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Income Inequality, Tax Regressivity are Worse Than We Thought

by | Sep 14, 2017 | Economy, Taxes

There has long been convincing evidence—both at the state and national levels—that income inequality has accelerated in recent decades, with an increasing share of wealth concentrated in fewer and fewer hands. Extreme income inequality—coupled with stagnant or declining real wages—undermines a consumer economy, since working families are less able to purchase the goods and services that the economy is producing, thereby reducing demand for these goods and services, and inhibiting economic growth and job creation. To make matters worse, a new study indicates that the degree of income inequality is even worse than we thought.

An August 2016 North Star article documented the growth of income inequality in Minnesota using information from biennial Minnesota Tax Incidence Studies (MTIS), which includes income data dating back to 1988. Using 2014 income data from the most recent MTIS, the following table presents household income at several points along the income spectrum. Household income at the tenth percentile (i.e., the income level at which ten percent of households have a lower income and ninety percent have a higher income) is $11,263, while the income level at the 50th percentile (i.e., the median) is $46,141. The income at the 99th percentile (i.e., the income level which divides the top one percent from the rest of population) is $512,192.

The full extent of income inequality does not become apparent until we examine the top fraction of the top one percent. For example, the income level at the 99.70 percentile is just under $1 million, while the income at the 99.95 percentile is $3.34 million. In the following chart, the dots represent income levels at various income percentiles as reported in the MTIS, with the line representing interpolated incomes at points between the reported levels.

The income curve in the chart resembles that of an exponential function, with the line remaining relatively flat and close to the horizontal axis through the 90th percentile and beyond. Approaching the 95th percentile, the line begins to curve sharply upward. Above the 99th percentile, the line is nearly vertical, denoting a rapid growth in income levels as we proceed from the bottom of the top one percent (i.e., the 99th percentile) to the top of the top one percent, at which truly astronomical income levels are achieved. At the 99.95th percentile (which marks the lower end of households in the top half of the top one-tenth of a percent), the income level is 72 times greater than the statewide median income. According to the 2017 MTIS, 1,186 of Minnesota’s 2,661,000 households have 2014 incomes above this level; these 1,186 households comprise 0.05 percent of all households in the state, but have 5.0 percent of statewide income.

New research indicates that even these startling findings probably understate the degree of income inequality. In a new report published by the National Bureau of Economic Research (NBER), a team of Scandinavian and U.S. economists combined information from tax audits—the conventional source of data when examining tax and income levels—with micro-level data recently leaked from large Panamanian and Swiss financial institutions. By matching information from these sources to population-wide data from Denmark, Norway, and Sweden, the researchers were able to gain new insights regarding the distribution of income and the degree of tax evasion by income level.

The addition of information from the leaked sources showed that the extent to which taxes are evaded and income is concealed is significantly greater than previously thought; this is particularly true for households within the top fraction of the top one percent. The study observes that:

In the case of Norway, accounting for [tax evasion] leads to an increase of 30% of reported wealth at the top of the distribution. Our results suggest that tax data may significantly under-estimate the rise of wealth concentration over the last four decades, as the world was less globalized in the 1970s, it was harder to move assets across borders, and offshore tax havens played a less important role. Because most Latin American, and many Asian and European economies own much more wealth offshore than Norway, the results found in Norway are likely to be lower bound for most of the world’s countries.

The information presented in the above table and chart—derived from the MTIS—is based primarily on individual income tax and property tax refund returns, supplemented with data on non-taxable income from “various sources.” However, this data from “various sources” is used primarily for identifying unreported income for low-income households that did not have to file an income tax return. Data from the MTIS does not incorporate leaked information from off-shore financial institutions—of the type examined in the NBER study—and thus almost certainly understates the degree of income inequality in Minnesota. Furthermore, MTIS data used in the August 2016 North Star article likely understates the growth in income inequality over time.

The conclusions of the new NBER study have important implications beyond the documentation of increased income inequality. As noted in the 2017 MTIS, income inequality is a major contributor to tax regressivity; consequently, as income inequality is greater than previously expected, so too is the degree of state and local tax regressivity in Minnesota and other states. In addition, the growth in regressivity over time is also likely to be greater than previous research has indicated. Finally, the NBER report notes that “fighting tax evasion can be an effective way to collect more tax revenue from the very wealthy.”

Based on the findings of the NBER study, the degree of income inequality, growth in inequality over time, and the degree of state and local tax regressivity in Minnesota is almost certainly even greater than that indicated by MTIS data. By the same token, the economic problems that these conditions create are also likely to be more pronounced than previously suspected.

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