Electronic copy available at: http://ssrn.com/abstract=2207372 Changes in Income Inequality Among U.S. Tax Filers Between 1991 and 2006: The Role of Wages, Capital Income, and Taxes Thomas L. Hungerford 1 [email protected]January 23, 2013 1 The author thanks Jane Gravelle, Stephen Jenkins, Donald Marples, and Austin Nichols for helpful comments on a previous draft. The views expressed here do not reflect the views of the Congressional Research Service or the Library of Congress.
Transcript
Electronic copy available at: http://ssrn.com/abstract=2207372
Changes in Income Inequality Among U.S. Tax Filers
1The author thanks Jane Gravelle, Stephen Jenkins, Donald Marples, and Austin Nichols for
helpful comments on a previous draft. The views expressed here do not reflect the views of the
Congressional Research Service or the Library of Congress.
Electronic copy available at: http://ssrn.com/abstract=2207372
Abstract
This paper examines changes in after-tax income inequality among tax filers between1991 and 2006. In particular, how changes in wages, capital income, and tax policy con-tribute to changes in income inequality is investigated. To examine the role of these threepossible contributors to the increase in income inequality, the Gini coefficient is decomposedby income source using the method developed by Lerman and Yitzhaki (1985). The Ginicoefficient of after-tax income increased by 15 percent (0.071 points) between 1991 and 2006.By far, the largest contributor to this increase was changes in income from capital gains anddividends. Changes in wages had an equalizing effect over this period as did changes intaxes. Most of the equalizing effect of taxes took place after the 1993 tax hike; most of theequalizing effect, however, was reversed after the 2001 and 2003 Bush-era tax cuts. Similarresults are obtained with other inequality measures.
1 Introduction
Social scientists and philosophers have been concerned with issues surrounding the distri-
bution of income or income inequality for over 200 years—for example, the economist and
philosopher Adam Smith (1937) discussed these issues as early as 1776. Academic writers
have been writing on income inequality measurement issues for at least a century.1 Policy
makers have also long been interested in income inequality issues.2 The Obama Administra-
tion has stated that one of its principles for tax reform was to observe the “Buffett rule”—“no
household making over $1 million annually should pay a smaller share of its income in taxes
than middle-class families pay” (OMB 2011).
Arguments are offered for and against rising income inequality. The classic argument
against rising income inequality is the rich get richer and the poor get poorer. This shift can
increase poverty, reduce well-being, and reduce social cohesion. Consequently, some argue
that reducing income inequality may reduce various social ills. Additionally, researchers are
concerned about the consequences of rising income inequality. Research has demonstrated
that large income and class disparities adversely affect health and economic well-being (see,
for example, Marmot 2004, Wilkinson 1996, Frank 2007, Singh and Siahpush 2006).
In contrast, others argue that rising inequality is nothing to worry about and point out
that average real income has been rising, so while the rich are getting richer, the poor are
not necessarily getting poorer. In addition, researchers and policy analysts argue that some
income inequality is necessary to encourage innovation and entrepreneurship—the possibility
of large rewards and high income are incentives to bear the risks (Deere and Welch 2002).
Furthermore, some have argued that income or social mobility (i.e., movement within the
income distribution) reduces income inequality and increases well-being (see, for example,
1For example, the Gini coefficient, which has long played a central role in the measurement of incomeinequality, was developed in 1909 by the Italian statistician and sociologist Corrado Gini.
2For example, distributional issues of wealth and income were part of Senate debate over the War RevenueAct of June 10, 1898. See Senator Richard Pettigrew, Senate debate, Congressional Record, June 10, 1898,pp. 5743–5744. More recently, there have been at least 17 hearings or testimony devoted to aspects ofincome inequality in the 110th, 111th, and 112th Congresses (based on a search of CQ.com).
1
Friedman 1962). Research has shown, however, that income mobility is not very great and
the degree of income mobility has either remained unchanged or decreased since the1970s
(Hungerford 2011, and Bradbury 2011).
CBO (2011) has documented that income inequality has been increasing in the United
States over the past 35 years. Several factors have been identified as possibly contributing
to increasing income inequality. This paper examines changes in after-tax income inequality
among tax filers between 1991 and 2006. In particular, how changes in wages, capital income,
and tax policy contribute to changes in income inequality is investigated. During this period,
there were changes in the sources of income that differed by income category and there were
many changes in tax policy. The years 1991, 1996, 2001, and 2006 are examined.
