continuous and sizable increase in wage inequality over the sample period. Changes in the distribution of hours worked sharpen the rise in earnings inequality before 1982, but mitigate its increase thereafter. Taxes and transfers compress the level of income inequality, especially at the bottom of the distribution, but have little effect on the overall trend. Finally, access to financial markets has limited both the level and growth of consumption inequality. (Copyright: Elsevier)
Children in households reporting the receipt of free or reduced price school meals through the National School Lunch Program (NSLP) are more likely to have negative health outcomes than eligible nonparticipants. Assessing the causal effects of the program is made difficult, however, by the presence of endogenous selection into the program and systematic misreporting of participation status. Using data from the National Health and Nutrition Examination Survey (NHANES), we extend and apply partial identification methods to account for these two identification problems in a single unifying framework. Similar to a regression discontinuity design, we introduce a new way to conceptualize the monotone instrumental variable (MIV) assumption using eligibility criteria as monotone instruments. Under relatively weak assumptions, we find evidence that receipt of free and reduced price lunches through the NSLP improves the health outcomes of children.
Twenty-two million families currently receive a total of $34 billion dollars in benefits from the Earned Income Tax Credit (EITC). In fact, the EITC is the largest cash transfer program for lower-income families at the federal level. An unusual feature of the credit is its explicit goal to use the tax system to encourage and support those who choose to work. A large body of work has evaluated the labor supply effects the EITC and has generated several important findings regarding the behavioral response to taxes. Perhaps the main lesson learned from the evidence is the confirmation that real responses to taxes are important; labor supply does respond to the EITC. The second major lesson is related to the nature of the labor supply response. A consistent finding is that labor supply responses are concentrated along the extensive (entry) margin, rather than the intensive (hours worked) margin. This distinction has important implications for the design of tax-transfer programs and for the welfare evaluation of tax reforms.
A recent "revisionist" literature characterizes the pronounced rise in U.S. wage inequality since 1980 as an "episodic" event of the first half of the 1980s driven by nonmarket factors (particularly a falling real minimum wage) and concludes that continued increases in wage inequality since the late 1980s substantially reflect the mechanical confounding effects of changes in labor force composition. Analyzing data from the Current Population Survey for 1963 to 2005, we find limited support for these claims. The slowing of the growth of overall wage inequality in the 1990s hides a divergence in the paths of upper-tail (90/50) inequality-which has increased steadily since 1980, even adjusting for changes in labor force composition-and lower-tail (50/10) inequality, which rose sharply in the first half of the 1980s and plateaued or contracted thereafter. Fluctuations in the real minimum wage are not a plausible explanation for these trends since the bulk of inequality growth occurs above the median of the wage distribution. Models emphasizing rapid secular growth in the relative demand for skills-attributable to skill-biased technical change-and a sharp deceleration in the relative supply of college workers in the 1980s do an excellent job of capturing the evolution of the college/high school wage premium over four decades. But these models also imply a puzzling deceleration in relative demand growth for college workers in the early 1990s, also visible in a recent "polarization" of skill demands in which employment has expanded in high-wage and low-wage work at the expense of middle-wage jobs. These patterns are potentially reconciled by a modified version of the skill-biased technical change hypothesis that emphasizes the role of information technology in complementing abstract (high-education) tasks and substituting for routine (middle-education) tasks. Copyright by the President and Fellows of Harvard College and the Massachusetts Institute of Technology.
"We use monthly gasoline price data for all 50 U.S. states over the period 1984-1999 to examine the incidence of state gasoline excise taxes. Our estimation results indicate full shifting of gasoline taxes to the final consumer. In addition, although we find that gasoline retail prices demonstrate asymmetric responses to changes in "gasoline wholesale prices", we find only limited evidence of such behavior for retail prices with respect to "gasoline excise taxes. "Finally, we find that gasoline markets in urban states exhibit full shifting, but those in rural states (with less competition) demonstrate somewhat less than full shifting". ("JEL "H22) Copyright (c) 2008 Western Economic Association International.
