Dylan Matthews reported today on research by Alvaredo, Atkinson, Piketty, and Saez on taxes and income inequality. They looked at the change in the top income shares since 1960 and compared it to the change in the top marginal tax rate. And not surprisingly, they found a very strong correlation. For example, in the United States, the top 1% of earners have seen their share of total income go up by a staggering almost 10 percentage points. Meanwhile, the top marginal tax rate has gone down by almost 50%.
Here is the graph:
The article put forward a couple of explanations as to why this is. The conservative idea is that having lower taxes makes rich people work harder and for productivity to grow. If that’s the case, why was growth so great under Clinton who raised the top tax bracket and so poor under Bush Jr who lowered the top tax bracket? There really is no evidence for this theory; it is all just the conservatives’ desire to justify their anti-tax mania.
The middle ground is that lowering taxes causes the rich to do less tax avoidance. That is to say that the rich aren’t actually richer, they just look richer on the books. This doesn’t explain much because it is simply not the case that the rich aren’t richer. Also, Matthews pointed out that if you include income from capital gains (the main way to avoid income taxes) the results of the graph above hardly change.
That leaves the liberal explanation. Matthews only mentioned one part of this: the rich have more money and this gives them more political power. This is undoubtedly happening. And it isn’t even limited to campaign contributions. It is just that the richer people are, the more parties they can give and the more politicians see them as “the right kind of people” who ought to be helped. What’s more, let’s not forget that our politicians are the rich.
Another important aspect of this is that lower taxes on the rich incentivize inequality. A company makes profits. Those profits could be used to reward the work force with raises (or bonuses). Or the company could invest in infrastructure. Or the company could distribute the profits to the owners. The lower the top marginal tax rate, the larger the incentives to distribute profits. This is more or less the same mechanism as found in the conservative explanation. But instead of the rich working harder, the rich just take more money from the lower classes.
In the end, I’m sure that this correlation is due to all of these causes and more. However, I think that my explanation is likely the strongest of these factors. There is a related factor, however: the “greed is good” mentality. The truth is that social forces kept greed in check for a couple of decades after World War II. But that really started to fall apart in the 1970s. Then we got the Reagan years where policy made a bad social phenomenon even worse. A big part of Winner-Take-All Politics discusses the fact that income inequality is not just a question of taxes. That’s clearly true. But it is wrong to think that taxes can’t be used as a mechanism to mitigate the problems of income inequality. There are direct and indirect effects. And we are clearly seeing this in the graph above.
The only real question now is if we live in a democracy. In general, I don’t think we do.