2 Potential Causes of Increased Income Inequality
Three potential causes of the increase in after-tax income inequality between 1991 and 2006
are examined in the analysis: changes in labor income (wages and salaries), changes in
capital income (interest income, capital gains, dividends, and business income), and changes
in taxes. These are not the only potential reasons for changes in income inequality, but
all are commonly cited as reasons by many observers (e.g., CBO 2011). It is important to
keep in mind, however, these three reasons are not mutually exclusive—a change in labor or
capital income could also affect the amount of taxes paid, which affects observed inequality
of after-tax incomes.
2.1 Changes in Labor Income
Earnings inequality has been increasing since at least the late-1960s (Kopczuk, Saez, and
Song 2010). Part of this has been attributed to increased salaries paid to CEOs, managers,
financial professionals, and athletes, which is estimated to account for 70 percent of the
increase in the share of income going to the richest Americans (Bakija, Cole, and Heim
2
2010). Such changes in the earnings distribution have been described by some as a move
toward a winner-take-all reward structure—labor markets where the rewards are few but
large with more and more people competing for these rewards (Frank and Cook 1995). In
an elaboration of this argument, some have argued that “public officials have rewritten the
rules of American politics and the American economy in ways that have benefited the few
at the expense of the many” (Hacker and Pierson 2010). This explanation would primarily
affect those at the top of the income distribution. Others have argued that rising returns to
education and skill-biased technological change are the important factors explaining rising
inequality (Bound and Johnson 1992, Autor, Katz, and Kearney 2006, and Lemieux 2006).
Skill-biased technological change would likely affect earnings in the upper part of the earn-
ings distribution. Other explanations for rising earnings inequality would affect different
parts of the income distribution. A declining real minimum wage could affect lower income
tax filers (the inflation-adjusted minimum wage fell from $6.57 per hour in 1996 to $5.57 per
hour in 2006) and declining unionization could affect tax filers in the middle of the earn-
ings distribution (Lee 1999, and DiNardo, Fortin, and Lemieux 1996). Increasing earnings
inequality has been identified as the main suspect behind rising income inequality, since a
large share of total income is from earnings.
Reed and Cancian (2001) found that changes in husband’s earnings was a major source of
rising inequality of family income while changes in female earnings had an equalizing effect
on family income between 1970 and 2000. However, Gottschalk and Danziger (2005), while
also finding that male wage inequality and family income are correlated, conclude that the
correlation “seems to be coincidental.” Overall, it is well understood that wage inequality
has increased since 1979, but how this contributed to increasing income inequality is unclear.
2.2 Changes in Capital Income
The role of capital income and capital gains has recently been thrust into the debate over
increasing income inequality with the Occupy Wall Street movement and proposed legislation
3
to increase the tax rate on carried interests received by private equity managers. CBO (2011)
documents the increased concentration of business income, capital income, and capital gains
between 1979 and 2007.
Capital income has generally been concentrated among higher-income tax filers. Cap-
ital income can be capital gains, dividends, and business income from partnerships and
S-corporations. The number of partnerships and S-corporations has steadily increased be-
tween 1991 and 2006. The number of partnerships increased by 1.4 million over this period
and the number of S-corporations increased by 2.2 million.3 Income from these types of busi-
ness is reported on an individual tax filer’s tax return and is not subject to the corporate
income tax. An increasing share of income for high-income tax filers is from capital income,
which could be part of the explanation for the rising income of this group of tax filers and
rising income inequality.
It has been shown that the income of the richest 0.1 percent of taxpayers is sensitive to
changes in asset prices and this may have been especially important in the increase in the
income share of those at the top of the income distribution (Bakija, Cole, and Heim 2010).
Fraβdorf, Grabker, and Schwarze (2011) also find that capital income’s share in disposable
income has increased in recent years in the U.S. and show that capital income made a large
contribution to income inequality in relation to its share in income.
2.3 Changes in Taxes
Tax policy has also been identified as a possible cause for rising income inequality (Feenberg
and Poterba 1993, and Gordon and Slemrod 2001). Research suggests that tax policy may
not have much impact on the longer-term trend or rate of change in inequality, but a change
in tax policy can have a one time affect on the level of income inequality (Slemrod and Bakija
2001, Levy and Temin 2007, Piketty and Saez 2003, and Gramlich, Kasten, and Sammartino
1993). Given that tax policy changes on an almost annual basis, the longer-term trend in
3The number of C-corporations fell by less than 150,000 or 6.8 percent. Internal Revenue Services,Statistics of Income, available at www.irs.gov.
4
income inequality could have been affected by tax policy changes. While the individual
income tax system is progressive and has been since it was introduced in 1913, the trend has
been toward lower marginal tax rates and a less progressive tax system (Piketty and Saez
2007, and Alm, Lee, and Wallace 2005). As a result, the tax system may be less able to
equalize after-tax incomes.
