The Evolution Of Wealth Inequality Over Half A Century: The Role Of Taxes, Transfers And Technology

Baris Kaymak and Markus Poschke, "The Evolution Of Wealth Inequality Over Half A Century: The Role Of Taxes, Transfers And Technology,"Journal Of Monetary Economics, October 2015, https://markus-poschke.research.mcgill.ca/papers/KP_toptax.pdf

“….. Results highlight the role of increasing wage dispersion during this period as the main driver of trends in inequality…The findings emphasize the role of increasing wage dispersion, often attributed to skill biased technical change, as the main culprit of higher income and wealth inequality in the U.S. Changes in tax and transfer policies over the second half of the 20th century have played a key role, accounting for nearly half of the rise in wealth concentration. Nevertheless, their combined effect on the distribution of income and consumption were limited. The results indicate the equilibrium adjustment in prices, the redistributive nature of transfers and the offsetting effects of taxes and transfers on consumption as main reasons for this limited role. As such, the results call for caution when drawing conclusions regarding welfare, based on income and wealth distributions. An interpretation of our findings is that changes in the transfer policies have been as influential as the changes in tax policies. Yet, unlike the wide coverage of falling top income tax rates, changes in the transfer system has received little attention of late. Our focus has been on two major federal programs: the social security and medicare. Several other programs were introduced during this period, both at the federal and the state level, that could potentially have similar effects on the economy, such as the Earned Income Tax Credit program or the Welfare-to-Work programs. Given the redistributive nature of transfers in U.S., our findings highlight the need for empirical measures of wealth dispersion including claims on the public sector. The findings here suggest that such a measure would generally display a lower concentration of wealth, and a smaller increase over time….. changes in tax policy have to be analyzed in connection with the corresponding changes in transfer policy. During the same period, the share of total transfer payments in GDP increased from 4.1% to 11.9%. The rise in transfer spending was driven by two major programs: Social Security and Medicare, both of which target senior citizens. By subsidizing income and healthcare expenditures for the elderly, these programs curb incentives to save for retirement, a major source of wealth accumulation over the life-cycle. Furthermore, since both programs are redistributive by design, they have a stronger effect on the savings of low and middle income groups. By contrast, those at the top of the income distribution have little to gain from these programs. We argue that the redistributive nature of transfer payments was instrumental in curbing wealth accumulation for income groups outside the top 10% and, consequently, amplified wealth concentration in the U.S….Since the wealth distribution reacts more slowly to the economic environment than income, the full effect of the more recent changes in policy and wage dispersion has not yet fully materialized. Given today's wage structure and barring any further changes in tax and transfer policy,the model predicts two to three more decades of increasing wealth concentration, at which point the wealthiest 1% will eventually hold about half the wealth in the economy, roughly 10 percentage points more than their current share. Should future top wages increase further relative to the rest, the future increase in top wealth shares would be even larger. In contrast to their contribution to wealth inequality, top income tax cuts had no effect on the income distribution. The increase in income inequality is instead almost entirely attributable to the changes in the wage distribution. The difference comes from equilibrium adjustments in prices that work in opposing directions when income and wealth dispersions are concerned. Accumulation of additional wealth in response to tax cuts leads to a decline in the interest rate and an increase in the wage rate. The fall in the equilibrium interest rate discourages savings by lower wealth groups and exacerbates the direct effect of tax cuts on wealth inequality. As for income, the lower interest rate mitigates the rise in top incomes, while a higher wage rate benefits lower income groups as they live mainly off labor income. Therefore, changes in prices amplify the impact of tax cuts on wealth dispersion, while they mitigate their impact on income dispersion …”

It also argues that increased transfers have reduced the need for the bottom 90% to save for retirement which has the effect of lowering their wealth accumulation which has amplified wealth concentration. Finds that btw 1980-2010 wage dispersion contributed 62.1% of the change in top 1% wealth (not income) share

Second paper David sent. This argues that wage dispersion, related to skill based technical change, has been the primary driver of higher income and wealth inequality in the US.