Would a significant increase in the top (US) marginal income tax rate substantially alter income inequality?

Yes.

This, you might think, qualifies as another in the series “Short Answers to Silly Questions”. But a Brookings Paper study by William G. Gale, Melissa S. Kearney, and Peter R. Orszag reaches the opposite conclusion. (Hat tip: Harry Clarke).

The study looks at increasing the top marginal tax rate (currently 39.6, applicable to incomes above $400k for singles), with the strongest option being an increase to 50 per cent. The proceeds are assumed to be redistributed to households in the bottom 20 per cent of the income distribution.

The headline finding is that the Gini coefficient is barely changed, as are other popular measures including the 99/50 ratio (the ratio of income at the 99-th percentile to 50-th percentile, that is the median). But the 99/10 ratio and 90/10 ratios change a lot, from 50 and 17 under current law to 37 and 12.5 with the redistribution.

What does this mean? Two things:

(i) As is well known, the Gini coefficient is a lousy measure of income inequality, much more sensitive to the middle of the income distribution than to the tails
(ii) The proposed redistribution would substantially improve the welfare of the poor, with most of the burden being borne by taxpayers in or near the top 0.1 per cent.

It’s obvious, as the authors note, that the 90-50 measure won’t change, since neither group is affected (there’s no simulation of behavioral responses which might have indirect effects). But, since the 99-th percentile income is very close to $400k, there’s very little impact on this group either. But the tax, as modelled, raises a lot of money from the ultra-rich incomes. As a result, distributing the proceeds at the bottom of the distribution raises incomes substantially, which explains the big changes in the 90-10 and 99-10 ratios.

The real lesson to be learned here, one I came to pretty slowly myself is that old-style measures looking at quintiles or even percentiles of the income distribution are no longer very relevant. The real question, in the economy of Capital in the 21st Century is how much should go to the ultra-rich.

38 thoughts on “Would a significant increase in the top (US) marginal income tax rate substantially alter income inequality?

  1. wow “what is the basis of the assertion?”???

    Seriously, John you are evidence for the truth of my PhD supervisor’s opinion that MD’s are not trained to be scientists.

    Do you think that you could join the local Progress Association or Hall Committee in your town; you could do a lot for the health of the community by speaking to people at these events?

  2. @Julie Thomas

    So typical of many Australians, go for a personal attack rather than discuss the issues rationally. At least Collin is putting up rational arguments, I am just not convinced about his underlying assumptions.

    I guess I know about as much about psychology as there is in a Bachelor Degree in Social Work and a Masters in Interntional & Community Development, a lifetime working in many different capacities and a personal interest in Brain Science (to wit I can recommend the Brain Science Podcasts by Dr Ginger Campbell an excellent program). I am not a psychologist.

  3. your assertion is that penalty rates shift employment from the weekend to the weekdays, what is the basis of the assertion?

    Honestly common sense is enough, but if you want to do it formally you’d be looking at shifts in consumption patterns of imperfect substitutes as prices shift.

    https://en.wikipedia.org/wiki/Substitute_good#Increase_in_price

    An increase in price (ceteris paribus) will result in an increase in demand for its substitute goods. If two goods have a high substitutability, the change in demand will be much greater. Thus, economists can predict that a spike in the cost of a particular brand of detergent is likely to result in a large change in demand for other brands, whereas a change in the price of pencils will have a much smaller effect on the demand for other stationery, such as pens on legal documents or pencils on most high-school maths homework.

    Or, labour on monday is an imperfect substitute for labour on sunday, so if the price of work on sunday increases the amount of labour on monday will increase.

    It’s fairly basic macro; this is essentially an economics blog, so you really do need at least a bit knowledge or at least a willingness to learn to participate usefully.

  4. @Ikonoclast
    I look forward to reading your future paper on power. A difficult subject with so many different facets to it.

    It has interested me since I did a Masters in International Development under Damien Kingsbury at Deakin although I would not profess any particular knowledge. Once got hammered on an assignment for the Masters which was marked by another department because of my critique about some of the methodologies used in International Aid programmes. The critique was centred on ideas about power and in particular the role of language and did not go down well with the managerialist bias of the partcular department concerned.

  5. @Collin Street

    You are right, I am no economist but does this blog exclude commentary from non economists. Sad if ithat is the intent. Academic economists often lose sight of how theory actually translates into real world experience, if they did not, perhaps we would not have the bias towards what JQ calls “Market Liberalism’

    I have learned that ‘common sense’ can be rather misguided. Similarly, that actual experience in practice does not always conform to economic theory. People do not always act with rationality and there are many reasons why people would or would not work on Sundays and legislated penalty rates is but one.

    Also, there are many circumstances surely where demand is not fixed and increased access or availability (ie by opening on Sundays) does not shift consumption but rather actually grows the total level of consumption? Health services is one such area. In my humble experience the ‘consumption’ of health services is driven not by patient demand, but by the availability of providers willing to provide the services. Increase the number of doctors and consumption of medical services will jump, open on a Sunday, people will not generally subsitute the Sunday for Monday, although obviously that will occur to some extent, but the total of services consumed will actually increase. I doubt if health is a unique situation.