The major tax changes between 1991 and 2006 were (1) the enactment of the Omnibus
Budget and Reconciliation Act of 1993 (OBRA93), which increased the top marginal tax
rate from 31 percent to 39.6 percent, and (2) the enactment of the 2001 and 2003 Bush tax
cuts, which reduced taxes especially for higher-income tax filers. The Bush tax cuts involved
reduced tax rates, the introduction of the 10 percent tax bracket (which reduced taxes for
all taxpayers), reduced the tax rates on long-term capital gains and qualified dividends,
and other changes. In 1991, long-term capital gains were taxed at 28 percent (15 percent for
lower-income taxpayers) and all dividends were taxed as ordinary income. The next year, the
long-term capital gains tax rate was reduced to 20 percent. By 2006, long-term capital gains
and qualified dividends were taxed at 15 percent (5 percent for lower-income taxpayers).
Tax policy changes that affect progressivity will affect after-tax income inequality (Kim and
Lambert 2009, and Hungerford 2010).
The equalizing effect of taxes can change even if there is no change in tax laws. Since the
mid-1980s, many tax parameters have been adjusted for inflation. In general, income tends
to rise faster than prices. Given the progressive nature of the U.S. individual income tax
system, modest bracket creep could lead to taxes having a larger equalizing effect in 2006
than in 1991 as more income is moved into higher tax brackets.
3 Data and Methods
The sources of data are the 1991, 1996, 2001, and 2006 Internal Revenue Service (IRS) Statis-
tics of Income (SOI) Public Use Files. The Public Use Files are nationally representative
5
samples of tax returns for these tax years. To protect the identity of individual tax filers
while preserving the character of the data, the IRS made changes to the data. Consequently,
while reliable aggregate information can be obtained, individual tax filer records may or
may not contain information from just one tax return. The unit of analysis is the tax return
for a tax filer (which may be a married couple), and IRS-provided sample weights are used
throughout the analysis. The number of sample observations in each income category for
each year are reported in table 1.
The IRS SOI public use files have advantages over other data sources commonly used for
inequality analyses as well as disadvantages. The major advantages are (1) a large sample
of tax filers, with an especially large sample of very high income tax filers, (2) income from
various sources, including capital gains, and federal income taxes are reported, (3) reported
income is not censored as it is in the March Current Population Survey data files, and (4)
reported income is not subject to recall errors as in survey data. The main disadvantages are
non-tax filers are excluded from the sample (primarily low-income individuals and families),
and income from public assistance is not reported. However, since the emphasis of this
study is on after-tax income changes, especially at the top of the income distribution, the
advantages clearly outweigh the disadvantages.
The unit of observation is the tax unit rather than the family. Burkhauser, Feng, Jenkins,
and Lattimore (2012) note that “aggregating income to the household level rather than the
tax unit, and adjusting for economies of scale using an equivalence scale” may yield slightly
different inequality estimates. Hungerford (2010) notes, however, that about 75 percent
of families contain just one tax unit (another 17 percent contain two tax units with the
second tax unit usually a cohabitating adult or a working child that cannot be claimed as
a dependent on another tax return). Consequently, most of the tax units likely represent a
family.
6
3.1 Income
Equivalence-adjusted gross income from all sources, except public assistance, is used for the
analysis; the equivalence scale is the square root of the total number of exemptions claimed
by the tax unit (excluding additional exemptions for the blind and the elderly). Capital
gains are also included. Piketty and Saez (2003) argue that capital gains are not an annual
flow of income and have large aggregate variations from one year to another; they exclude
capital gains from much of their analysis. Blinder (1980) argues that capital gains should not
be included in income because what is important is real accrued capital gains. Citing work
by Eisner (1980), he points out that realized capital gains represent partial maintenance of
principle in an inflationary world. Eisner examined the period between 1946 and 1977 when
annual inflation averaged almost 4 percent (using the GDP deflator). Between 1991 and
2006, however, annual inflation averaged slightly over 2 percent.
Furthermore, capitals gains have increasingly become an important source of compensa-
tion for corporate executives (through stock options4), and private equity and hedge fund
managers (carried interests). Consequently, income from capital gains is included in the
analysis.
3.2 Taxes
U.S. taxes from all sources should be included in an analysis of the effective tax burden
and this analysis considers the individual income tax, the corporate income tax, and the
payroll tax. But three issues need to be addressed regarding the burden of the corporate
income tax. The first issue is the question of who actually bears the burden of the corporate
income tax. Several recent studies estimate that most or all (in some cases more than 100
percent) of the burden of the corporate income tax falls on labor through reduced wages.
These studies, however, have been shown to suffer from various methodological deficiencies
4A stock option is reported on a tax return as wages and salaries when it is exercised, but when the stockis sold, any gain is reported as capital gains.
