A New Look at Income Inequality in the US

Yesterday, at the Hoover Economic Policy Working Group (EPWG), David Splinter of the Staff of the Joint Committee on Taxation discussed a paper he wrote with Gerald Auten of the Office of Tax Analysis at the Department of Treasury. A video of Splinter’s presentation, including many questions and answers, is posted on the EPWG web page here along with the paper “Income Inequality in the United States: Using Tax Data to Measure Long-term Trends” My internet went down so the video is really nice to have. There are also links there to Splinter’s excellent web page.

The paper and presentation explore in fascinating detail various data sources that bear on the widely reported finding of Thomas Piketty and Emmanuel Saez that the income distribution has widened. By adjusting for key technical issues and examining alternative assumptions for distributing income, their paper shows that there was little change in after-tax top income shares since the early 1960s, in contrast to the findings of Piketty and Saez (2003), which are based on individual tax returns.

Many have written about this topic and many, including me, have noted limitations of the data, including that IRS data are not ideal for measuring income because, for example, people report more income when the tax rate goes down, or because transfers are not in the data.  The important and highly original contribution of Splinter and Auten is that they have actually done the empirical work in a convincing quantitative way. Here is a graph from their paper which illustrates the difference.

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But even if the Piketty-Saez series are correct, policy should focus on the cause of the change. Is it a poor education system in which educational opportunities are restricted, especially for those who are disadvantaged, a fact that COVID 19 has made very clear? More generally, the explanation for the widening inequality may be restrictions on economic freedom. Not extending economic freedom to all in education is one example. Regulatory capture, crony capitalism, deviations from the rule of law are other examples.

Ironically some argue that moving away from the principles of economic freedom—higher marginal tax rates, more regulations, more discretion for regulators, more interventionist macro policy—is the way to change the distribution of income.  That would be a great tragedy since history shows that it has been more economic freedom that has pulled people out of poverty. And as Splinter and Auten show, it may not even be a distribution problem.

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