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The Misuse of Top 1 Percent Income Sharesas a Measure of Inequality 
Alan Reynolds
Senior Fellow
Cato Institute, 1000 Massachusetts Avenue N.W., Washington, D.C. 20001
 The Cato Working Papers are intended to circulate research in progress forcomment and discussion. Available at www.cato.org/workingpapers.
 
 
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Abstract
This paper confirms recent studies which find little or no sustained increase in theinequality of disposable income for the U.S. population as a whole over the past 20years, even though estimates of the top 1 percent’s share of pretax, pretransfer (market) income spiked upward in 1986-88, 1997-2000 and 2003-2007.It has become commonplace to use top 1 percent shares of market income as ashorthand measure of inequality, and as an argument for greater taxes on higher incomes and/or larger transfer payments to the bottom 90 percent. This paper findsthe data inappropriate for such purposes for several reasons:
 
Excluding rapidly increased transfer payments and employer-financed benefits from total income results in exaggerating the rise in the top 1 percent’s share between 1979 and 2010 by 23 percent because a growingshare of other income is missing.
 
Using estimates of the top 1 percent’s share of pretax, pretransfer income(Piketty and Saez 2003) as an argument for higher tax rates on top incomesor larger transfer payments to others is illogical and contradictory becausethe data exclude taxes and transfers.
 
Using highly cyclical top 1 percent shares as a measure of overall inequalityleads, paradoxically, to describing most recessions as a welcome reductionin inequality, because poverty and unemployment rates typically rise whenthe top 1 percent’s share falls, and fall when the top 1 percent’s share rises.
 
Top 1 percent incomes are shown to be extremely sensitive (“elastic”) tochanges in the highest tax rates on ordinary income, capital gains anddividends. Although estimates of the elasticity of ordinary income for thetop 1 percent range from 0.62 (Saez 2004) to 1.99 (Moffitt and Wilhelm),those estimates fail to account for demonstrably dramatic responses tochanges in the highest tax rate on capital gains and dividends.I estimate that more than half of the increase in the top 1 percent’s share of pretax, pretransfer income since 1983, and all of the increase since 2000, is attributable to behavioral reactions to lower marginal tax rates on salaries, unincorporated businesses,dividends and capital gains. After reviewing numerous data sources, I find no compellingevidence of any large and sustained increase in the inequality of disposable income over the past two decades.
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