7
(Gravelle and Hungerford 2008; Gravelle 2011). The evidence suggests that most or all of the
burden of the corporate income tax falls on owners of capital. In the analysis, it is assumed
that 100 percent of the corporate income tax falls on capital income (dividends and capital
gains), which mostly affects high-income taxpayers (almost 60 percent of all capital gains
and dividends are received by taxpayers with income over $1 million).
Second, not all of this income is taxed at the corporate level. The Internal Revenue
Service (IRS) reports that a substantial proportion of capital gains and losses (short-term
and long-term) reported by taxpayers are passthrough gains or losses (that is, the income is
not reported on any corporate tax form and passes directly to individual taxpayers to report
on their individual income tax form), gains or losses from the sale of government bonds,
and other assets never taxed at the corporate level (Wilson and Liddell 2011). For example,
hedge funds are generally organized as partnerships. Under current tax law, a partnership
does not pay income taxes; instead gains and losses flow through to the partners who include
it on their income tax returns.
The income from the partnership is often taxed as capital gains or qualified dividends at
reduced tax rates (i.e., 15 percent in 2006). Essentially, if the partnership earns long-term
capital gains or qualified dividends, the income flows through to the partners as long-term
capital gains or qualified dividends and is taxed accordinglythe income is not recharacterized
(e.g., from capital gains to ordinary income) as it passes through from the partnership to the
individual partners. Some partners receive partnership interests in exchange for contributions
of capital (that is, investments) and are referred to as limited partners; some partners receive
partnership interests in exchange for services (carried interests) and these are general partners
who actively manage the partnership. Most of this income is taxed at the reduced long-term
capital gains rate and is not taxed at the corporate level.5 It is assumed that 50 percent of
net capital gains are taxed at the U.S. corporate level as well as the individual level (such
5About 45 percent of net capital gains are from passthrough net gains or a transaction involving part-nership, S-corporation, and estate or trust interests. It is unknown how much of this was from the sale ofcorporate equities.
8
as corporate stock, mutual funds, and capital gains distributions).6 It is also assumed that
all dividends are taxed at both the corporate and individual levels.7
The third issue concerns the corporate tax rate. The statutory corporate tax rate in 2010
was 39.2 percent, which includes federal and state corporate taxes. However, several studies
estimate the effective corporate tax rate is between 22.2 percent and 27.1 percent (Gravelle
2011). After subtracting out the state corporate tax rate from the highest estimate, it is
assumed that the effective corporate tax rate is 24.2 percent.
Taxes attributed to tax filers that are not directly paid by them (that is, the employer’s
contribution of the payroll tax and corporate taxes) are also imputed to the tax filer as
income. Total income includes income from all sources reported on the 1040 form including
tax-exempt interest and Social Security benefits that are excluded from adjusted gross income
as well as the imputed taxes.
3.3 Inequality Measures
To examine the role of the three explanations for the increase in income inequality, the Gini
coefficient is decomposed by income source using the method developed by Lerman and
Yitzhaki (1985). The contribution of each income source (k = 1, . . . , K) to the overall Gini
coefficient depends on (1) how important the income source is to total income (Sk), (2) how
the income source is distributed (Gk), and (3) how the income source is correlated with total
income (Rk). The overall Gini coefficient (G) can be written as:
G =
K∑
k=1
Sk × Gk × Rk.
If Sk, Gk, or Rk are close to zero, then the particular income source does not make a
significant contribution to income inequality (see Lerman and Yitzhaki 1985 for formulas).
6The results are virtually unchanged if it is assumed that 100 percent of net capital gains are taxed atboth the corporate and individual levels.
7Gale (2002) shows that about half of dividends do not face double taxation. Consequently, this assump-tion will tend to overstate the taxes paid on dividend income.
9
The change in the Gini coefficient between two years can be decomposed as:
G2− G1 =
K∑
k=1
(S2
k× G2
k× R2
k− S1
k×G1
k× R1
k)
The Gini coefficient is sensitive to income changes in the middle of the income distribution
(at the mode). The generalized Gini (also known as the S-Gini), denoted as G(ν), is a
generalized version of the Gini coefficient with an additional parameter (ν) that can be
varied so as to place more weight on inequality in different parts of the income distribution
(Donaldson and Weymark 1980, 1983; and Yitzhaki 1983). If the value of ν is 2.0, then
the generalized Gini is the familiar Gini coefficient. Values of ν less than 2.0 place more
emphasis on inequality in the upper part of the distribution, while values greater than 2.0
emphasize the lower part of the distribution. In addition to the Gini coefficient (ν = 2.0),
two other values are used (1.5 and 4.0).8 Jackknife standard errors are estimated.