How are hourly wages affected by the Earned Income Tax Credit? Using variation in state EITC supplements, I find that a 10 percent increase in the generosity of the EITC is associated with a 5 percent fall in the wages of high school dropouts and a 2 percent fall in the wages of those with only a high school diploma, while having no effect on the wages of college graduates. Given the large increase in labor supply induced by the EITC, this is consistent with most reasonable estimates of the elasticity of labor demand. Although workers with children receive a much larger EITC than childless workers, and the effect of the credit on labor force participation is larger for those with children, the hourly wages of both groups are similarly affected by an EITC increase. As a check on this strategy, I also use federal variation in the EITC across gender-age-education groups, and find that those demographic groups that received the largest EITC increases also experienced a drop in their hourly wages, relative to other groups.
The March Current Population Survey (CPS) is the primary data source for estimation of levels and trends in labor earnings and income inequality in the USA. Time-inconsistency problems related to top coding in theses data have led many researchers to use the ratio of the 90th and 10th percentiles of these distributions (P90/P10) rather than a more traditional summary measure of inequality. With access to public use and restricted-access internal CPS data, and bounding methods, we show that using P90/P10 does not completely obviate time inconsistency problems, especially for household income inequality trends. Using internal data, we create consistent cell mean values for all top-coded public use values that, when used with public use data, closely track inequality trends in labor earnings and household income using internal data. But estimates of longer-term inequality trends with these corrected data based on P90/P10 differ from those based on the Gini coefficient. The choice of inequality measure matters.
This book assembles nine papers on tax progressivity and its relationship to income inequality, written by leading public finance economists. The papers document the changes during the 1980s in progressivity at the federal, state, and local level in the US. One chapter investigates the extent to which the declining progressivity contributed to the well-documented increase in income inequality over the past two decades, while others investigate the economic impact and cost of progressive tax systems. Special attention is given to the behavioral response to taxation of high-income individuals, portfolio behavior, and the taxation of capital gains. The concluding set of essays addresses the contentious issue of what constitutes a 'fair' tax system, contrasting public attitudes towards alternative tax systems to economists' notions of fairness. Each essay is followed by remarks of a commentator plus a summary of the discussion among contributors.
AbstractWe use a new, large, and confidential panel of tax returns to study the persistent-versus-transitory nature of rising inequality in male labor earnings and in total household income, both before and after taxes, in the United States over the period 1987-2009. We apply various statistical decomposition methods that allow for different ways of characterizing persistent and transitory income components. For male labor earnings, we find that the entire increase in cross-sectional inequality over our sample period was driven by an increase in the dispersion of the persistent component of earnings. For total household income, we find that most of the increase in inequality reflects an increase in the dispersion of the persistent income component, but the transitory component also appears to have played some role. We also show that the tax system partly mitigated the increase in income inequality, but not sufficiently to alter its broadly increasing trend over the period.
Do low property taxes attract new home construction? This question is answered using a large shock to property tax burdens caused by an unusual school finance reform in the state of New Hampshire. The estimates suggest that, in most of the state, communities with a reduced tax burden experience a substantial increase in residential construction. In the area of the state near the region's primary urban center (Boston), however, the shock clears through a price adjustment—i.e., by capitalizing into property values. The differing responses are attributed to differing housing supply elasticities.
This paper assesses the effects of U.S. tax policy reforms on inequality over around three decades, from 1979 to 2007. It applies a new method for decomposing changes in government redistribution into (1) a direct policy effect resulting from policy changes and (2) the effects of changing market incomes. Over the period as a whole, the tax policy changes increased income inequality by pushing up the income share of high-income earners (the top 20%). (JEL H23, H31, H53, P16)
Researchers considering levels and trends in the resources available to the middle class traditionally measure the pre-tax cash income of either tax units or households. In this paper, we demonstrate that this choice carries significant implications for assessing income trends. Focusing on tax units rather than households greatly reduces measured growth in middle class income. Furthermore, excluding the effect of taxes and the value of in-kind benefits further reduces observed improvements in the resources of the middle class. Finally, we show how these distinctions change the observed distribution of benefits from the tax exclusion of employer provided health insurance.Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.
