While most studies of income inequality in the United States have emphasized the role of pre-tax income trends, leaving little room for even large changes in taxes to have an impact, new research suggests that changes in the tax code can actually affect pre-tax income. These findings are summarized in a new briefing paper from EPI Tax and Budget Analyst Andrew Fieldhouse, Rising Income Inequality and the Role of Shifting Market-Income Distribution, Tax Burdens, and Tax Rates.
Lower top marginal tax rates since 1979 have increased the rate of return to efforts by executives and managers to bargain for greater compensation—at the expense of both workers’ paychecks and even shareholders’ portfolios. While executives have substantial power over the level of their own pay, they balance the incentive to push for ever-higher salaries against other constraints, such as the possibility that excessive pay could anger shareholders or attract unwanted media attention. Cuts to top marginal rates increase executives’ incentives to ignore these constraints and push for higher pre-tax pay. Reducing incentives for powerful economic actors to exercise their full bargaining power by raising top marginal tax rates would therefore slow the growth of market-based income inequality, while also having an impact on post-tax, post-transfer inequality.
“Higher top tax rates reduce the payoff to bargaining for higher salaries by executives, leaving a bigger share of income for workers without changing the size of the economic pie,” said Fieldhouse. “Raising top rates is one of the more concrete policy levers we have for pushing back against income inequality, and there is plenty of room to do so without hurting economic growth.”
This paper builds on research by Fieldhouse and others at EPI showing that, contrary to conventional wisdom, raising tax rates on top earners would have substantial economic benefits and few downsides.