TaxProf Blog

Friday, April 16, 2004

Boston College Symposium on “The State of the Federal Income Tax: Rates, Progressivity, and Budget Processes”

James Repetti (Boston College), Opening Remarks

Martin McMahon (Florida), The Matthew Effect and Federal Taxation

Abstract: “For whosoever hath, to him shall be given, and he shall have more abundance; But whosoever hath not, from him shall be taken away even that he hath.” — Gospel of Matthew, chapter 25, verse 29.

The term the “Matthew effect,” was coined by sociologist Robert K. Merton in 1968 based on the passage from the Gospel of Matthew in the epigram. “Put in less stately language, the Matthew effect insists in the accruing of greater increments of recognition for particular scientific contributions to scientists of considerable repute and the withholding of such recognition from scientists who have not yet made their mark.” The Matthew effect is not limited to the context in which Robert Merton first coined it. More generally, it is a synonym for the well known colloquial aphorism, “the rich get richer and the poor get poorer.” This article is about the Matthew effect in the distribution of incomes in the United States, and the failure of the federal tax system to address the Matthew effect.

Over twenty years ago Paul Samuelson observed, “[i] f we made an income pyramid out of a child’s blocks, with each layer portraying $1,000 of income, the peak would be far higher than the Eiffel Tower, but most of us would be within a yard of the ground.” Things have changed little since then. The peak is higher, but most people are still in essentially the same place. During the last two decades of the Twentieth Century the distribution of incomes and wealth in the United States reached levels of inequality that have not been seen since the Roaring Twenties. Although the “Roaring Nineties” might have been “the world’s most prosperous decade,” as described by Joseph Stiglitz, the prosperity was not spread around. The data indicate that a very small number of people garnered an overwhelming amount of the increase in incomes and wealth in that decade, as well as in the prior decade.

During the 1950s and 1960s, family income inequality decreased, but the tide changed after 1969, and through the last three decades of the twentieth century income inequality increased. Nevertheless, the federal tax system did little to ameliorate the increasing economic inequality. As of 2000, the redistributive effect of the income tax was somewhat less than it was in the early1980s, although it was somewhat greater than it was in the early 1990s. As we move into the new Millennium, however, recent changes in the federal tax system presage a decreasing role not only in redistribution, but in mitigation of vast disparities in income and wealth. Since the inauguration of the Bush administration in 2000, there have been three major tax acts, which have reduced significantly the tax burden of the super-rich, while handing out small change to everyone else.

This article first examines in detail the increasing concentration of income and wealth in the top one percent, and particularly within much narrower cohorts near the top of the top one percent, that has occurred over the past twenty-five years. It demonstrates the strong Matthew effect in incomes in the United States over that period. The super-rich are pulling away from everyone by so much and at a rate so fast that the fact that incomes of many households at the bottom and in the middle have stagnated, or even fallen in constant dollars, has been obscured by ever increasing per capita income — a false talisman of progress because it obscures distributional issues.

The article then examines changing effective federal tax rates over the last two decades of the twentieth century. It discusses relevant legislative changes and the shifting tax burdens, as measured by effective tax rates on different income cohorts, of the various federal taxes individually and collectively. The article demonstrates that by the close of the twentieth century the tax system was not raising revenue as fairly and was doing less to mitigate inequality than it had in the middle of that century.

Moving into the new century, the Republican tax policy, as embodied in tax legislation enacted in 2001 through 2003, provides tax cuts very disproportionately favor those at the top of the income pyramid with very small tax cuts going to everyone else, even the upper middle class and the merely rich, in contrast to the super-rich.

The article demonstrates that economic theory does not support the argument that the tax cuts were necessary to spur incentives to save and invest and to work, and that the empirical evidence of the effect of tax cuts on savings and investment clearly contradicts the claims made by supporters of the tax cuts. It examines the rapidly growing body of economic literature supporting the thesis that economic inequality impedes economic growth rather than fostering it, and concludes that because the tax cuts increase inequality, they probably impede economic growth. The article then examines empirical data that debunks the notion that “a rising tide lifts all boats.”