We assess the effects of U.S. tax policy reforms on inequality by applying a new decomposition method that allows us to disentangle the direct policy effect from the effect of changing market incomes. Over the whole period 1979-2007 the cumulative tax policy effect aggravated income inequality by increasing the income share of the top 20% in contrast to the middle class' share. The tax policy effect accounts for up to 29% of the total change in inequality; its contribution increases up to 41% if we take into account behavioral responses.Using our unique policy effect measure and variation in tax policies across U.S. states and time, we also identify the redistributive intention of policymakers. The estimated effect of partisan politics on the U.S. income distribution is statistically significant and economically important. Republican policymakers increased inequality especially at the top whereas Democrats increased the income share of the bottom 80% of the distribution.
All data and codes necessary to replicate results of the article. Also includes the data for figures.
* Abstract - This paper tests the hypoth- esis that state and local retail sales taxes are fully shifted to consumers. The empirical analysis focuses on city-specific clothing price indices for eight cities during the 1947-77 period and fourteen cities during the 1925-39 period. The results for the postwar period suggest that retail prices rise by approximately the amount of the sales tax, in contrast to other studies that reveal tax overshifting. For the Depression period, clothing prices appear to rise by only two-thirds of the amount of sales taxes. This finding accords with earlier evidence based on retailer surveys in the interwar period.
This chapter reviews the concepts, methods, and results of studies that analyze the incidence of taxes. The purpose of such studies is to determine how the burden of a particular tax is allocated among consumers through higher product prices, workers through a lower wage rate, or other factors of production through lower rates of return to those factors. The methods might involve simple partial equilibrium models, analytical general equilibrium models, or computable general equilibrium models.In a partial equilibrium model, the burden of a tax is shown to depend on the elasticity of supply relative to the elasticity of demand. Partial equilibrium models also are used to consider cases with imperfect competition.In a two-sector general equilibrium model, a tax might be imposed on either commodity, on either factor of production, or on a factor used in one sector. The original use of this model is to analyze the corporate income tax as a tax on capital used only in one sector, the corporate sector. The model can be used to show when the burden falls only on capital or when the burden is shared with labor. The model also has been applied to the property tax, and results of the model have been used to calculate the overall burden on each income group.Because the total stock of capital is fixed in that model, however, dynamic models are required to show how a tax on capital affects capital accumulation, future wage rates, and overall burdens. Such models might also provide analytical results or computational results. The most elaborate recent models calculate the lifetime incidence of each group. Finally, the chapter reviews the use of such incidence methods and results in the policy process.
Economics is at its best when it offers important insights that contradict initial, casual impressions. The theory of tax incidence provides a rich assortment of such insights. Tax incidences basic lesson that the real and nominal tax burdens are not necessarily related means that taxes on capital are born by workers, that investment incentives are injurious to capitalists, that taxation of foreigners simply represent indirect domestic taxation, and that generations alive many decades in the future may be supporting those currently alive. The study of tax incidence is both fun, because it offers such surprising findings, and very important, because of its implications about the impacts of government policies. Much of the current tax incidence literature considers the settings of certainty, perfect information, and market clearing. As more sophisticated models relax these assumptions, the theory of tax incidence is enriched and, with all probability, provides even more surprising and exciting economic insights.
We use a new, large, and confidential panel of tax returns from the Internal Revenue Service to shed light on the permanent versus transitory nature of rising inequality in individual male labor earnings and in total household income, both before and after taxes, in the United States over the period 1987-2006. Due to the quality and the significant size of our dataset, we are able to conduct our analysis using rich and precisely estimated error-components models of income dynamics. Our main specification finds evidence for a quadratic heterogeneous income profiles component and a random walk component in permanent earnings, and for a moving-average component in autoregressive transitory earnings. We find that the increase in inequality over our sample period was entirely permanent for male earnings, and predominantly permanent for household income. We also show that the tax system, though reducing inequality, nonetheless did not materially affect its increasing trend. Furthermore, we compare our model-based findings against those of simpler, non-model based inequality decomposition methods. We show that the results for the trends in the evolution of the permanent and transitory variances are remarkably similar across methods, whereas the results for the shares of those variances in cross-sectional inequality differ widely. Further investigation into the sources of these differences suggests that simpler methods produce erroneous decompositions because they cannot flexibly capture the relative degree of persistence of the transitory component of income.