After-tax income is broken down into (1) wages and salaries (including the employer por-
tion of the payroll tax), (2) interest income (taxed and tax exempt), (3) capital gains and
dividends (including corporate income tax paid), (4) net business income (proprietorships,
partnerships, S-corporations, and farms), (5) social insurance (Social Security and unem-
ployment compensation), (6) retirement income (pension income and IRA distributions),
(7) all other income, and (8) federal taxes paid (individual and corporate income taxes, and
employee and employer paid payroll taxes).
3.4 Sensitivity Analysis
The Gini coefficient is not the only inequality that can be decomposed by income source.
Jenkins (1995) provides methods to decompose the coefficient of variation (CV) and half
the square of the CV (GE(2))—the latter is a member of the Generalized Entropy class of
inequality measures.9 The inequality measures (generically denoted by I) can be written as:
8The Stata command (sgini) used for the estimation was developed by Philippe Van Kerm (2009).9Stephen Jenkins has developed a Stata command (ineqfac) to perform the decomposition.
10
I =K∑
k=1
Fk
where Fk is the absolute contribution of income source k to overall inequality. The change
in the inequality measure can be written as the sum of the changes of the contributions of
the income sources:
I2− I1 =
K∑
k=1
(F 2
k− F 1
k).
4 Results
The trend in after-tax income inequality as measured by the S-Gini is reported in table 2.
The first column reports the estimated Gini coefficient (i.e., ν = 2.0). The Gini coefficient
steadily climbed from 0.468 in 1991 to 0.539 in 2006—an increase of 15.2 percent. The next
two columns report the values of the S-Gini for ν = 1.5 (relative weight at the top of the
income distribution) and ν = 4.0 (relative weight at the bottom of the income distribution).
The S-Gini with ν = 1.5 increased by 23 percent between 1991 and 2006 (from 0.330 to
0.406), while the S-Gini with ν = 4.0 increased by 5.2 percent over this period. These
results are consistent with research showing that the rise in income inequality is due to
changes at the top of the income distribution rather than to changes at the bottom (e.g.,
Piketty and Saez 2003).
4.1 Income Shares by Income Source
The share of after-tax income accounted for by the various income sources (taxes are con-
sidered a negative income source) are reported in table 3.10 Wages are by far the largest
source of income, but accounted for a smaller share of income in 2006 (77 percent) than in
1991 (92 percent). In addition, the wage share appears to be counter-cyclical—the share
10The full set of basic estimation results are reported appendix tables A.1-A.3.
11
is higher in the recession years of 1991 and 2001 than in the expansion years of 1996 and
2006. Interestingly, the decline in the wage share during the economic recovery after the
2001 recession (2001 to 2006) was considerably larger than the decline during the years after
the 1990–91 recession (13 percentage points versus 4 percentage points).
The next three rows of the table show the income shares of capital income. Interest
income as a share of total after-tax income fell by over half between 1991 and 2006, with
most of the decline occurring between 1991 and 1996. Capital gains and dividends as a
share of income increased from 5.4 percent in 1991 to 15.6 percent in 2006—a 287 percent
increase. The capital gains and dividends share appears to be pro-cyclical, increasing during
the expansions and falling during recessions. Business income also greatly increased as a
share of income between 1991 and 2006 by 265 percent (from less than 2 percent in 1991 to
over 5 percent in 2006). There does not appear to be a strong cyclical pattern to the trend
in the business income share. Overall, income from capital increased as a share of income
from 16.7 percent to over one-quarter over this 15-year period.
The income share of federal taxes (including individual and corporate income taxes as
well as the payroll tax) declined (in absolute value) from −28.4 percent in 1991 to −25.5
percent by 2006. The income share, however, increased (i.e., became more negative) in the
intervening years. The next three rows of table 3 separate federal taxes in three components.
The negative income share of individual income taxes increased between 1991 and 1996, most
likely due to the tax hikes contained in OBRA93. The share was essentially constant between
1996 and 2001. The income share fell (in absolute value) between 2001 and 2006 due to the
rate reductions contained in the 2001 and 2003 Bush tax cuts.11 The income share of the
corporate income tax (in absolute value) follows the same trend as for capital gains and
dividends since were no changes in the corporate tax rate during this 15-year period. The
income share (in absolute value) of the payroll tax follows the same trend as for wages.
11The Bush tax cuts were enacted by the Economic Growth and Tax Relief Reconciliation Act of 2001(EGTRRA) and the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA).
