Increasing inequality is a purely political (taxation) problem

Here we show that the source of increasing income inequality in the tax law. At the end of the day, the whole bunch of US politicians is responsible for the increase in the portion of personal income for the richest families. This is good news since the return to “normal” income distribution is a political procedure. There are no economic forces behind the change, which would be much more difficult to overcome.   

We have discussed the evolution of inequality   in the USA a few times in this blog and demonstrated that the proportion of personal (money) income in the Gross Domestic Product has not been changing much since 1947. This is the year when the Bureau of Labor Statistics started to measure personal incomes. We have also revealed the source of some kind of virtual increase in income inequality – private companies redistribute their income in favor of personal income of their owners. The question is – how do they get extra money to redistribute to their private owners? This post answers this question - the US tax system started to reduce the level of tax for private companies. Primarily, it is made by increasing the rate of depreciation, which enterprises are officially permitted to charge for tax purposes (usually fixed by law).  Hence, the tax law in responsible for the increasing inequality.

We start with a graph showing the growth in GDP, gross personal income (GPI) and compensation of employees (paid) since 1929. Figure 1 demonstrates that the level of GPI has been rising faster than that of the GDP (and the compensation) since 1979. (The share of GPI in the GDP has been rising since 1979!) The difference between the GPI and GDP curves depicted in Figure 2 has a striking kink around 1979. And this is the start of the current rally in the rich families’ personal income. In other words, a new political (taxation is a fully political issue) era started in 1979. We would like to stress again the proportion of the compensation of employees in the GDP has not been changing since 1929, with a small positive deviation in the end of 1990s and a negative deviation since 2009.  This observation supports our previous finding that the proportion of personal (money) income in the GDP has not been changing.

So, where the extra money is from? The level of personal income has been actually increasing faster than that of the GDP and it should be a looser, which lost its share in the GDP.  Figure 3 shows two major components of the GPI. The net operating surplus (private) has been changing at the same rate as the GDP since 1929, while the proportion of taxes on production and imports has been growing at lower rate since 1980. We have allocated the source of income for rich families. They take money from the decreasing taxes. But what is the mechanism of money appropriation? Figure 4 demonstrates that the decrease in taxes goes directly into the increasing share of consumption of fixed capital. This is the force behind the increasing income inequality.  The increasing share of the consumption of fixed capital is successfully converted in private money, not in investments! This is a political problem started likely started by Reagan.

There is no economic problem behind increasing income inequality. 

Figure 1. GDP, GPI, and compensation of employees normalized to their respective levels in 1960.

Figure 2. The difference between the GPI and GDP curves in Figure 1.

Figure 3. GDP, net operation surplus (private), and taxes (on production and imports) normalized to their respective levels in 1960.

Figure 4. GDP and consumption of fixed capital normalized to their respective levels in 1960.