In combination with municipal zoning and the "vote with your feet" discipline proposed by Charles Tiebout, the local property tax is both a benefit tax and an efficient tax, at least when compared to statewide or federal taxes used to fund the same services. To pursue this claim, I modify the Tiebout model by adding to it something Tiebout himself wanted to avoid: politics. The politics I add is not that of the political science department, but of the finance department. In my view, homeowners are the major stockholders - the risk-bearing, residual claimants - of modern municipal corporations. As scores of capitalization studies show, the good and bad things that local governments do affect the value of homeowners' largest asset. Because their risks cannot be diversified like those of stockholders of business corporations, homeowners are especially watchful of municipal affairs. They want local officials - their board of directors - to choose the mix of spending, taxes, and land-use regulations that maximizes the value of their homes. This choice has the benign effect of making the local property tax into a fee for service. Voters will accept an increase in this fee if the value of the service redounds to their net benefit. Even homeowners without children will be interested in efficient funding for local public schools, since prospective buyers have school-age children. The declining quality of public schools in states that have centralized their financing and attenuated the local tax and spending connection is consistent with this view.
This chapter reviews the evidence on cross-national comparisons of annual disposable income inequality in over 20 wealthy nations. We begin by reviewing a number of conceptual and measurement issues which must be addressed by any cross-national comparison of survey-based household income data. With these caveats in mind, we present data on both the level of inequality during the early to mid-1990s, and in inequality trends since 1970. While most comparisons are made in terms of relative incomes within nations, we also make some real income comparisons at a point in time using purchasing power parities. The data indicate that a wide range of inequality exists across these rich nations during this decade, with the most unequal nation experiencing a level of inequality which is more than twice the level found in the most equal nation. Country specific trends in income inequality are more similar, although not universally so. The large majority of nations have experienced rising income inequality over the last decade or longer. This increase is not offset by changes in income mobility over this period, and follows a period of declining income inequality in most of these same nations.
The evidence presented in this paper supports the basic theoretical presumption that state and local governments cannot redistribute income. Since individuals can avoid unfavorable taxes by migrating to jurisdictions that offer more favorable tax conditions, a relatively unfavorable tax will cause gross wages to adjust until the resulting net wage is equal to that available elsewhere. The current empirical findings go beyond confirming this long-run tendency and show that gross wages adjust rapidly to the changing tax environment. Thus, states cannot redistribute income for a period of even a few years. The adjustment of gross wages to tax rates implies that a more progressive tax system raises the cost to firms of hiring more highly skilled employees and reduces the cost of lower skilled labor. A more progressive tax thus induces firms to hire fewer high skilled employees and to hire more low skilled employees. Since state taxes cannot alter net wages, there can be no trade-off at the state level between distribution goals and economic efficiency. Shifts in state tax progressivity, by altering the structure of employment in the state and distorting the mix of labor inputs used by firms in the state, create deadweight efficiency losses without achieving any net redistribution.
This paper uses tax return data to analyze bunching at the kink points of the US income tax schedule. We estimate the compensated elasticity of reported income with respect to (one minus) the marginal tax rate using bunching evidence. We find clear evidence of bunching around the first kink point of the Earned Income Tax Credit but concentrated solely among the self-employed. A simple tax evasion model can account for those results. We find evidence of bunching at the threshold of the first income tax bracket where tax liability starts but no evidence of bunching at any other kink point. (JEL H23, H24, H26)
We analyze the long-run trends in executive compensation using a new dataset of top officers of large firms from 1936 to 2005. The median real value of compensation was remarkably flat from the late 1940s to the 1970s, revealing a weak relationship between pay and aggregate firm growth. By contrast, this correlation was much stronger in the past thirty years. This historical perspective also suggests that compensation arrangements have often helped to align managerial incentives with those of shareholders because executive wealth was sensitive to firm performance for most of our sample. These new facts pose a challenge to several common explanations for the rise in executive pay since the 1980s. Published by Oxford University Press 2010, Oxford University Press.