After analyzing the economic issues, the article discusses the philosophical basis for a highly redistributive tax system, arguing that in a modern industrialized democracy, most of what everyone earns is attributable to infrastructure created by society acting as a whole, principally through government. It rejects the notion that individuals have the first claim to everything that they earn and adopts a more communitarian approach. The article then examines the paradox of public concern with increasing economic inequality, thinking it undesirable, and while simultaneously supporting tax cut legislation that in fact delivers vastly disproportionate benefits to the super-rich.

Finally, the article suggests that its time for the tax system to address these problems by substantially increasing progressivity at the top of the income pyramid. Marginal tax rates should be increased for incomes in excess of $500,000, and as incomes increase to progressively higher levels, additional rate brackets should be added to impose substantially higher marginal rates on incomes in excess of $1,000,000, and particularly on incomes that exceed $5,000,000. Future tax legislation ought to mitigate the Matthew effect, rather than enhance it.”

Comments by: Deborah Schenk (NYU) & Richard Schmalbeck (Duke)

William Gale, Tax Policy in the Bush Administration: 2001- 2004

Abstract: This paper examines tax policy in the Bush Administration. After describing the key elements of the tax cuts enacted since 2001, the paper examines the impact of the tax changes on the federal budget, the distribution of tax burdens and after-tax income, economic growth, complexity, government spending, and fundamental tax reform. We also examine interactions between the tax cuts and the alternative minimum tax. We conclude that many of the ultimate effects of the tax cut will depend on how it is financed — with either spending cuts or future tax increases.

Comments by: Paul McDaniel (Boston College) & Linda Sugin (Fordham)

Daniel Shaviro (NYU), Reckless Disregard: The Bush Administration’s Policy of Cutting Taxes in the Face of an Enormous Fiscal Gap

Abstract: The Bush Administration’s policy of sharply cutting taxes while increasing government spending is both misguided and harmful. Presumably rationalized as a way of shrinking government over the long term without paying a current political price, it in fact increases the government’s distributional intervention by handing money to current voters at the expense of younger and future generations. The Bush policies have increased the future tax increases that are likely to be necessary. In addition, they are likely to require additional Social Security and Medicare cuts that can be seen in large part as negative taxes, refunding some of the positive lifetime net taxes that future retirees will by then have paid. Reducing future negative taxes is a lot like increasing future positive ones. Finally, the Bush policies may lead to an Argentina-style meltdown in the U.S. government’s position as a borrower in world capital markets, potentially yielding chronic inflation, unemployment, and bank and currency crises that affect our economic productivity for an indefinite period.

Comments by: Lawrence Lokken (Florida) & David Walker (Boston University)

Thomas Griffith (Southern California), Progressive Taxation and Happiness

Abstract: The strongest argument for progressive taxation is that transferring income from richer to poorer individuals through a combination of taxation and government spending increases total welfare in the society. The reason is simple: additional income produces more utility for a poor person than a rich person. Progressive taxation also, however, may be costly. The higher marginal rates required to fund redistribution may reduce work effort and encourage individuals to engage in costly and nonproductive activities to shelter their income from taxation. The gains in social welfare from redistributing income to the poor, then, must be weighed against the losses in social welfare from reduced work effort. This Article focuses on one half of that balance the potential gains from redistribution and considers the following questions. How much, if at all, does redistributing income from the rich to the poor increase total happiness in the society? Is the answer different in wealthy societies than in poor societies? If redistributive tax and spending policies slow economic growth, does such a slowdown significantly reduce total happiness in the society? More broadly, what is the relationship between economic conditions in a society and the happiness of the members of that society? Until recently there was little serious scholarship focusing on such questions. Over the past two decades, however, there has been an explosion of what might be called happiness studies research on the determinants of human happiness. This Article examines some of the central findings of this literature and considers their implications for redistributive tax and spending policies.

Comments by: Marjorie Kornhauser (Tulane) & Diane Ring (Harvard)