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Can taxing the rich reduce inequality? You bet it can!

Henry J. Aaron

Two recently posted papers by Brookings colleagues purport to show that “even a large increase in the top marginal rate would barely reduce inequality.”[1]  This conclusion, based on one commonly used measure of inequality, is an incomplete and misleading answer to the question posed: would a stand-alone increase in the top income tax bracket materially reduce inequality?  More importantly, it is the wrong question to pose, as a stand-alone increase in the top bracket rate would be bad tax policy that would exacerbate tax avoidance incentives.  Sensible tax policy would package that change with at least one other tax modification, and such a package would have an even more striking effect on income inequality.  In brief:

    • stand-alone increase in the top tax bracket would be bad tax policy, but it would meaningfully increase the degree to which the tax system reduces economic inequality.  It would have this effect even though it would fall on just ½ of 1 percent of all taxpayers and barely half of their income.
    • Tax policy significantly reduces inequality.  But transfer payments and other spending reduce it far more.  In combination, taxes and public spending materially offset the inequality generated by market income.
    • The revenue from a well-crafted increase in taxes on upper-income Americans, dedicated to a prudent expansions of public spending, would go far to counter the powerful forces that have made income inequality more extreme in the United States than in any other major developed economy.

[1] The quotation is from Peter R. Orszag, “Education and Taxes Can’t Reduce Inequality,” Bloomberg View, September 28, 2015 (at http://bv.ms/1KPJXtx). The two papers are William G. Gale, Melissa S. Kearney, and Peter R. Orszag, “Would a significant increase in the top income tax rate substantially alter income inequality?” September 28, 2015 (at http://brook.gs/1KK40IX) and “Raising the top tax rate would not do much to reduce overall income inequality–additional observations,” October 12, 2015 (at http://brook.gs/1WfXR2G). 

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