Reversal of the Trend: Income Inequality Now Lower than It Was under Clinton

William McBride:

Numerous academic studies have shown that income inequality in the U.S. over the 20th century exhibits a U-shape. After reaching a peak in the 1920s, it fell during the Great Depression and World War II and rebounded mainly in the 1980s and 1990s.1 The rebound has been attributed to various economic factors, such as globalization, immigration, the growth of super-star salaries, and the computer revolution. However, these factors might better be described as the normal outcomes of a growing economy, according to Adam Smith’s idea that the division of labor is limited by the extent of the market. The resurgence of inequality has also been attributed to tax policy, particularly the reduction of top marginal rates on personal income from 94 percent in 1945 to 28 percent in 1988.2
The first decade of the 21st century does not exhibit the same trend. Based on the most recent IRS data, from 2009, income inequality has fluctuated considerably since 2000 but is now at about the level it was in 1997. Thus, the Bush-era tax cuts (which had provisions benefitting both high- and low-income taxpayers) did not lead to increased income inequality. By contrast, inequality rose 12 percent between 1993 and 2000, following two tax rate increases on high-income earners. Thus, changes in inequality over the last two decades appear to be driven more by the business cycle than by tax policy.