Yesterday, I posted this analysis of an informative new report from the CRS on the increase in income inequality between 1996 and 2006. One important finding from the report decomposes the increase in inequality, as measured by the Gini coefficient, into the contributions made by different income types. Such diagnostics can be very helpful when we’re thinking about prescriptions.
I’ve plotted the results below. The Gini coefficient is a measure of inequality that ranges between 0 and 1, where higher numbers imply a less equal distribution. Over these 10 years, the Gini of after-tax income increased from 0.503 to 0.560, an increase of 0.057, or 11%. The figure below assigns that 0.057 point growth to the different sources of income. Note that some sources led to higher inequality, while other reduced its growth. On net, however, inequality grew.
The largest single contributor to the growth of inequality, 1996-2006, was dividends and capital gains. Adding in business income, like profits from a hedge fund, comes to 0.061, more than explaining the 0.057 point increase in the Gini index.
It may surprise you that income from earnings reduced inequality’s growth over these years. It’s not because the distribution of earnings became more equal—to the contrary. It’s because earnings are a) less skewed than cap gains, dividends, and business income, and b) comprised a significantly smaller share of income in 2006 than in 1996.
In other words, a more equal type of income (earnings) was a smaller share of total income at the end of the period, and visa versa: a more skewed income source comprised a larger share.
Note also that tax changes led to higher inequality. As I noted in yesterday’s post, and as other analysis has corroborated (see CBO inequality study), and as anyone who’s been paying attention should know, federal taxes have become less progressive over time.
I can think of a good solution to both of these last two problems: the increased inequality-inducing function of cap gains, and the diminished progressivity of taxation. Tax capital gains and dividends as regular income. Stop favoring them in the tax code. The research is quite clear that privileging these income types has little to do with investment patterns, and instead leads to all kinds of timing and game-the-system distortions.
OK? Problem solved. Next question? Bueller?…Bueller?