The Congressional Budget Office recently released new estimates of the distribution of taxes and income between and CBO includes all federal taxes except estate and gift levies; counts as income all cash income, taxes paid by businesses, k contributions, and in-kind benefits; and uses standard incidence assumptions—for example, capital owners bear the corporate income tax.
Income is aggregated across household members and adjusted for household size. The table shows that the federal tax system was progressive in both and —average effective tax rates ETRs rose with income. During that time, the ETR rose on an overall basis, but fell in almost every income group.
The ETR for the top 1 percent fell by 3. I emphasise this point particularly for those who will be involved in pay bargaining in the year ahead. Take-home pay will be substantially increased by these unprecedented cuts in income tax. This will more than make good the price effects of higher spending taxes. Any further attempts to cover those price effects by higher pay claims will be utterly self-defeating. The money will simply not be there to finance higher pay as well as lower income tax.
Any attempt to have it both ways will simply end up by threatening jobs and putting firms—on which jobs depend—out of business. That is why it is so important for this Budget to be considered as a whole. These policies start with our conviction that it is people and not Governments who create prosperity. This Budget seeks to reduce the role of Government.
Government will spend less, Government will borrow less. This will lay the foundations for controlling inflation. So, too, in the short run, are the consequences of the inflation that has afflicted us for so long. Until that is controlled, some check to the growth of output and employment is unavoidable.
It is not a give-away Budget. Indeed, it is not in the power of the Government to give anything away. However, it is an opportunity Budget.
The shift from taxes on income to taxes on spending will widen choice and improve incentives. As a result of this progressive structure, the after-tax income distribution was substantially more equal than the pre-tax distribution. Before federal taxes our Gini index for was 0. After taxes it was 0. The tax code has reduced income inequality, to varying degrees, every year since at least Benefits such as Social Security or unemployment insurance help reduce income inequality.
In the Gini index for U. Government assistance reduced it to 0. Though it is outside the scope of this analysis to discuss these government transfers in detail, suffice it to say that their impact on income inequality has declined over time. Since the late s there have been many changes to the federal tax code. Some of those changes have been progressive, asking those at the top of the income pyramid to pay more or those in the middle and bottom to pay less.
And some have been regressive changes, mostly in the form of large tax cuts that disproportionately benefit the rich. Not surprisingly, fluctuations in the effect of the federal tax system on income inequality track very closely to major policy changes in the federal tax code. In the Gini index for before-tax income inequality was 0. Before federal taxes the richest 1 percent claimed 9. That year federal taxation reduced the Gini index by 11 percent to 0.
In the early s President Ronald Reagan spearheaded major tax cuts that primarily benefited those with higher incomes. The total federal effective tax rate for a household in the richest 1 percent declined from 37 percent in to less than 26 percent by Tax rates for everyone else barely moved at all.
For those in the middle 20 percent of income, the effective federal tax rate in was Seven years later it was 18 percent. And taxes actually went up for households in the bottom 40 percent of income earners. The result was a tax code that asked far less from the rich—even as it asked the same or more from everyone else.
Consequently, the effect of the federal tax system on income inequality dropped sharply. Whereas in the after-tax income distribution was 11 percent more equitable than the pre-tax income distribution, in after-tax income was just 5 percent more equitable than pre-tax income.
In Congress passed and President Reagan signed a comprehensive tax reform package that temporarily boosted the power of the federal tax system to reduce income inequality. The reforms lowered the top marginal tax rate but also removed or reformed a host of provisions that allowed rich households to reduce their tax bills, and raised the tax rate on investment income.
The combined effect was an increase in the effective tax rate for the richest 1 percent from With the rich paying more and the middle and poor paying less, the after-tax distribution of income was substantially more equitable than it had been before the tax reform. In , before the reform was implemented, federal taxes reduced the Gini index by 5 percent. In , after reform, federal taxes reduced the Gini score by 7 percent.
In the first years of the s, President George H. Bush and then President Bill Clinton signed major federal deficit-reduction packages into law.
Both packages included tax increases, and one important component of each was an increase in the top marginal income tax rate. The Clinton tax increase also included additional Medicare taxes for higher-income individuals. Both packages served to boost the impact of the tax code on inequality. From to the reduction in inequality, as measured by the Gini index, grew from 6 percent to 8. The other measures of income inequality actually show an even more marked change, especially after the tax increases.
In the average before-tax income for someone in the top 1 percent was nearly In other words, using this measure, the tax code reduced inequality relative to the pre-tax distribution by about 19 percent. Two years later the tax code reduced inequality, using the same measure, by almost 29 percent. In fact if we measure inequality based on average income of the top 1 percent versus the middle, then federal taxes in and actually reduced income inequality just as much as the taxes of In President Clinton signed another budget package, but this one included a tax cut, not a tax hike.
Top bracket. Calendar Year. Rate percent. Taxable Income Up to.
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