In this paper, we provide new evidence regarding the pass-through of diesel and gasoline taxes to prices, and how the estimated pass-through depends on a variety of supply conditions including a measure of state residual supply elasticity, and refinery and inventory constraints. In addition, we estimate the response of tax incidence to gasoline content regulations, which complicate the supply chain by increasing product heterogeneity. We find that state gasoline and diesel taxes are on average fully passed on to consumers. We also find that the pass-through of diesel taxes is greater in settings where untaxed uses of diesel are more important, which corresponds to times when residual supply is more elastic. We find that only half of the state diesel tax is passed on to consumers when U.S. refinery capacity utilization is above 95 percent. Gasoline taxes, on the other hand, are fully passed through regardless of season or capacity utilization, indicating that a gas tax holiday would provide price relief to consumers. We find that regional gasoline content regulations affect pass-through – we estimate tax pass-through is 22 percentage points lower in a state using two blends of gasoline than a state using one blend of gasoline.
This chapter reviews the concepts, methods, and results of studies that analyze the incidence of taxes. The purpose of such studies is to determine how the burden of a particular tax is allocated among consumers through higher product prices, workers through a lower wage rate, or other factors of production through lower rates of return to those factors. The methods might involve simple partial equilibrium models, analytical general equilibrium models, or computable general equilibrium models. We review partial equilibrium models, where the burden of a tax is shown to depend on the elasticity of supply relative to the elasticity of demand. In particular, we consider partial equilibrium models with imperfect competition. Turning to a general equilibrium setting, we review the classic model of Harberger (1962) and illustrate its generality by applying it to a number of different contexts. We also use this model to demonstrate the practicality of analytical general equilibrium modeling through the use of log linearization techniques. We then turn to dynamic models to show how a tax on capital affects capital accumulation, future wage rates, and overall burdens. Such models might also provide analytical results or computational results. We also focus on relatively recent models that calculate the lifetime incidence of taxes, with both intratemporal and intertemporal redistribution. Finally, the chapter reviews the use of incidence methods and results in the policy process.
This paper analyzes the effects of dividend taxation on corporate behavior using the large tax cut on individual dividend income enacted in 2003. We document a 20 percent increase in dividend payments by nonfinancial, nonutility publicly traded corporations following the tax cut. An unusually large number of firms initiated or increased regular dividend payments in the year after the reform. As a result, the number of firms paying dividends began to increase in 2003 after a continuous decline for more than two decades. Firms with high levels of nontaxable institutional ownership did not change payout policies, supporting the causality of the tax cut in increasing aggregate dividend payments. The response to the tax cut was strongest in firms with strong principals whose tax incentives changed (those with large taxable institutional owners or independent directors with large share holdings), and in firms where agents had stronger incentives to respond (high share ownership and low options ownership among top executives). Hence, principal-agent issues appear to play an important role in corporate responses to taxation. © 2005 MIT Press
This paper presents new homogeneous series on top shares of income and wages from 1913 to 1998 in the United States using
individual tax returns data. Top income and wages shares display a U-shaped pattern over the century. Our series suggest that
the large shocks that capital owners experienced during the Great Depression and World War II have had a permanent effect
on top capital incomes. We argue that steep progressive income and estate taxation may have prevented large fortunes from
fully recovering from these shocks. Top wage shares were flat before World War II, dropped precipitously during the war, and
did not start to recover before the late 1960s but are now higher than before World War II. As a result, the working rich
have replaced the rentiers at the top of the income distribution.
Just like economists, voters have conflicting views about redistributive taxation because they estimate its incentive costs differently. We model rational agents as trying to learn from their dynastic income mobility experience the relative importance of effort and predetermined factors in the generation of income inequality and therefore the magnitude of these incentive costs. In the long run 'left-wing dynasties' believing less in individual effort and voting for more redistribution coexist with 'right-wing dynasties.' This allows us to explain why individual mobility experience and not only current income matters for political attitudes and how persistent differences in perceptions about social mobility can generate persistent differences in redistribution across countries. Copyright 1995, the President and Fellows of Harvard College and the Massachusetts Institute of Technology.
