Rigorous Research is Needed to Eventually Inform Better Economic Policy, Regardless of Political Realities

In his latest Bloomberg column, Ezra Klein has a nice feature of my recent paper on income inequality growth in the United States and the role of tax policy. Klein’s dichotomy of the income inequality debate splits the “fatalists” from the “redistributions,” with differing views on government’s role in widening income inequality. Downplaying government’s complicity and scope for policy, Klein’s fatalists chalk up income inequality growth to market forces and factors like globalization, technological change, and job polarization. (See Larry Mishel, John Schmitt, and Heidi Shierholz refute this latter argument.) The redistributionists, on the other hand, believe that government policy has contributed to income inequality and policy should be reoriented to instead push back against post-tax, post-transfer income inequality growth.

With regard to the fatalists, one cannot dispute on objective grounds that changes in federal tax and transfer policies between 1979 and 2007 have exacerbated post-tax, post-transfer income inequality growth, up 33 percent over this period, versus market-based income inequality growth of 23 percent (both measured by the Gini index). Moreover, the role of tax policy changes in exacerbating post-tax and post-transfer inequality is understated in these measures because of the phenomenon of “bracket creep”—top incomes rise faster than the inflation adjustment for tax brackets, subjecting more income to taxation at top rates—which innately increases the redistributive nature of the tax and transfer system over time. But while tax and transfer policy should have been pushing harder against inequality growth instead of exacerbating it, there are practical limits to how much increased redistribution can mitigate strong market trends.

Klein characterizes my views on income inequality as making the “most optimistic version” of the redistributionist case, because I give weight to research suggesting that tax policy changes, particularly reductions in top income tax rates, have exacerbated market-based income inequality growth. Essentially, a lower top tax rate increases the rate of return to executives’ efforts demanding greater compensation from boards of directors, and successful efforts will come out of workers’ paychecks, not shareholders’ portfolios. Meaningfully curbing income inequality growth necessitates reducing the market income share accumulating to upper-income households, and higher top marginal tax rates may be one of the more concrete policy levers to advance that end, while necessarily further reducing post-tax, post-transfer measures of inequality. (For concise, accessible versions of this argument and surrounding research, see this blog post of mine and Dylan Matthews’ Wonkblog post on my paper. For a more thorough treatment with respect to executives’ income growth, see this new paper by Josh Bivens and Larry Mishel or Josh’s summary blog post.)

But after walking through these empirical arguments about the role of policy, Klein brushes off my case for higher top tax rates on political grounds:

“Ultimately I think Fieldhouse gives the tax code too much credit. Changes he attributed to the tax code are really rooted in political culture. Taxes on the wealthy didn’t lower themselves, after all. Wealthy Americans fought to bring them down. And now that they’ve grown used to those low taxes and high incomes, they will fight to keep them.”

Prima facie, this is irrelevant to the “fatalist” versus “redistributionist” schism for explaining driving forces of income inequality growth explored by Klein. That said, I don’t dispute that reductions in top U.S. tax rates stemmed from a calculated, multi-decade campaign by supply-siders (pdf), or that the plutocrats and conservatives in Congress will fight like hell to prevent any increase in top tax rates. But that’s entirely beside the point of empirically grounded economic research intended to inform better public policy.

From my perspective, Congress ran the plutocrats’ “supply side” experiment, the robust growth promised never materialized, the income growth we saw never trickled to the vast majority (see this State of Working America figure), income gains highly skewed toward the top drove a marked trend of income inequality growth, and the budgetary opportunity cost of this experiment was staggering. But rather than resigning yourself to these monumental policy failures and the current political landscape in which higher tax rates are a huge political lift, one must build an evidence-based case for reversing these policy shifts to eventually make that lift easier.

As it happens, recent economic research strongly refutes supply-siders’ arguments. Best estimates of behavioral responses to top tax rates have trended downward with improved research methods and data availability (pdf). While tax increases decrease upper-income households’ reported taxable income more  than they decrease moderate-income households’ reported income, research suggests this is entirely because upper-income households take advantage of their greater capacity to shift income from one category to another or one time period to another to reduce their taxes, as opposed to working less (pdf). And time series regression analysis suggests that reductions in top tax rates have had no statistically significant impact on overall economic growth (pdf) or its driving factors (pdf). I summarized this research in a recent paper on the economic effects of raising top tax rates, which argues that there is considerable scope to raise top tax rates without unduly slowing productive economic activity or overall growth.

Moreover, this research suggests that broadening the tax base (eliminating or curbing tax expenditures such as deductions, exclusions, credits, exemptions, and preferential treatment of capital income over labor income) in ways that reduce tax avoidance opportunities only strengthens the case for higher top tax rates. Consequently, broadening the tax base and raising top rates should be thought of as complements, not substitutes—exactly the opposite of Washington’s dominant thinking toward a modern tax overhaul, as I explain in this recent paper.

In other words, there is a strong policy case for higher top tax rates that too many policymakers are either unaware of or wrongly ambivalent toward: Rates can be raised significantly without hurting economic growth, and higher top rates would generate substantial revenue, necessarily reduce after-tax income inequality, and could yield big gains in reducing market-based income inequality.

I don’t naively expect higher top tax rates to be enacted in the 113th Congress. But I hope a much broader swathe of the Democratic Party eventually grows a spine regarding higher tax rates, joining their colleagues in the Congressional Progressive Caucus who better understand realistic revenue needs and the scope of policy changes necessary to meaningfully improve economic opportunity and mobility. Widespread misconceptions about tax policy are currently impeding such a needed change of heart among Democratic members of Congress, hence the importance of economic research debunking those fallacies and distilling said research for policymakers.

The plutocrats peddling supply side snake oil will likely never come around, but when push comes to shove, they’re hugely outnumbered by the economically struggling vast majority—whose living standards the Democratic Party is supposed to be championing.

  • tyler30ish

    Inequality can be solved by pulling down the rich or lifting up the poor. I think it makes much more sense to do the latter.
    Federal tax increases are deflationary because they pull money out of the economy. It makes no sense to pull more money out of an economy that is already starving for money.

  • Robert Bostick

    Why does a monetarily sovereign government need revenue per se to spend? Why does it need budget ceilings? Why does the fact that public sector deficits are equal, to the penny, to net financial assets in the non-public sector, escape most modern monetary economists?

    When you come to grips with those realities your analysis can be reworked to a new start date; Aug. 15, 1971.

    The rich knew federal taxes would no longer be needed to fund public sector expenditures. Becoming a fiat currency issuer was the paradigm shift that most economists either innocently ignored, or cynically suppressed to serve the top 20%.