Taxes, Government Transfers, and Income Inequality

THE Congressional Budget Office recently published a report, The Distribution of Household Income and Federal Taxes, 2011which examines incomes and taxes across income brackets from 1979 – 2011.  In short, the report found that higher earners experienced greater income gains, and government transfers and taxes helped reduce inequality. As the report notes, market income* has grown considerably for the top 20%, and remained stagnant for the bottom 80%.  Market income for the bottom 80% of earners increased by 16%, while market income for the 81st to 99th percentiles increased by 56%, and for the top 1% market income increased 174%:Fig8

As the growth in before-tax income reveals, government transfers has helped to (somewhat) narrow the disparity in market income growth.  The bottom 20% experienced gains of 40%, while the 21st to 80th percentiles increased at a slower rate of 22%, the 81st to 99th percentiles gained 59%, and the top 1% increased 175%: fig11

Now, adding in taxes to the equation and the disparity in incomes further narrows.  After-tax income*** gains for the bottom 20% totaled 48%, for the 21st to 80th percentiles 40%, the 81st to 99th percentiles 67%, and the top 1% 200%. Fig12

To get a clearer picture of the impact of government transfers and taxes on inequality, the CBO report compared changes in the Gini index****.  As the CBO notes, using all three measures of income, inequality has increased.  However, for 2011 data, the level of inequality for after-tax income is lower than market-income: fig14 The report parsed out the impact that taxes and government transfers, both independently and cumulatively had on the reduction of inequality: Fig15

One interesting thing to note is that while government transfers make-up a large portion of the bottom 20%’s after-tax income than the top 20%. . . tbl 3

. . . on average, government transfers to the bottom 20% is lower than what all other income groups receive: tbl1

 

*Market income is defined as “labor income, business income, capital gains, other capital income, and income received in retirement for past services.”

**Before-tax income is market income plus government transfers, which are defined as “are cash payments and in-kind benefits from social insurance and other government assistance programs. Those transfers include payments and benefits from federal, state, and local governments.”

***After-tax income is before-tax income minus federal taxes

**** The Gini index is defined as “A standard measure of income inequality. . .which summarizes an entire distribution in a single number that ranges from zero to one.  A value of zero means that income is distributed equally among all income groups, while a value of one indicates that all of the income is received by the highest-income group and none is received by any of the lower-income groups.”

John Haskell

About John Haskell

John graduated from the University of Southern Maine with a degree in Political Science, and from the University of Maine School of Law. He has worked in both the public and private sectors, and currently, works with a small business services company in the Mid-Coast area.