12
4.2 Contributions to Income Inequality by Income Source
The contribution of each income to overall income inequality is reported in tables 4–6. Table
4 reports the results for the Gini coefficient (ν = 2.0). In each year, wages make the largest
contribution to the overall Gini coefficient, though the share of wages in inequality is less than
its share in income (compare to table 3). The contribution of wages to the Gini coefficient
fell between 1991 and 2006 (from 0.774 to 0.600). A 1 percent increase in wages, all else
equal, would reduce the 1991 Gini coefficient by 0.15 percent and the 2006 Gini coefficient
by 0.17 percent.12
In 1991, of the three capital income sources, capital gains and dividends made the largest
contribution to income inequality (with an inequality share of 0.146), followed by interest
income, and lastly by business income. A 1 percent increase in each of the sources (one at
a time) would increase the Gini coefficient by 0.025 percent (for interest income) to 0.092
percent (for capital gains and dividends). By 2006, the contribution of capital gains and
dividends to income inequality almost doubled to 0.280 while the contribution of interest
income fell by half to 0.059. The inequality share of business income increased modestly
to 0.105. Increasing each of the capital income sources by 1 percent, all else equal, would
increase the Gini coefficient by 0.016 percent for interest income, by 0.124 percent for capital
gains and dividends, and by 0.053 percent for business income.
Taxes subtract from income and, consequently, account for a negative share of income
and inequality. Total federal taxes had a −0.328 income inequality share in 1991. After the
OBRA93 tax increase the inequality share of federal taxes increased in absolute value to
−0.370 (that is, had a larger equalizing effect). The inequality share fell after the enactment
of the 2001 and 2003 Bush tax cuts to −0.305 by 2006. A 1 percent increase in taxes,
all else equal, would have reduced the Gini coefficient by about 0.04 percent in 1991 and
by 0.5 percent in 2006. In 1996, after the enactment of the OBRA93 tax increases, a 1
12The marginal effect is equal to the difference between the inequality share and the income share of anincome source.
13
percent increase in federal taxes would have reduced the Gini coefficient by slightly over
0.07 percent. Individual income taxes in 2006 accounted for the smallest income inequality
share (in absolute terms) of the four years—the 15-year pattern for individual income taxes
is what would be expected with the enactment of OBRA93 (increased absolute inequality
share) and the Bush tax cuts (decreased absolute inequality share). Since the payroll tax is
regressive above the maximum taxable income limit, a 1 percent increase would lead to an
increase in the Gini coefficient of about 0.03 percent in each of the four years.
The next two tables, table 5 and table 6, show the results for the generalized Gini (S-
Gini) for ν = 1.5 (table 5) and ν = 4.0 (table 6). Wages contributed a smaller share to the
overall S-Gini when the relative weight on inequality at the top of the income distribution
is increased (ν = 1.5) compared to the bottom of the income distribution (ν = 4.0). But a
1 percent increase in wages has a larger negative effect on the S-Gini when ν = 1.5 (G(1.5))
than when ν = 4.0 (G(4.0)). Capital income is a much more important contributor to the
S-Gini when the aversion to inequality is lower (ν = 1.5).
Lastly, the negative influence of federal taxes is larger when ν = 1.5 than when ν = 4.0.
In 2001 (before the Bush tax cuts), a 1 percent increase in individual income taxes would
reduce the G(1.5) by about 0.1 percent and the G(4.0) by 0.05 percent. In 2006 after the
enactment of the Bush tax cuts, a 1 percent increase in individual income taxes would reduce
the G(1.5) by 0.08 percent and the G(4.0) by about 0.05 percent. This is consistent with
the argument that changes to the income tax system by the Bush tax cuts generally favored
taxpayers at the top of the income distribution.
The contributions of the various income sources to the change in the Gini coefficient
between 1991 and 2006 are reported in table 7. Between 1991 and 2006 the Gini coefficient
increase by 0.071 points or 15 percent (see the last row of table 7). The Gini coefficient
increased over each of the 5-year sub periods examined at what appears to be an accelerating
pace. Between 1991 and 1996, the Gini coefficient increased by 0.012 points, which is about
17 percent of the total 15-year increase. The increase in the Gini was 0.023 points between
14
1996 and 2001, and was 0.036 points between 2001 and 2006. The latter 5-year sub period
accounts for half of the 15-year increase in the Gini coefficient.
The change in wages’ share of inequality was negative over the 1991 to 2006 period.
Consequently, changes in wages had an equalizing effect on income inequality (i.e., reduced
the Gini coefficient). Most of the equalizing effect occurs over the final 5-year sub-period.
Changes in capital gains and dividends are the largest contributor to the rise in income
inequality over the 15-year period, with most occurring between 2001 and 2006. Changes
in taxes had an equalizing effect on overall inequality between 1991 and 2006. Most of this
equalizing effect occurred between 1991 and 1996 due the OBRA93 tax increase; the 2001
and 2003 Bush tax cuts had a disequalizing effect between 2001 and 2006.
