2007 February 26 Monday
Growing Income Inequality Boosts Tax Revenues

The Wall Street Journal explores some basic facts on tax revenue and wages.

Before taxes, the bottom 40% of U.S. households got 13% of the nation's income in 2004; after federal taxes of all sorts they got about 15%, according to the Congressional Budget Office's latest estimates. Because of the Earned Income Tax Credit, a cash bonus the government offers low-wage workers, many Americans at the bottom get money from the government, rather than having to pay income taxes; they still face payroll taxes on their wages.

Before taxes, the top 1% got about 16% of income; after taxes they ended up with 14%. (Yes, you read that right: The 1.2 million best-off households got about as much income, even after taxes, as the 45.5 million worst-off.) That top 1%, by the way, pays about a quarter of all federal taxes.

If the wealthy produce more new technology, goods, and services then the rest of us benefit from that. Plus, if they make more the rest of us get our government paid for by them. How much of income inequality is due to differences in productivity? How much is due to parasitism? I figure the parasitism argument is equally applicable to the lower classes who contribute little in the form of new designs and methods of production and who make an outsized contribution to total crime and other costs.

We've been seeing news reports on how the US government's revenues are surging and that surge is reducing the deficit more than expected. Why? The more rapid growth in income for the upper few percent means that the government is collecting much more revenue than it would if the people at the bottom were experiencing a big surge in income.

It's simple: Taking all federal taxes into account -- including payroll as well as income taxes, and allocating corporate profits and taxes paid on them to those who hold shares -- the CBO says those in the bottom fifth pay an average of $4.50 in taxes for every $100 they take in. Those in the top 1% pay $31.10 in taxes for every $100 they take in.

The US government makes more money if the wealthy continue to make a growing percentage of total income. But the government then also faces higher costs to subsidize medical care and other costs that the poor are too poor to pay for. Plus, the growing income inequality might cause more crime and the costs such as prisons and police that come as a result. My guess is the government comes out ahead if income inequality continues to rise. But I'm not certain on that point.

Share |      By Randall Parker at 2007 February 26 11:36 PM  Economics Demographic

Snouck said at February 27, 2007 12:44 AM:

The incomes of people in the highest income bracket are most susceptible to conjunctural development of the economy. So if there is a downturn tax revenues that are so inflated by taxes received from the highest bracket will nose dive. The income of the state has become more unstable.



Mensarefugee said at February 27, 2007 3:27 AM:

A Flat Tax would go a heck of a long way to getting politicians under control. They would have to listen to the 'beast' known as the public.

But as long as theres a progressive tax...most people dont care as its other people's money.

Mensarefugee said at February 27, 2007 5:53 AM:

"Those in the top 1% pay $31.10 in taxes for every $100 they take in."

Its worse in Canada. Hence the brain drain to the States.

Irish Savant said at February 27, 2007 2:55 PM:

One factor which should be taken into account in relation to severe income disparities is the effect on social cohesion. Despite impressions to the contrary, the US has one of lowest social mobility rates of any advanced country. It seems to me likely, I've no proof, that such disparities breed resentment and cynicism. It's also questionable whether those who have wealth have created it with ingenuity etc. Much of it is inherited, or like with so many of Bush's cronies, derives from having the inside track to the loot.

Robert Hume said at February 27, 2007 4:54 PM:

It's true that the top pays more and the bottom gets a free ride. So why not keep it that way? One reason is that happiness studies suggest that happiness is reduced when there is a large spread in income.

Larry said at February 28, 2007 5:32 AM:

Irish Savant ... There are studies to dispute your claims about mobility. I'm a living example of income mobility. I'm much better off than I was at 28.

And what do you have against inherited wealth? If I manage to accumulate a million or more dollars by the time I die, why shouldn't my son benefit from it when I die? Why should he have to start out working part-time and living in a trailer to make ends meet like I did? In fact, I plan on living long enough that he'll be middle age before he inherits it.

I'm sure not working all these years (and paying taxes) only to have the gov't steal my son's inheritance in the form of an "estate tax".

Mensarefugee said at February 28, 2007 8:34 AM:

Precisely why it pays to be a Bum these days :)

Rob said at February 28, 2007 2:01 PM:


Got any advice for a current 28 year old with a part time job?

jdwill said at February 28, 2007 5:45 PM:

Mensarefugee hit this in comment 2, but I was watching Bernard Lewis in a C-SPan Booknotes from 2001 and he made this remark in reference to Middle Easterners being cursed by oil wealth which allowed their elites to ignore them:

"People always remember the motto of 'no taxaction without representation' but they don't always realize that the converse applies, 'no representation without taxation'"

pjgoober said at March 1, 2007 2:26 PM:

"the US has one of lowest social mobility rates of any advanced country"

Did those studies control for our racial demographics? I am going to guess no.

pjgoober said at March 2, 2007 6:38 PM:

Expect average social mobility throughout the western world (especially the USA) to continue to decline, as the proportion of underperforming minorities continues to increase.

Half Sigma said at March 9, 2007 6:32 AM:

"If the wealthy produce more new technology, goods, and services then the rest of us benefit from that."

Sorry, I don't buy into the idea that the top 1% wealthy are producing more technology goods and services. They are just better at TRANSFERRING money from other people to themselves.

I believe that between 0 and $100,000 of annual income there is probably a very good correlation between actual contribution to economic productivity and income. But once one goes into extremely high incomes, we see people who are lucky winners of winner-takes-all competitions. They enjoy the profits of the productivity of the losers of such winner-takes-all competitions.

Randall Parker said at March 9, 2007 11:14 AM:

Half Sigma,

First off, I do not think the correlation between productivity and income is that good between $0 and $100,000. What I see on engineering teams is variation in productivity by multiples: 2, 3, 4 times and even more. I never cease to be amazed by this. But I see much narrower differences in salaries, less than a factor of 2.

Also, look at teachers. Productivity varies far more as a function of number of years teaching than with productiveness.

Some of the people who get wealthy basically come out on top in a winner-take-all race. Competitors might have produced many of the ideas that the winner copied. So the system does not do a great job of rewarding all contributions.

Having said all that, I think a basic change in technology is driving the widening inequality: There's more stuff a mind can do to manipulate reality. Smarter minds can manipulate reality far more than dumber minds. Yes, some of those manipulations amount to preying on the dumber. But most of those manipulations are productive.

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