CBO Data Show Income Inequality Continues to Widen

CBO issues the most comprehensive and authoritative data available on the levels of and changes in incomes and taxes for different income groups, capturing trends at the very top of the income scale that are not shown in Census data.

In contrast, the income of the middle fifth of the population rose $1,700, or 3.6 percent, to $48,400.  The income of the bottom fifth rose a scant $200 (or 1.4 percent) to $14,700.

Income is now more concentrated at the top of the income spectrum than in all but two years since the mid-1930s.  This conclusion is reached by examining the CBO data in conjunction with data from a ground-breaking historical analysis of pre-tax income distribution trends published in a leading economics journal.   When viewed together, the studies indicate that the top one percent of households now receive a larger share of the national pre-tax income than at any time since 1937, except for the years 1999 and 2000.

The new data also highlight the degree to which income gains over the past quarter-century have become increasingly concentrated at the top of the income scale.  Since 1979 — the first year for which the CBO date are available — income gains among high-income households have dwarfed those of middle- and low-income households.  Over this 25-year period:

The average after-tax income of the top one percent of the population nearly tripled, rising from $314,000 to nearly $868,000 — for a total increase of $554,000, or 176 percent.

The CBO data also indicate that the growth in income disparities since 1979 largely reflects changes in before-tax income.  That is, most of the divergence in income patterns among various income groups reflects diverging outcomes in the income that they received before taking changes in federal tax policies into account.  Nonetheless, changes in federal taxes have had some influence over these patterns.

The direction in which the tax system influences inequality depends on the time period examined.  Changes in federal tax policies exacerbated the growth in income disparities during the 1980s, when taxes were cut sharply for high-income individuals, but slowed the growth in income disparities during the 1990s, when tax rates for high-income households were raised and the Earned Income Tax Credit for low- and moderate-income working families was substantially expanded.

Legislation enacted since 2001 has provided taxpayers with about $1 trillion in tax cuts over the past six years.  These large tax reductions have made the distribution of after-tax income more unequal.  Because high-income households received by far the largest tax cuts, the tax cuts have increased the concentration of income at the top of the spectrum.

The CBO data provide additional evidence that the recent tax cuts have contributed to the widening income gaps.  CBO provides data on effective federal income tax rates — that is, on the share of income that is paid in income taxes — for different groups of households.  While all groups of households have seen declines in their effective federal income-tax rates since 2000, the declines have been much larger for the highest income taxpayers.  For example, between 2000 and 2004, households in the top one percent of the income spectrum saw a drop in their effective federal income-tax rate of about 4.6 percentage points, more than twice the drop for households in the middle quintile (2.1 percentage points).  This decline in the effective rate translated into an average income tax reduction of almost $58,000 for people in the top one percent, relative to what these households would have paid if their effective tax rate had remained unchanged.

These data do not provide a direct measure of the impact of tax policy changes because they reflect the impact not only of legislative changes but also of changes in household incomes and other factors that influence tax rates.  Direct estimates by the Urban Institute-Brookings Institution Tax Policy Center that consider only the impact of the recent tax policy changes provide definitive evidence that the recent tax cuts have widened income inequality.  The Tax Policy Center finds that as a result of the tax cuts enacted since 2001:

• In 2006, households in the bottom fifth of the income spectrum received tax cuts (averaging $20) that raised their after-tax incomes by an average of 0.3 percent.
• Households in the middle fifth of the income spectrum received tax cuts (averaging $740) that raised their after-tax incomes an average of 2.5 percent.
• But the top one percent of households received tax cuts in 2006 (averaging $44,200) that increased their after-tax income by an average of 5.4 percent.
• Households with incomes exceeding $1 million received an average tax cut of $118,000 in 2006, which represented an increase of 6.0 percent in their after-tax income.  That is more than double the percentage increase received by the middle fifth of households.

Finally, some of the tax cuts enacted in 2001 are still being phased in, and the tax cuts still phasing in are heavily tilted to people at the top of the income scale.  These include the elimination of the tax on the nation’s largest estates and two income-tax cuts that started to take effect on January 1, 2006 and will go almost exclusively to high-income households. As a result, the tax cuts ultimately will be even more skewed toward high-income households, and will increase income inequality to a still larger degree, than was the case in 2006.