The effects of changes in the inequality share of various income sources on the change
in the S-Ginis are reported in table 8. The change in the inequality share of wages is
considerably larger when ν = 4.0 than when ν = 1.5 implying wages had a greater equalizing
effect when weight is on income inequality at the bottom of the income distribution. Changes
in capital gains and dividends has a greater relative disequalizing effect when ν = 4.0 than
when ν = 1.5. Changes in federal taxes has a small disequalizing effect when ν = 4.0 and an
equalizing effect when ν = 1.5. The former disequalizing effect is due to changes in payroll
taxes, which likely reflects changes in wages since the payroll tax rate remained constant.
4.3 Sensitivity Analysis
Between 1991 and 2006, both the coefficient of variation (CV) and half the square of the CV
(GE(2)) steadily increased (see table 9). This is roughly the same pattern as with the Gini
coefficient (compare to table 2). The CV increased by 105.6 percent over this period and
the GE(2) increased by 322.9 percent.
Table 10 reports the contribution of the various income sources to the increase in the CV
and GE(2) between 1991 and 2006 (compare to the last two columns of table 7 for the Gini
coefficient). The results for the CV and the GE(2) are broadly consistent with one another
15
and somewhat consistent with the results for the Gini coefficient. Changes in wages makes
a relatively small contribution to the increase in the CV and the GE(2) between 1991 and
2006. Changes in wages had a modest equalizing affect on inequality as measured by the
Gini coefficient.
Changes in capital gains and dividend income account for over 100 percent of the in-
crease in both the CV and the GE(2)—the same result as with the Gini coefficient. The
contributions of interest income and business income are much smaller, and not particularly
comparable to the Gini coefficient results (reported in table 7). Changes in interest income
had a slight equalizing effect on the CV and almost no effect on the GE(2), which is in
contract to the modest to large equalizing effect on the S-Gini.
Regardless of the choice of inequality measure, overall federal taxes had a modest equal-
izing effect. The equalizing effect is due to both the individual and corporate income taxes;
payroll taxes contributed relatively little to the change in measured inequality (and often
had a disequalizing effect).
5 Simulations
To further investigate the sources of income inequality changes, a series of simulations are
performed. The basic idea of the simulations is to hold either the components of the Lerman-
Yitzhaki decomposition constant (income source shares, income source inequality, or income
source correlations), or tax law constant between two years.
5.1 Decomposition Components
The method decomposes each income source’s contribution to the Gini coefficient into three
terms, each of which change from year to year. To focus on what changes between 2006
and earlier years occurred that contributed to the increase in the Gini coefficient, a series of
simulations are performed. The simulations involve replacing the vector of Sks, Gks, or Rks
16
in the calculation of the 2006 Gini coefficient with prior year values (1991, 1996, or 2001).
The results are reported in table 11.
The first entry on the table—0.4636—is the simulated Gini for 2006 using the 1991 vector
of Sks (the importance of each income source to total income). The simulated Gini is 14
percent less than the actual 2006 Gini coefficient of 0.5389. The other two entries in the first
column of numbers are the simulated Gini coefficient using the vector of Sks for 1996 and
2001. In each case, the simulated Gini is lower than the actual Gini coefficient. The lower
simulated Gini is primarily due to three sources of income: capital gains and dividends, net
business income, and taxes. Using the prior years values of Sk yields a smaller contribution
to the total Gini (that is, less disequalizing) for capital gains and dividends, and net business
income. In 1991, 1996, and 1996 capital income was a less important source of total income
than in 2006. Taxes make a greater equalizing contribution with the prior year Sks because
taxes were a more important negative source of after-tax income in the three earlier years.
The second column of numbers in table 11 report the simulated 2006 Gini coefficients
using the prior values of the Gks (the distribution of each income source). In each case, the
simulated Gini is larger than the actual 2006 Gini coefficient though the simulated Gini using
the 1996 vector of Gks is very close to the actual Gini. The simulated Gini using the 1991
vector is 25 percent larger than the actual. By far the largest contributor to the difference
between the simulated and actual Gini is capital gains and dividends, which accounted
for two-thirds of the difference. Net business income accounted for about 30 percent of
the difference. Changes in the distribution of capital income account for almost all of the
difference when the 1991 and 2001 vectors are used. Capital income appears to be more
unequally distributed in recession years than in expansion years (though capital income is a
more important source of income in expansion years).
The final column of table 11 reports the simulated Gini coefficients using prior year values
of Rk—the correlation of each income source with total income. Overall, the simulated Gini
coefficients are close to the actual Gini when the 1996 and 2001 vector is used. When the
17
1991 vector of Rks is used the difference is primarily due to capital gains and dividends and
retirement income, both of which were less correlated with total income in 1991 than in 2006.
