Do low taxes explain inequality?

Even if you accept we have lower taxes on the rich.

Don’t we also have the highest per capita income. By 20% over all other large diverse non oil countries?

It might be a case where the figures fit both narratives. Lower taxes increase inequality but they also boost (or are atleast neutral) to lower incomes. So it comes down to what is better for society – less inequality but overall less wealth (if you view income over a certain level as status competition more than utility then plausible) or higher absolute and wealth as a goal.

Also a bit of a free-rider issue for the rest of the world. If our model is better for growth then they can piggyback our technological achievement. Letting some people getting extremely wealthy and win status games pushes them to achieve more. It gives someone motivation to go from earning a nice 500k a year to earning a billion a year.

The top marginal tax data used by the Piketty, Saez and Stantcheva paper referenced by Yglesias comes from this Tax Policy Center report:

http://www.taxpolicycenter.org/sites/default/files/legacy/taxfacts/content/PDF/oecd_historical_toprate.pdf

The numbers in that report are pretty much the same as reported here. They should include central and sub-central government top statutory tax rates. For the US is has 46.3% in 2013. However, like Scott says, this is likely low for high tax states like California and New York.

When I take the tax rates reported in the Tax Policy Center document and match them to the World Wealth and Income Database for the countries that are available (16 out of 34) for 2013, I do get a slight negative relationship between the two, but a low R squared of 0.1187. What’s more, the relationship is highly sensitive to the countries that are included. For example, dropping Turkey lowers the relationship by more than a half and reduces the R squared to 0.0291.

Overall, I agree with Scott that it seems unlikely that the 10 percentage point difference in the top 1 percent income share in the United States relative to Australia is due to a top income tax rate of 46.5 percent instead of the 46.3 percent rate we have in the United States.

I would assume he’s including both halves of the Medicare tax, i.e. 1.45 + 1.45 + 0.9, which is also 3.8%. I believe the Pease limitation adds a bit more than one percentage point, too.

In New York City for the highest bracket, you have to pay an additional 8.82% State income tax and an additional 3.876% City income tax (excluding SALT deductions). Mind you, if, like many do, commute from CT or NJ, get ready to pay the highest property taxes in the nation.

TravisV:

It’s very difficult to cut Federal income taxes on people who don’t pay income taxes (leaving aside income grants, like refundable credits to people who don’t otherwise pay).

As virtually everyone who pays income taxes in the United States is rich, how do you propose Congress cut income taxes for only non-rich people?

What would be your definition of rich?

Also, what do you see as the point of cutting income taxes?

The Piketty paper linked by Yglesias seems to have a fundamental flaw. It hinges on the correlation between:

1. Pre-tax share of 1% income.
2. Drop in top marginal rates since 1960.

The correlation works out well enough. But it’s merely because the US and UK had extremely high top marginal rates in 1960, while other countries didn’t.

After 1960, the US and UK merely adopted similar tax rates as other countries. It doesn’t make much sense why *changes* in marginal tax rates, rather than the marginal tax rates themselves, cause income inequality.

The causal theory gets tougher to accept the more you think about it. If marginal dollars are taxed at 80 cents vs. 30 cents, then sure the causal theory shows a big effect. But 40 cents versus 50 cents?

Income inequality, at least in US, has a few big causes:

1. Bad financial regulation in US (and probably UK). Not deregulation per se, but a lot of moral hazard scenarios which were abused. For example, hedge funds made a lot of fees from pension funds, which have government backing.

2. Less cultural restraints on executive pay. Krugman called this the “Monday Night Football” effect, where CEO’s saw athletes get millions and they rose their salaries accordingly.

3. The income tax rates could be similar, but the US wastes more of its government money on overpriced medicine, military and criminal justice spending.

I get frustrated by the frequent comparison of the Federal U.S. tax rate to the tax rate of particular European countries.

In California the top marginal tax rate on individual earned income is well north of 50% (although it’s almost impossible to figure out the actual rate). That’s also true of Sweden (56% top rate). It’s not true of Germany or the U.K., nor of Florida.

If we’re going to compare particular European countries, let’s compare them to particular U.S. states. For a Manhattan taxpayer, the federal rate is irrelevant.

The observation about Monday Night Football may not apply. There are a few soccer players who make more than the top paid NFL player.

In the old days of 70 or even 90 percent marginal tax rates, it wouldn’t make much sense for executives to expend enormous amounts of time and energy trying to maximize the amount of money they can personally extract from a company in the form of salary.

The above seems contradict the Democrat ideas that people care much more about relative income and there is a sharp fall off in the marginal utility of money.

