Tax Policy and Income Inequality

David Grusky interviews Emmanuel Saez about his work on income inequality:

DG: I think a lot of people would be worried that, by resorting to tax policy, you reduce not just the incentive for rent-seeking but also the incentive for undertaking the hard work that makes for real productivity. This may well be a big price to pay. How do you make sense of that dilemma?
ES: It is a central question and indeed economists have expended a lot of effort trying to understand the relationship between the rewards of working and behavior. Do taxes and transfers that reduce the reward for working discourage work? There are many situations where reducing the reward to work leads to less work. That’s true for the bottom of the distribution, especially for parents with kids who have very high opportunity costs for work. And that’s true for people near retirement as well: it’s been shown that if you reduce the reward to working through the retirement system you can easily have effects on the retirement margin.
For top earners, we need more research, but I have yet to see a study that shows me that when you increase top tax rates, top earners work less. An interesting study that was done by Robert Moffitt and Mark Wilhelm using the tax overhaul of 1986—Reagan’s big second tax reform. The study showed that when Reagan cut the top tax rate, pre-tax top income surged, but the authors looked at the hours of work of those high earners and couldn’t see any effect on their reported hours. Of course, it was a small sample, but I hope that in the future, researchers can look at margins like retirement—do highly paid executives retire earlier now that Obama has raised their tax rates? That’s exactly the type of study we need. And of course I would revise my views if you showed me convincingly that those top guys are indeed working a lot less.
DG: Let me turn to some of the evidence that I think informs your view on this issue. What you found is that, when top tax rates go down, the top 1 percent garners an increasing share of pre-tax income. My query is whether that’s a causal relationship or a spurious one. It may be spurious because those countries that reduced tax rates at the top often happen to be the very same countries that allowed for institutional changes, such as de-unionization, that restricted the capacity of those at the bottom of the distribution to secure higher wages. And so it’s possible that the decline in the income share going to the top is actually driven, in part, by what happens at the bottom.
ES: I am sympathetic to this argument. It’s true that the Reagan and Thatcher revolutions were not only about reducing top tax rates; there were a number of other policies, such as deregulation and restrictions on unions. My best answer to you is that we have to do more data analysis. That is what I’ve prepared for my preparation this afternoon. I really look only at top tax rates but in principle you can use other variables like unionization, strikes, financial deregulations, etc., and then try to tease out the role of each factor. My sense, at this stage, is that it’s work we should be doing. The tightness of the correlation between top tax rates and pre-tax top incomes is so strong that I doubt that it will go away entirely. Maybe it will be not as strong but my guess is that a lot will survive.
Another reverse causal relationship that people mention is that if top earners earn more, they have more resources to deploy to influence policy makers through lobbying and campaign contributions. Once you have a very high level of income concentration, it might indeed be harder for policy makers to advocate and enact policies that are unfavorable to top earners.

The whole piece is worth reading.  I tend to agree with the idea that a leading driver of income inequality is lowering the top marginal rates, and that a very good tool for reversing inequality would be to increase marginal rates, especially with extra tax brackets that target the very top incomes, and leave alone many folks who make, say, $500,000 a year (which is still a shitload of money).

One problem with the spiraling salaries at the top is that these folks end up bidding against each other for high-end properties in places like Manhattan, Greenwich, CN, the Hamptons, Newport Beach and the fancy ski resorts.  The competition pushes up property values in these areas so high that even with giant pay packages, these folks feel like they need even more money to buy their trophy homes.  Which leads to higher compensation, which leads to more inflation in these markets.  Wash.  Repeat.  Meanwhile, folks at the other end of the spectrum can barely afford food, clothing and shelter with a little money to save for a rainy day.  I don't know that higher taxes would solve these problems, but I don't see things getting better without higher marginal rates.