Behavioral Responses to Taxation and Inequality: Evidence from Policy Variation Using Administrative Data

Project Outcomes Statement

This project has used administrative tax return data from the IRS returns to analyze the effects of taxes and transfers and measure income inequality.

On the effects of taxes and transfers, we have published a paper that provides evidence on behavioral responses to taxation of the 2013 tax increase that raised substantially top marginal tax rates. We find that reported top 1% incomes were significantly higher in 2012 than in 2013, implying a large short-run response of reported income. This large short-run response is due to income retiming for tax avoidance purposes and is particularly high for realized capital gains, and highest at the very top of the income distribution. However, comparing 2011 and 2015 top incomes uncovers only a small medium-term response to the tax increase as top income shares resumed their upward trend after 2013. This implies that the 2013 tax increase was an efficient way to raise revenue.

On measuring inequality, we have published a paper that constructs distributional national accounts for the United States that distributes national income to income groups. We estimate the distribution of both pretax and post-tax income, making it possible to provide a comprehensive view of how government redistribution affects inequality. Average pretax real national income per adult has increased 60% from 1980 to 2014, but we find that it has stagnated for the bottom 50% of the distribution at about $16,000 a year. The pretax income of the middle class -- adults between the median and the 90th percentile -- has grown 40% since 1980, faster than what tax and survey data suggest, due in particular to the rise of tax-exempt fringe benefits. Income has boomed at the top. The upsurge of top incomes was first a labor income phenomenon but has mostly been a capital income phenomenon since 2000. The government has offset only a small fraction of the increase in inequality.

We have extended these distributional national accounts by creating real-time inequality statistics in a new working paper where we construct high-frequency and timely income distributions for the United States. We develop a methodology to combine the information contained in high-frequency public data sources -- including monthly household and employment surveys, quarterly censuses of employment and wages, and monthly and quarterly national accounts statistics -- in a unified framework. This allows us to estimate economic growth by income groups, race, and gender consistent with quarterly releases of macroeconomic growth, and to track the distributional impacts of government policies during and in the aftermath of recessions in real time. Analyzing the Covid-19 pandemic, we find that all income groups recovered their pre-crisis pretax income level within 20 months of the beginning of the recession. Although the recovery was primarily driven by jobs rather than wage growth, real wages experienced significant gains at the bottom of the distribution in 2021 and 2022, highlighting the equalizing effects of tight labor markets. After accounting for taxes and cash transfers, real disposable income for the bottom 50% was nearly 20% higher in 2021 than in 2019, but fell in 2022 as the expansion of the welfare state during the pandemic was rolled back.