While income redistribution has always been a hot topic, the debate has become more intense in recent years. In part, this has reflected stagnation in median family income. Also, standard measures of income distribution had been showing growing inequality in the distribution of income. However, inequality decreased and median family income improved in 2018 and 2019 as the economy ran “hot” and unemployment dropped to historic lows. No doubt, both have suffered a setback in 2020 owing to the COVID-19 crisis.
Shown below are the most recent data on the distribution of income before and after federal redistribution programs—progressive income taxes and transfer payments (importantly through Medicaid and the food stamp or SNAP program). The chart illustrates the share of income accounted for by each quintile, from the lowest on the left to the highest on the far right. The green bars show the share of income before taxes and transfers for each quintile and the purple bars the share after taxes and transfers.
Before taxes and transfers, the lowest twenty percent received only about 4 percent of income, while the top twenty percent received 65 percent. However, after taxes and transfers, the lowest quintile received around 8 percent—a doubling—while the top quintile received just under 50 percent. The top 1 percent is also shown. Its share goes from 27 percent before taxes and transfers to around 13 percent after—a halving.
Perhaps you are wondering how much tax rates vary across the quintiles. The next chart shows average tax rates for the top and bottom quintiles, the middle three quintiles, and the top 1 percent. (Marginal tax rates—the rate on an extra dollar of income—are even higher for the upper-income groups because of the progressive income tax.) The rate goes from around 25 percent for those in the top quintile down to roughly 1 percent for those at the bottom. The average tax rate for the top 1 percent is around 30 percent.
The next chart translates tax rates and income shares to the portion of all federal taxes paid by each group. The top 1 percent pays one-fourth of all taxes and the rest of the top 20 percent pays around 45 percent. The bottom 60 percent pay less than 15 percent of all taxes.
A very common narrative is that the rich are not paying enough, and this argument has gotten pretty vigorous in recent years. However, there does not appear to be a consensus on how much higher tax rates should be raised on the upper-income groups. One reason why a sizable segment of the population favors such higher tax rates is that the distribution of voters is even across the quintiles at 20 percent, as shown by the broken line in the first chart. Those not affected by boosting the progressivity of tax rates substantially outnumber at the ballot box those who would be called upon to pay the higher tax bill.
It should be noted that higher rates have consequences for all. High rates reduce the incentive to work and take a risk which causes the size of the pie and tax receipts to be lessened. History shows that nations that have imposed high graduated tax rates have lowered them to reinvigorate their economies after they have stagnated.
For more on the reasons why there are big differences in the distribution of income and the impact of high tax rates on incentives, see Chapters 2 and 5 of my recent book, Capitalism Versus Socialism: What Does the Bible Have to Say? Note that the Old Testament called for tithing to God—a flat 10 percent rate. Does this have implications for taxation?