U.S. Income Inequality Has Not Increased

New Cato study demonstrates weaknesses of popular data

January 8, 2007

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WASHINGTON — It’s become an unquestioned part of the conventional wisdom that income inequality is rising steadily and has been for two decades. In a new policy analysis, “Has U.S. Income Inequality Really Increased?” Cato Institute senior fellow Alan Reynolds shows that these claims are wrong in both their premises and their conclusions.

“The widespread impression that the United States has experienced a large and continuous increase in income inequality since the 1970s is almost entirely dependent on the disingenuous practice of using estimates,” writes Reynolds, “which are highly misleading, because of dramatic changes in the tax rules and tax reporting in recent decades.”

“The top 1 percent’s share [of national income] jumped from 9.1 percent in 1985, when the top tax rate was 50 percent, to 13.2 percent in 1988 when the top tax rate dropped to 28 percent,” Reynolds explains, but the change was not due to “a sudden two-year spurt in inequality. It was a sudden increase in the amount of high income reported on individual income tax returns rather than being concealed, deferred, or reported on corporate income tax returns.”

Reynolds notes that taxpayers are very responsive to changes in the law, so “a substantial reduction of top tax rates should be followed by a very substantial increase in the amount of income reported on tax returns. And [since 1986] that is exactly what happened.”

Once these facts are considered, Reynolds concludes, “There is no clear evidence of a significant and sustained increase in the inequality of U.S. incomes, wages, consumption, or wealth since the late 1980s.”

Policy Analysis Paper no. 586