Income Inequality and Taxes
A long view on income inequality demonstrates the current trends in the growing apart of income distribution haven’t always been the case. Analysis by the Congressional Research Service shows that the share of income going to the top 0.1% and 0.01% remained relatively stable from 1945 until the 1970s when it began to rise precipitously. The Congressional Budget Office found that the after-tax income for the top fifth saw a 10 percentage point increase from 1979 to 2007 while all other income groups saw their shares decline by 2 to 3 percentage points.
The Congressional Reserve Service analysis additionally shows that top tax rates have a strong negative relationship to the income shares going to the top of the income distribution. That is, as the top tax rates have been reduced, income accruing to the top has increased. While the analysis finds that growth of capital gains and dividends as a share of taxpayers’ income was the largest contributor to growing income inequality, it also finds that the earnings share of income becomes higher with higher top marginal tax rates.
One policy step that could address growing income inequality while also contributing to reducing the federal deficit would be to reduce the tax preference for capital gains over other forms of income, mainly earnings. As the Center on Budget and Policy Priorities details in a recent report, preferential rates overwhelmingly benefit very high-income taxpayers while delivering no significant contribution to real GDP growth.
But fixing these preferential rates alone will not address the issues that have reduced the tax system’s ability to address income inequality in recent decades. Such solutions must include a focus on addressing the overall regressivity of the tax system and that means being particularly comprehensive in our look at all the taxes that are paid and the interactions between the federal, state and local systems.