Income Response to Tax Rates

Taxman

Let me tell you how it will be
 There's one for you, nineteen for me
  Cause I'm the taxman yeah, I'm the taxman

Taxes should be a way to grow the economy, not to  increase inequity.

No  one likes paying taxes.  Taxes are levied to raise revenue for governments. In the United States, the principal source of federal government revenue is the income tax.  However, the purpose of the income tax code is not only to collect revenue.  It is enacted to promote economic growth, while arguably not unnecessarily adversely affecting various economic sectors.  Income inequality is a measure of how the poor (lower income percentiles) compare to the rich ( upper income percentiles).  A proposed measure of income inequality is the ratio of Mean household income (i.e. total income divided by total households), divided by Median household income ( i.e. the income above, or below, which 50% of the households occur).  For a perfect normal distribution of household income, the mean and median would be the same. 

A measure of success of the income  tax code might be that total income increases, but the income inequity does not increase.  The Federal Reserve Bank of St Louis provides Mean and Median household incomes, as reported by the US Census.  The reported Mean and Median household incomes are shown in Figure 1.

Figure 1 Mean And Median US Household Income: All Years Current Dollars

If the goal of the Tax Acts were to increase economic growth, those Acts have fallen below an Compound Annual Growth trend line established by income from all years.  Also, from that figure, the  gap between Mean and Median household incomes has been increasing over time.

To account for inflation, the reported household incomes were adjusted by the Bureau of Labor Statistics Consumer Price Index, CPI,  to convert incomes to 1967 dollars ( any year could be used as an index, which would change the values on the y-axis, but would not change the data or curves because the impact of inflation would be the same.) These results are shown in Figure 2.

Figure 2 Mean and Median US Household Income, Adjusted For Inflation, By Tax Act

The major Tax Acts during this period are shown, which regress very well to the reported household incomes.  The analysis does not include the impact of the Tax Cut and Jobs Act of 2017 because it was signed in law in December of 2017 and not enough time yet has occurred to compute its impact on household income.  Shown in Table 1 is the Compound Annual Growth Rate, CAGR,  computed for the reported respective mean and median household incomes during these periods. If the intent of the Tax Acts was to promote economic growth, then arguably  growth has been less during each of Tax Act periods.  What has occurred is that the gap between mean and median incomes has increased during the period of these Tax Acts.

Table 1 Growth Rate During Periods Of Tax Acts.

	pre 1981	1981-1990	1991-2001	2002- 2018
Mean Income CAGR	2.30%	1.63%	1.93%	0.40%
Median Income CAGR	2.23%	1.21%	1.46%	0.13%

While the Tax Acts were adopted during, or immediately following, economic downturns, recessions, economic downturns, and recoveries have also occurred during periods with no changes to the tax codes.  The official National Bureau of Economic Research beginning and ending dates of recessions are shown in Table 2. There have been more recessions than there have been changes to the Tax Code during the reported period.  Based on the reported incomes, it is possible to recover from a recession without  any corresponding changes to the Tax Code.

Table 2 NBER Reported Recessions Corresponding to the Years In Figures 1 And 2

Beginning date	Ending date
1953-07-01	1954-05-01
1957-08-01	1958-04-01
1960-04-01	1961-02-01
1969-12-01	1970-11-01
1973-11-01	1975-03-01
1980-01-01	1980-07-01
1981-07-01	1982-11-01
1990-07-01	1991-03-01
2001-03-01	2001-11-01
2007-12-01	2009-06-01

---

[1] https://alfred.stlouisfed.org/