Tax Policy and Inequality: What Research Shows About Redistribution

Tax policy is one of the most powerful mechanisms available to governments for affecting the distribution of economic resources across the population. Through the rate structure, the definition of taxable income, the treatment of capital versus labor income, the design of credits and deductions, and the choice of what to tax at all, tax systems can either reduce economic inequality or amplify it. The research on how tax policy affects distribution is extensive, and its findings are relevant to debates that often generate more heat than light. Income inequality in the United States has increased substantially since the 1970s, measured by any of the standard metrics including the Gini coefficient, the share of income going to the top decile or top percentile, and the comparison of income growth at different points of the distribution. Research by Thomas Piketty, Emmanuel Saez, and colleagues using tax records has produced particularly detailed pictures of top income growth, finding that the share of national income going to the top one percent has roughly doubled since the late 1970s. The tax system's role in this trend has been studied extensively. Research documents that the effective tax rates paid by high-income households have declined substantially over the past several decades, reflecting both explicit policy changes including top marginal rate reductions from the Tax Reform Act of 1986 and the Bush-era tax cuts, and structural changes in how wealthy individuals receive and report income. The preferential tax rate on capital gains, which is lower than ordinary income rates, disproportionately benefits high-income households who receive a larger share of their income from capital. The estate tax, which applies to the transfer of wealth at death, affects wealth concentration across generations. Research on inheritance and wealth dynamics documents that inherited wealth is a significant driver of wealth inequality, with the wealthiest decile receiving dramatically larger inheritances than those lower in the wealth distribution. The estate tax affects a small fraction of estates, as the exemption has grown substantially and now exempts the vast majority of estates from taxation. Research on the effects of the estate tax on wealth concentration finds that it reduces the rate at which dynastic wealth accumulates, though behavioral responses including charitable giving and trust structures reduce its revenue impact. Consumption taxes, including sales taxes and value-added taxes, are generally regressive: lower-income households spend higher shares of their incomes, so taxes levied on spending fall more heavily on them proportionally. Research on the distributional effects of consumption taxes documents their regressive character, which has led to design modifications in many tax systems including exemptions for food, medicine, and other necessities to reduce regressivity. Progressive income taxes, which apply higher rates to higher income, are the primary tool for tax-based redistribution. Research on the incidence of income taxes and on behavioral responses to rate changes informs debates about how progressive the income tax should be. The elasticity of taxable income, a measure of how much reported income changes in response to tax rate changes, is central to estimates of the revenue cost of rate increases and the efficiency cost of progressivity. Research on this elasticity produces a range of estimates, with academic researchers generally finding lower elasticity than implied by some policy arguments. The earned income tax credit is widely viewed as one of the most effective components of the US tax code for reducing poverty and encouraging work among low-income households. Research on EITC effects consistently finds significant poverty reduction, particularly for families with children, and positive effects on employment, particularly for single mothers. Studies have also found positive effects on child health, educational outcomes, and long-term earnings for children in families that receive the EITC. The evidence base for the EITC is among the strongest in tax policy research. Cross-national comparisons of tax systems and inequality are informative for understanding the range of possible policy choices. Peer nations with similar economic development levels generally have more progressive tax systems and lower post-tax inequality than the United States. The comparison suggests that higher tax progressivity is compatible with strong economic performance, challenging the argument that reducing inequality through taxation necessarily harms growth. The mechanisms through which high inequality itself may harm growth, through reduced social mobility, reduced consumption by lower-income households, and political instability, are increasingly studied.