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The Federal Tax Code and Income Inequality

The Federal Tax Code and Income Inequality

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Michael Linden examines how our tax code has grown less effective at dampening income inequality, and how various proposals to reform the code would affect inequality.
Michael Linden examines how our tax code has grown less effective at dampening income inequality, and how various proposals to reform the code would affect inequality.

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Published by: Center for American Progress on Apr 19, 2012
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1Center or American Progress |  The Federal Tax Code and Income Inequality
 The Federal Tax Code and Income Inequality
How Federal Tax Policy Changes Have Affectedand Will Affect Income Inequality
Michael Linden April 2012
Introduction
Over he pas 30 years, our naion’s income has grown increasingly unequal. In 1979 heaverage income or a household in he riches 1 percen was abou 10 imes higher hanhe average income or a household in he middle 20 percen. By 2007 ha raio hadalmos ripled. Te average household in he riches 1 percen was now earning nearly 30 imes as much as hose in he middle.
1
Ye even as income inequaliy increased dra-maically, he eec o he ederal ax code on income disribuion declined subsanially.Because, on average, richer households pay more o heir income in ederal axes hando middle- and low-income households, he “aer-ax” disribuion o income is alwayssomewha more equiable han i was beore ederal axes are aken ino accoun. Bu hemagniude o his eec can vary quie a lo because policy changes make he ax codeless or more progressive.From 1979 o 2007 here were a number o major ax changes, bu he cumulaive eec was o render he ederal ax code less progressive and hereore less able o dampenincome inequaliy. By one measure o inequaliy, he ederal ax code in 2007 was abouone-hird less eecive a reducing income inequaliy han i had been in 1979.Tis issue brie will examine he consequences o hese changes o he ederal ax code onhe income disribuion. I will begin wih a review o several measures o income inequal-iy. Te second secion will briey explain why ederal axaion has he eec o reducingincome inequaliy. Nex up is a close look a how changes in he ax code since 1979 haveaeced is impac on he aer-ax income disribuion. Te nal secion will compare how some proposed changes o oday’s ax code would aec income inequaliy in he uure.
 
2Center or American Progress |  The Federal Tax Code and Income Inequality
Measuring income inequality
In order o measure he impac o he ax code on income inequaliy, i is imporan oundersand how income inequaliy isel is measured. Tere are a variey o dieren wayso measure income inequaliy, each wih is own srenghs and weaknesses. Each meric,however, ells essenially he same sory abou income equaliy in he Unied Saes: Wehave relaively high levels o income inequaliy, income inequaliy has goten worse overime, and he ederal ax code can make a signican dierence in income inequaliy. Sole’s look briey a hree dieren merics or measuring income inequaliy.
 The Gini index
Te mos comprehensive and widely used measure o income inequaliy is he Giniindex. Tis index (also known as he Gini coefcien, Gini raio, or Gini score) essen-ially measures he dierence beween acual income disribuion and a perecly equiable disribuion in which everyone makes he same amoun. A perecly equiabledisribuion o income scores a 0 on he Gini index, whereas he mos unequal disribu-ion, in which a single person makes all he income, scores a 1. According ohe U.S. CensusBureau , he Gini index orhe Unied Saes in 2010 was 0.469—a score ha highindicaes we have a ar moreunequal sociey hanmosoher advanced, developedcounries.
2
Te Scandinaviancounries are he mos equal wih Gini scores o around 0.25.Bu even compared o counriesha are ar more similar o ushan Sweden or Norway, heUnied Saes is sill an oulier.Canada, or example, has a Giniindex o 0.321, and he UniedKingdom’s Gini index is 0.34.In ac, our Gini index is muchcloser o counries like Malaysia(0.462) and Uganda (0.443).
3
 (see Figure 1)
FIGURE 1
The United States has far more income inequalitythan other developed countries
Inequality, as measured by the Gini index, among select countries
 
Source: CIA World Factbook 
00.10.20.30.40.50.60.7
    S   w   e    d   e   n    (    2    0    0    5    )    N   o   r   w   a   y    (    2    0    0    8    )    G   e   r   m   a   n   y    (    2    0    0    6    )    A   u   s    t   r   a    l    i   a    (    2    0    0    6    )    C   a   n   a    d   a    (    2    0    0    5    )    U   n    i    t   e    d    K    i   n   g    d   o   m    (    2    0    0    5    )    J   a   p   a   n    (    2    0    0    8    )    R   u   s   s    i   a    (    2    0    1    0    )    U   g   a   n    d   a    (    2    0    0    9    )    M   a    l   a   y   s    i   a    (    2    0    0    9    )    U   n    i    t   e    d    S    t   a    t   e   s    (    2    0    1    0    )    P   e   r   u    (    2    0    0    9    )    M   e   x    i   c   o    (    2    0    0    8    )    B   r   a   z    i    l    (    2    0    0    9    )    S   o   u    t    h    A    f   r    i   c   a    (    2    0    0    5    )
 
3Center or American Progress |  The Federal Tax Code and Income Inequality
Ratio of average incomes
Tough he Gini index is he broades and mos widely used measure o income inequal-iy, i does have he disadvanage o being raher echnical. Saying ha a counry’s Giniindex is 0.469 does no have an inuiive meaning or mos people. Saying ha he aver-age household among he riches 1 percen o households akes home nearly 30 imes asmuch as he average household among he middle 20 percen, however, may be a clearer way o expressing he same hough.In 1979 he average income or ahousehold in he riches 1 perceno households was $550,000 (in2007 dollars) beore ederal axes,according o he nonparisanCongressional Budge Ofce.Ta same year, he averagehousehold in he middle 20percen o all households made$54,100. So hree decades agohe average household in heop 1 percen made more han10 imes as much as he averagehousehold in he middle. In 2007ha raio was all he way up oalmos 30. Te average householdin he op 1 percen made almos$1.9 million in 2007, compared ohe $64,000 made by he aver-age household in he middle 20percen. (see Figure 2)
Share of income going to the richest 1 percent
Fundamenally, income inequaliy is all abou he relaive concenraion o income. I a rich ew claim more and more o he oal income hen he disribuion o incomeis necessarily very unequal. Indeed, he Gini index is calculaed by looking a incomeconcenraion across he enire income specrum. In a very equal sociey, he riches 1percen o households would make close o 1 percen o he income, as would he poor-es 1 percen o households, as would any oher percenile. Te Gini score is essenially a combinaion o all he dierences all along he income scale beween an income disri- buion ha has no disproporionae concenraion and realiy.
FIGURE 2
The richest 1 percent pull away from the middle
Ratio of the average income among the richest 1 percent of households compared to theaverage income of households in the middle quintile
Source: Congressional Budget Office
051015202530351979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007

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