I think you need to look at consumption rather than income. If in a full employment economy you tax Warren Buffet and give the revenue to a low income person who consumes more, who consumes less, not Warren Buffet.

Matthew,

The smaller the percentile, the less relevant it really is. The top .1% may be the object of a great deal of enmity, but redistributing the sum of their ‘excess income’ wouldn’t amount to much more than a drop in the bucket. Top 1% or top 10% amount to more statistically, but increasingly we are no longer talking about hedge fund managers and are instead talking about successful surgeons and small business owners.

Anyway, I don’t think ‘culture’ is the only way (or the best way) to explain it. High bracket tax rates have a significant effect on pre-tax salaries, for one thing. But it’s also possible that there’s simply more competition for high quality executives in one country than another, which likely has to do with what industries are dominant in each country. How common monopolies or oligopolies are also seems like something that would be relevant.

In the case of Germany, until not long ago, German CEOs tended to come from within the company and were often not professional managers (e.g., Siemens had Chemists or Engineers in managerial positions). Professional management came to Germany (and I suspect other European countries) much later than in the US. Also German in German companies, the employees (per regulation) get a much bigger say in corporate policy (and I wouldn’t be surprised if similar ‘stakeholder’ rules apply in other European countries). So the role of management (and who determines their salaries) is different from the US. These factors also likely play a role in difference in managerial compensation.

Lastly, inasmuch as managers do ‘overpay themselves’, would this not depress profit margins? I guess one could argue that investors, by and large, are so passive that they don’t notice or care much about their CEOs being overpayed, or that the amount of overpayment has only an insignificant effect on profits (in which case I’d be inclined to rule insignificant in general). In any case, if managers are robbing their investors, it seems like an issue for the investors, not the tax payers.

I think tax is only a part of the phenomenon, since the UK and US are also the places in the OECD where pre-tax income for the 1% rose the most.
See: https://www.oecd.org/social/OECD2014-FocusOnTopIncomes.pdf

However, you forget that what matters for the 1%, 0.1%, 0.01% is the capital gains tax rate, which is relatively low with a top rate of 19.1% in the USA, versus 28% in the UK, 31% in France and 25% in Germany (2011, Ernst & Young).
See: http://www.theasi.org/assets/EY_ASI_Dividend_and_Capital_Gains_International_Comparison_Report_2012-02-03.pdf

One thing we need to remember is that tax rates have an effect on pre-tax income if said income is mainly derived from capital gains; if we reinvest our income, then lower taxes or evaded taxes in year Y mean more pre-tax income in year Y+1 !

Reasons I haven’t seen in the comments for this rise in income for the richest 1% :

1) Financiarization : the UK and US are heavily financiarized economies: the correlation between with the share of finance in the economy and the share of income of the richest 1 percent is strong. This is historical, but was accentuated by a series of deregulations since the 1970s. It is an important factor in increasing inequality, since pay inequality is extreme in finance, and since larger financial sectors bring with them the too-big-to-fail mechanism, whereby taxpayer’s money serves to insure large financial institutions and the state is forced to bail them out in times of crisis. Also, the presence of a financial industry brings lighter regulations on capital movements and brings in know-how in tax planning and tax evasion.
See graph (and text) : http://scalar.usc.edu/works/growing-apart-a-political-history-of-american-inequality/wall-street-and-main-street-the-rise-of-finance

2) Immigration (both legal and illegal) : obviously, expanding the supply of labor keeps wages low. The US and UK have a high net migration rates, and for the US a very high number of undocumented migrants who keep wages extremely low in cleaning, construction and agriculture. The number, between 10 and 15 million, means about 3-4% of the total population, when it’s under 1% for other Western countries (or 2% in the UK if you take the extreme estimate of 1.3 million, based on a 1.1 million number in 2010 according to anti-immigration group MigrationWatchUK).

3) The executive pay competition, which is probably cultural in some part.

4) Weakness and decline of unions. This one is a bit less certain. But here’s the gist: in the US, only 20% of workers were unionised in 1983, a proportion which went down to only 10% in 2016. The UK, which had a high trade union density in 1975, at 43.7%, went down to 25% in 2013. But the Germany, France and the Netherlands also went down by half of more (to rates close to that of the US), while Spain stagnated at 10-15% and the Nordics remained at 50-70%.
See: http://stats.oecd.org/Index.aspx?DataSetCode=UN_DEN#

5) Lack of effective minimum wage laws. In many European countries, there are minimum wage laws which automatically raise minimum wages with inflation. Employees also negotiate wages at the company or sector level. This means that growth doesn’t necessarily translate into higher wages in the US for low-wage sectors and jobs.