CBO Finds Growing U.S. Income Inequality

By :: December 9th, 2013

Just as President Obama was decrying our nation’s rising income inequality, the Congressional Budget Office provided him with some new ammunition. CBO’s latest report on household income and taxes—which goes only through 2010—shows that the rich have indeed gotten richer. (Full disclosure: In my former life at CBO, I helped assemble these income and tax data.)

CBO finds that over the past three decades, a growing fraction of income has gone to the top of the income distribution (see first graph). The top fifth saw its share of pretax income rise from 43 percent in 1979 to more than 50 percent in 2010. Much of the gain went to the top 1 percent, whose share increased from 9 percent to 15 percent over that period.Shares of Pretax Income 2

In contrast, households in the bottom two quintiles saw their income shares drop. The poorest 20 percent collected just 5.1 percent of pretax income in 2010, down from 6.2 percent in 1979. Households in the second quintile suffered a bigger decline—from 11.2 percent to 9.6 percent over the period.

This trend has been quite steady for the past three decades, though it was temporarily interrupted by the bursting of the dot-com bubble in 2000 and again in 2008-2009. But CBO shows inequality began growing again in 2010. That year, households in the bottom 60 percent got less than 30 percent of total income and the Tax Policy Center projects that their share will fall further in the future.

What about after-tax income? Has the federal tax system narrowed the disparity in incomes over the past 30 years? Not by much, according to CBO.

Average Tax Rate by Percentile 3Average federal tax rates have fallen over the last 30 years but, at least until recently, households at all income levels benefited roughly equally. Between 1979 and 2010, the average tax rate declined by the same 6 percentage points for the bottom and middle quintiles as for the top 1 percent (see second graph).

We won’t know for a few years what has happened since 2010 but it appears that income inequality has once again grown. Wages have stagnated for low- and middle-income households while corporate profits and stock prices have skyrocketed.

The American Tax Relief Act of 2012 (ATRA) may have somewhat offset those relative changes in pre-tax income by raising taxes on high-income households. But those tax hikes at the top are too small to reverse the overall trend.

Inequality is a serious concern and it shows no sign of abating.  The tax system may be part of the solution, but if past history is a guide, other policies will play much larger roles.

 

10Comments

  1. ND  ::  3:21 pm on December 9th, 2013:

    What is a “household”? Does this include the income of both parents of a child, even when the parents live separately?

    Isn’t a big problem here the family structure bias in the tax code, i.e. the fiction of earned income splitting in tax measurement, the subsidies to sole breadwinners who take no personal responsibility for meeting the needs of their children, the overtaxing/underbenefitting of families where men and women who each juggle earning and the personal responsibility of meeting children’s needs and unpaid work of the home?

    These contribute to inequality in many ways if more from creating a horizontal instability than a raw measure of the top 1% versus the bottom 10%

    For one thing, lower income families are still having many children (Latinos in the US have more children per adult than Latinos in Mexico, probably due to our subsidies to patriarchal families) and their rate of family breakdown means their “households” are measured in skewed faction (excluding the 2-earner measure mentioned above).

  2. AMTbuff  ::  5:07 pm on December 9th, 2013:

    It’s true that household composition has changed significantly in 30 years, and that the decrease in married couples would have caused an increase in “income inequality” even if nobody’s income had changed.

    Another difficulty is incidence. Income taxes on top earners may not be paid entirely by those taxpayers. For example dentists or surgeons may be in a position to increase their billing rates to offset some of the increased tax burden, passing that portion along to customers.

    Consider an extreme example. If a dentist’s tax rate were to increase from 50% to 90% his take-home pay would drop by a factor of 5. He would attempt to increase his prices by a factor of 5 to compensate. If all other dentists faced the same increase, most of that price increase would stick. The dentist’s customers would be soaked for the new taxes even more than the dentist. The graphs would show, as above, pretax income inequality growing and after-tax income inequality remaining about the same.

    Achieving actual redistribution of income is more difficult than it appears at first because people don’t just sit still when you take more of their money. This effect is especially pronounced above a 50% government take.

  3. Michael Bindner  ::  8:41 am on December 10th, 2013:

    2012 income for the top 1% will be much higher, as well as their income in the years leading up to it, because this centile cashed out their capital gains in advance of the higher taxes in 2013. Because they were realizing their gains, they turned them from potential income to actual income. The other side of the equation is the stagnation in wages. A healthy bump in the minimum wage wold increases wages up the line until to you get to the highest management level, whose wages are already so much higher than everyone else that they won’t get a raise when the minimum wage goes up.

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  5. SteveinCH  ::  12:23 pm on December 10th, 2013:

    This might be a good thing to read.

    http://taxfoundation.org/sites/taxfoundation.org/files/docs/wp9_sr211_Redistribution_Working_Paper_2013.pdf

    Turns out when you throw spending and taxes into the mix, the picture appears to change materially.

    Funny that.

  6. Javier Gonzalez  ::  12:50 pm on December 10th, 2013:

    Income inequality is a serious concern. I first became acquainted with the topic on a seminar by Emmanuel Saez in 2001. In it he explained how before WWI there was large income inequality, in a period of unfettered economic activity, and it was not until the WWI and WWII that income inequality decreased, when more was asked from the richest citizens. Later on, income inequality increased some say due to 2 factors: personal computers that make white-collar workers more productive and global media reach which makes of celebrities and sports stars, superstars, deriving revenue from most of the world.

  7. Ralph H  ::  3:04 pm on December 10th, 2013:

    Very little of this should be blamed on tax policy (or could be corrected by it). The world wide economy and rapid communications have made it possible to outsource production, reducing greatly the value of ordinary labor in the US. Meanwhile, the highly talented have a worldwide market and the power of automation to greatly increase their value and rewards. Even the US is powerless to even up the outcomes, because capital and talent can flee to a tax friendly venue, especially corporations.

    If you look at total tax revenue and subsidies, we are really very progressive in tax policy. I suspect that if we did not have borders that were sieves and a lack of will to deport, we would have a much higher “floor” wage, but the question is would we be able to find the workforce for our service economy?

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