5.2 Tax Law
To investigate the role of tax policy as distinct from bracket creep an additional simulation is
performed: federal individual income taxes were calculated for 1991 and 2006 taxpayers using
NBER’s TAXSIM program using 1991 tax laws.13 The Lerman-Yitzhaki decomposition of
the Gini coefficient is estimated. Holding tax law constant at the 1991 parameters almost
doubled the equalizing effect of individual income taxes on the Gini coefficient (see table 7
for the equalizing effect). Bracket creep as well as the increasing concentration of income at
the top of the income distribution account for a fairly significant change in the equalizing
effect of individual income taxes. Tax policy changes between 1991 and 2006 appear to have
had a disequalizing effect on the Gini coefficient.
Two major tax changes occurred between 1991 and 2006 that has opposite effects on
income inequality. The simulations were repeated to focus on (1) the 1991 to 1996 period
to isolate the effect of OBRA93, and (2) the 2001 to 2006 period to isolate the effects of
the 2001 and 2003 Bush tax cuts. Holding tax law constant at the 1991 parameters reduces
the equalizing effect of the individual income tax between 1991 and 1996 by 39 percent,
suggesting that bracket creep accounted for about 60 percent of the equalizing effect of the
individual income tax.
Individual income taxes had a disequalizing effect between 2001 and 2006 (see table 7).
Holding tax law constant at the 2001 parameters actually leads to individual income taxes
having an equalizing effect (for a −136 percent change in the disequalizing effect). Bracket
creep between 2001 and 2006 would have produced a smaller Gini coefficient, which was
more than offset by the tax law changes between 2001 and 2006.
13See Feenberg and Coutts (1993) for a description of the TAXSIM program.
18
6 Discussion and Concluding Remarks
The Gini coefficient of after-tax income increased by 15 percent (0.071 points) between 1991
and 2006. Other measures income inequality also increased significantly between 1991 and
2006. The coefficient of variation increased by about 106 percent while half the square of
the coefficient of variation increased by over 300 percent. Potential contributors to this
increase in after-tax income inequality among taxpayers are examined: changes in wages,
capital income, and taxes. Some of the changes between 1991 and 2006 appear to be due to
economic factors—the contribution of wages to income inequality is countercyclical (higher
in recessions, lower during the recovery) while that of capital gains and dividends appears
to be cyclical.
Changes in Labor Income. Changes in wages over this 20-year period had an equalizing
effect on the Gini coefficient. Although wages are slightly more unequally distributed than
after-tax income, the share of wages in after-tax income decreased from 92 percent in 1991
to 77 percent by 2006. Wages had no or a small disequalizing effect when other incequality
measures are used. Overall, changes in labor income does not appear to be a significant
source of increased income inequality between 1991 and 2006.
Changes in Capital Income. By far, the largest contributor to increasing income inequal-
ity (regardless of income inequality measure) was changes in income from capital gains and
dividends. Capital gains and dividends were less equally distributed in 1991 than in 2006,
though highly unequally distributed in both years. The large increase in the contribution of
capital gains and dividends to the Gini coefficient, however, is due to the large increase in
the share of after-tax income from capital gains and dividends, and to the increase in the
correlation of this income source with after-tax income.
Changes in Taxes. Federal individual and corporate income taxes had an equalizing
effect on inequality regardless of the inequality measure. Federal taxes had a slightly greater
equalizing effect in 2006 than in 1991—taxes appear to have been slightly more progressive
in 2006 than in 1991. The top marginal tax rate in 1991 was 31 percent compared to 35
19
percent in 2006; the lowest tax marginal rate was 15 percent in 1991 and 10 percent in 2006.
However, the increased equalizing effect of the individual income tax is likely due to bracket
creep—more income is taxed at the highest rates—than to tax law changes. Tax policy
changes appear to have played a direct role: OBRA93 tended to have an equalizing effect
on after-tax income while the 2001 and 2003 Bush tax cuts tended to have a disequalizing
effect.
Tax policy may have also have had an indirect effect on rising income inequality, especially
between 2001 and 2006. The reduction in the tax rate on long-term capital gains and qualified
dividends may have led to the increased importance of this source in after-tax income. This
could work through two possible mechanisms. First, some researchers have found that capital
gains realizations are fairly sensitive to the capital gains tax rate (see Dowd, McClelland and
Muthitacharoen 2012 for a recent example). Others, however, conclude there is little basis
for this mechanism (see, for example, Burman 1999). Second, lower capital gains tax rates
may be part of a change in the institutional structure that increased the gains to bargaining
or rent extraction by CEOs and managers (see, for example, Hacker and Pierson 2010, and
Picketty, Saez and Stantcheva 2011).
20
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