Getting rich ... on paper.

• Author: Reynolds, Alan
• Position: Income tax

ESTIMATES OF THE TOP ONE PERCENT'S share of total U.S. income have been cited widely as evidence of a large and continuous increase in U.S. income inequality since the 1970s. Yet, many changes in U.S. tax laws and regulations after 1980 made a dramatic difference in what is reported as income to the Internal Revenue Service. Lower tax rates on individual income induced thousands of businesses to switch to filing under the individual tax rather than the corporate tax. Corporate executives switched from accepting stock options taxed as capital gains to nonqualified stock options taxed as salaries. New tax-deferred savings plans also resulted in much of the dividends and capital gains of middle-income taxpayers being shifted away from tax returns, thus making billions of dollars of investment income invisible in tax returns (except at the top). Meanwhile, exclusion of transfer payments in the most widely cited estimates results in exaggerating the increase at the top by ignoring a growing fraction of lower incomes.

Estimates from Emmanuel Saez (professor of economics at the University of California at Berkeley) and Thomas Piketty (of Ecole Normale Superieure in Paris) indicate substantial responsiveness ("elasticity") of reported income among high-income taxpayers. When top tax rates fall, on salaries or capital gains, a much larger fraction of high incomes shows up on tax returns. This is consistent with international comparisons of top percentile income shares, which rose most where top tax rates were most reduced (the U.S., U.K., and India) and rose least where top tax rates remained very high (France and Japan). Aside from executive and nonexecutive stock option windfalls during the 1997-2000 stock boom, there is little evidence of a significant and sustained increase in the inequality of U.S. incomes, wages, consumption, or wealth between 1986-88 and 2002-03.

Tax return data provides a highly misleading comparison of income distribution before and after such dramatic changes in tax law as those that occurred in the U.S. from 1981-86. Practically every major newspaper and magazine in the U.S. and U.K. repeatedly has reported that the share of national income received by the top one percent has increased enormously and continuously since the 1970s. Of the many difficult statistics used to influence public perception and policy, this one surely is the most often repeated and the least often understood.

Piketty and Saez are not the only...