The March Current Population Survey (CPS) is the primary data source for estimation of levels and trends in U.S. earnings and income inequality. However, time-inconsistency problems related to top coding lead many CPS users to measure inequality via the ratio of the 90th to the 10th percentile (P90-P10) rather than by more traditional summary measures. With access to public use and restricted-access internal CPS data, and by applying bounding methods, we show that using P90-P10 does not completely obviate time-inconsistency problems, especially in capturing household income inequality trends. Using internal data, we create consistent cell mean values for all top-coded public use values that, when used with public use data, closely track inequality trends in earnings and household income using internal data. But estimates of longer-term inequality trends with these corrected data based on P90-P10 differ from those based on the Gini coefficient. The choice of inequality measure still matters. Copyright 2009 The Authors. Journal compilation 2009 International Association for Research in Income and Wealth Published by Blackwell Publishing.
One of the most fundamental questions in public finance is who bears the burden of taxes -- the incidence of taxation.' Our understanding of incidence from an empirical standpoint is quite meager. Indeed, there seems to be little evidence even in the case that is theoretically the easiest -- partial equilibrium commodity taxes. Are taxes levied on commodities completely shifted into their prices, or does the incidence also fall on firms? How long does the shifting process take? In this paper we employ a unique data source to examine the incidence of sales taxes. The main idea is to take information on the prices of specific commodities in different U.S. cities and to examine the extent to which differences in tax rates and bases are reflected in prices, controlling for other factors (such as costs). We find a surprising variety of shifting patterns. For some commodities, the after-tax price increases by exactly the amount of the tax, a result consistent with the standard competitive model. However, taxes on other commodities are overshifted -- an increase in tax revenue of one dollar per unit increases the price by more than one dollar.
I compute the lifetime tax incidence of the major state and local taxes used in the United States during the 1980s. Using data from the Consumer Expenditure Survey, I show that over the life cycle, general sales taxes are progressive and equally as progressive as state and local income taxes. While the progressivity of sales taxes has not changed between 1984 and 1989, income taxes have become less progressive over that five-year period. Property taxes on the other hand have become more progressive. The system of state and local taxes is mildly progressive the life cycle and has become slightly more progressive between 1984 and 1989. Finally. eliminating deductibility for sales taxes in 1986 appears to have had little effect on the overall progressivity of the tax system.
We introduce a new hybrid approach to joint estimation of Value at Risk (VaR) and Expected Shortfall (ES) for high quantiles of return distributions. We investigate the relative performance of VaR and ES models using daily returns for sixteen stock market indices (eight from developed and eight from emerging markets) prior to and during the 2008 financial crisis. In addition to widely used VaR and ES models, we also study the behavior of conditional and unconditional extreme value (EV) models to generate 99 percent confidence level estimates as well as developing a new loss function that relates tail losses to ES forecasts. Backtesting results show that only our proposed new hybrid and Extreme Value (EV)-based VaR models provide adequate protection in both developed and emerging markets, but that the hybrid approach does this at a significantly lower cost in capital reserves. In ES estimation the hybrid model yields the smallest error statistics surpassing even the EV models, especially in the developed markets.
This paper use income tax return data from 1960 to 2000 to analyze the link between reported incomes and marginal tax rates. Only the top 1% incomes show evidence of behavioral responses to taxation. The data displays striking heterogeneity in the size of responses to tax changes overtime, with no response either short-term or long-term for the very large Kennedy top rate cuts in the early1960s, and striking evidence of responses, at least in the short-term, to the tax changes since the 1980s. The 1980s tax cuts generated a surge in business income reported by high income individual taxpayers due to a shift away from the corporate sector, and the disappearance of business losses for tax avoidance. The Tax Reform Act of 1986 and the recent 1993 tax increase generated large short-term responses of wages and salaries reported by top income earners, most likely due to re-timing in compensation to take advantage of the tax changes. However, it is unlikely that the extraordinary trend upward of the shares of total wages accruing to top wage income earners, which started in the 1970s and accelerated in the 1980s and especially the late 1990s, can be explained solely by the evolution of marginal tax rates.