  6. @Collin Street

    It’s fairly basic macro; this is essentially an economics blog, so you really do need at least a bit knowledge or at least a willingness to learn to participate usefully.

    Wrong, but what a performance – it is fairly basic “micro”.

    Increasing the price of labour on any day will lead to employers looking to shift some activity to alternative days – true.

  7. @John Brookes

    But current thinking is that somehow all the best and brightest would run away to a tax haven somewhere if we taxed them too much.

    What is the evidence?

    Most “best and brightest” I know go overseas for post-graduate studies but return in due course often bring a new partner with them. Only some stay offshore for extended periods if their specialty is better pursued there.

    These flows have little to do with tax.

  8. @Ivor

    I confess to playing something of a role of Devils advocate in relation to this penalty rates discussion. I was trying to show the impact on a single organisation by reference to one that I am familiar with. I do not believe that ‘consumers’ or providers of medical services react/ behave in the same way as perhaps consumers and providers of other goods and services do. In part this due to the power relationship between ‘seller’ and ‘consumer’ that is derived from the imbalance in knowledge. At the individual organisation level while you are right to suggest that pricing labour higher on a Sunday might cause the employer to try to shift some activity to alternative lower priced days, it might not actually be possible because of capacity constraints. i.e in my example, all rooms are booked out, all medical staff fully utilised in the ‘alternative lower priced days’. Similarly with the alternative suppliers of which there is one, within reasonable travelling distance. So the supplier, having no lower priced alternative, and a situation where the higher priced alternative leads to a loss even on a marginal costing basis, will not supply. I.e access to services is constrained despite medical need.

    Similarly, I contend that the ‘demand’ curve for health services is rather unusual. As access (i.e supply) is increased demand will surely follow. Why should this be so? Put simply, demand is significantly controlled by the supplier. A doctor will not sit idle for long, for example the frequency of reviewing a patient’s health condition is a matter determined not by the patient but by the provider, a decision whether to issue a repeat prescription without seeing the patient is a provider decision not a consumer decision, identifying people at risk of a particular condition then actively pursuing those individuals for health checks and other health prevention measures is very much in the provider’s control. There are many ways in which the provider can and does induce demand.

    I am of the opinion that health ‘demand’ is not finite but is a function of availability and access. Consequently, opening on a Sunday will not in this particular instance cause a shift in consumption patterns from one part of the week to another so much as actually increase consumption.

    Some evidence for this can be deduced from what happened at our local level occurred when a second practice opened in the area. Total medical services being provided increased from around 64,000 inclusive of ED to 90,000 with the introduction of the additional doctors. Later when the Hospital ED had its own doctors it continued to see the same number of patients while the two medical practices now with more doctor ‘ resources actually increased their services to over 100,000. As more doctors have been brought into the practices the number of services has continued to grow and now stands at 250% of its level 10 years ago. The actual population has grown somewhat more modestly in the 10 year period by about 2.5% a year. Meanwhile, the waiting time to see a doctor has only slightly diminished. It may be thought that we are now providing services that were provided by practices outside the area but all the evidence I have suggests this is not the case. Rather, the number of services per patient has increased, are the patients sicker? I doubt it.

    Colin Street and others on the blog who have lamblasted me over this may well be right at the total aggregate level for all goods and services but not I suggest in respect of medical services, and certainly not correct for individual businesses.

  9. @Julie Thomas

    Not an MD. Started off as a statistician in 1965, became a finance analyst, then a marketing manager of a major vehicle producer, then a finance manager for the exporting arm of that organisation, then Finance Director of an overseas subsidiary in Japan, then corporate finance analyst for a different producer in Australia, then Commercial Manager for a dairy company, then a sea change – Social Welfare degree, Community Health Manager, Masters in International & Community Development, worked in Mental Health Area before for the last 12 years the CEO of a large rural general practice. So don’t make presumptions.

  10. @Julie Thomas

    I should have added that I do indeed speak to local organisations about health and other matters, write columns for the local newspaper on health matters, such as ‘The impact of discrimination on health’, ‘Effective Consultations’, ‘Climate change and health’ ‘Immunisation- a case for compulsion’ ‘diabetes type 2. – a lifestyle choice?’ To mention but a few. I put community development theory into practice in more ways than one and try to encourage community engagement and encourage my staff to engage by providing them with paid leave to undertake some community work during the year.

  11. @John Turner

    Good for you John, I am impressed with your quality as a do-gooder, full of the milk of human kindness and so keen to help the poor and stupid, and of course make a profit that you deserve along the way, but this sort of do-gooding doesn’t work for we poor people.

    When I suggested that you involve yourself in the community, the idea I had was that you live with us and set an example for us, by the way you live. The people you want to ‘help’ (you do want to do good?)do not go to talks by people like you.

    And I’ll make all the presumptions I like dude and seriously you are so boring and full of yourself and unable to see the mediocrity of your ideas that I don’t care to talk to you any more.

    I’ll leave you with a suggestion; it’s bottom up self-organisation we poor people need, not top down prescriptions about how we should live from people who are so sure they have the answer without understanding the problem; from my perspective it is dudes like you who are the problem.

    Cease trying to make me and my poor neighbours lives ‘better’ by forcing your values and ideas about the good life, onto me and mine from above.

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