Sunday, July 25, 2010

Income Inequality Thoughts


There has been a lot of talk recently about the growing income inequality in the United States. Personally, and I could not care less about what others have as long as people are capable of living a decent life. however, for some reason this seems to bother a lot of people. In addition, people like to speculate as to why income inequality has increase so much over the past 30 years. While this is a complicated subject with a lot of contributing factors, it seems to me that we seem to miss the most obvious and, quite likely, the most important factor. Over the past 40 to 30 years the top marginal tax rate has decreased significantly from approximately 90% to 35%. Does it surprise anyone that over the same period the amount of money that the top 1% of people make has increased as the amount that they are taxed decreased? Is this not basic economics? If you tax something, you get less of it and if you tax something less you get more of it.
If all we want is to significantly reduce income inequality, all we would need to do is raise the marginal tax rate to 100% for some given income level, such as 1 million dollars. We could set up a system where the dollar amount does not increase with inflation, or only increases at half the rate, which would slowly lead to converging income levels and reduce income inequality. However, I think that this would have some serious costs. In fact, if you think that this would have any negative effect on economic output and performance, you agree, at least in part, that supply side economics does have some merit.
Included with this post is a graph from the Visualizing Economics blog by Catherine Mulbrandon that I think supports my assertion. Upon looking at this chart, I was actually a bit surprised as to how well the tax rate and income level tracked.

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