We analyze the long-run trends in executive compensation using a new panel dataset of top executives in large firms from 1936 to 2005. In sharp contrast to the well-known steep upward trajectory of pay of the past 30 years, the median real value of compensation was remarkably flat from the late 1940s to the mid-1970s, highlighting a weak relationship between compensation and aggregate firm size. While this correlation has changed considerably over the century, the cross-sectional relationship between pay and firm size has remained stable. Another surprising finding is that the sensitivity of changes in an executive's wealth to firm performance was not inconsequentially small for most of our sample period. Thus, recent years were not the first time when compensation arrangements served to align managerial incentives with those of shareholders. Overall, these trends pose a challenge to several common explanations for the recent surge in executive pay.
This paper analyzes distributional changes over the last quarter of the twentieth century. We focus on four distinct distributions: the distribution of hourly wage rates, the distribution of annual earnings of individuals, the distribution of annual earnings of families, and the distribution of total family income adjusted for family size. Both male wage rate inequality and family income inequality accelerated during the early 1980s, increased at a slower rate through the early 1990s and then stabilized at a high level through the early 2000s. The similarity in the timing of changes in these two distributions has been used as evidence that increased family income inequality primarily reflects increased inequality of wage rates. We show that other important factors were also at work. Copyright 2005 Blackwell Publishing Ltd.
This paper provides estimates of federal tax rates by income groups in the United States since 1960, with special emphasis on very top income groups. We include individual and corporate income taxes, payroll taxes, and estate and gift taxes. The progressivity of the U.S. federal tax system at the top of the income distribution has declined dramatically since the 1960s. This dramatic drop in progressivity is due primarily to a drop in corporate taxes and in estate and gift taxes combined with a sharp change in the composition of top incomes away from capital income and toward labor income. The sharp drop in statutory top marginal individual income tax rates has contributed only moderately to the decline in tax progressivity. International comparisons confirm that is it critical to take into account other taxes than the individual income tax to properly assess the extent of overall tax progressivity, both for time trends and for cross-country comparisons. The pattern for the United Kingdom is similar to the U.S. pattern. France had less progressive taxes than the United States or the United Kingdom in 1970 but has experienced an increase in tax progressivity and has now a more progressive tax system than the United States or the United Kingdom.
Specialists in labor economics and public economics at 40 leading research universities provided opinions of policy proposals, quantitative best estimates and 95-percent confidence intervals for economic parameters, and answers to values questions regarding income redistribution, efficiency versus equity, and individual versus social responsibility. Their positions on policy are more closely related to their values than to their estimates of relevant economic parameters. Average best estimates of the economic parameters agree well with the relevant literature, but individual best estimates are usually widely dispersed. The individual 95-percent confidence intervals are much narrower than the substantial cross-respondent variation in estimates would warrant.
This Paper analyses the effects of dividend taxation on corporate behaviour using the large tax cut on individual dividend income enacted in 2003. Using data spanning 1980 to 2004-Q2, we document a sharp and widespread surge in dividend payments following the tax cut, along several dimensions. First, an unprecedented number of firms initiated regular dividend payments after the reform. As a result, the number of publicly traded firms paying dividends, after having declined continuously for more than two decades, began to increase precisely in 2003. Second, many firms that were already paying dividends prior to the reform raised regular dividend payments significantly. Third, special dividends also rose. All of these effects are robust to introducing controls for profits and other firm characteristics. Additional evidence for specific groups of firms suggests that the tax cut induced increases in total payout rather than substitution between dividends and repurchases. The tax response was confined to firms with lower levels of forecasted growth, consistent with an improvement in capital allocation efficiency. The response to the tax cut was strongest in firms with strong principals whose tax incentives changed (presence of large taxable institutional owners or independent directors with large share holdings), and in firms where agents had stronger incentives to respond (large executive ownership and low levels of executive stock-options outstanding). These findings show that principal-agent issues play a central role in corporate responses to taxation.