Income inequality has been on the rise in the US, and the middle class is shrinking. The following chart shows income equality grew before the Great Depression but was stable, and the middle class grew after the Depression until something happened in 1981. Compare this chart to the Income Tax Rate chart to discern a possible cause.

The effect of government programs on income distribution is indisputable.  But it is certainly not the only factor at work. In recent years international competition by labor for jobs has intensified. Competition has reduced the effectiveness of labor organization. Technology has dramatically improved productivity and reduced the demand for labor and allowed labor to be replaced with automation (i.e. capital). These factors have restricted the growth of real median personal income in the US to just 10% in the past 20 years. And this has occurred even while business has been highly profitable, rewarding top management, owners and those with capital. In the US the federal income tax is the most progressive tax among the five largest revenue producing taxes (federal and state income, payroll, sales, and property) so it would be tool of choice if the government wanted to regulate the income distribution. 

The following chart shows the income tax has not been used to redistribute wealth from the rich to the poor.  Since 1969 the highest tax rates have been steadily reduced to rates last experienced in the 1920’s. In addition to these marginal rates, the treatment of dividends and capital gains has been made even more favorable.

Income Tax rates:

From WWII until 1981 the US middle class grew steadily and income inequality steadily decreased in America. Since 1981 macro-economic factors and government policy have increased US income inequality. Wealth has been steadily concentrating in the hands of the wealthiest.

The Gini coefficient measures income disparity and shows income inequality in the US is now the highest among OECD countries, except Mexico and Chile. The US Gini has not been this high since 1929. The $56T in tangible US wealth, if divided equally (a Gini index of 0) would provide $170,000 for every American man, woman and child. The $15T GDP would provide $80,000/year income for every member of the workforce. Divided as it is, the top 1% control 40% of the income and wealth, the top 10% controls 80%. Nearly 50% of Americans have no financial wealth (savings) at all. The $7.25/hour minimum wage provides a floor under $15,000/year for full time employment. The average nonfarm wage of $22.45/hour provides a median $45,000/year income for the 157 million adults able to find a job.

Government redistributes wealth through taxation and transfer payments.  Since Reagan, taxes have become more regressive. The Republicans have been pursuing a theory of “trickle down or supply side” economics. Top income tax rates have dropped to all-time lows while payroll and sales taxes have grown. The net effect is that the Tax System in the US is now very flat with everyone paying 28-33% of their income in taxes. The chart shows for different annual earnings what the expected percentage of that income goes to various federal, state and local taxes.

2009 Tax Summary					106
	Sales	Prop	St Inc	Fed Inc	FICA	Med		Total
Earn
0-50,000	6.0%	3.0%	1.0%	3.0%	12.4%	2.9%		28.3%
50-75,000	3.7%	3.0%	2.0%	7.0%	12.4%	2.9%		31.0%
75-100,000	3.7%	3.0%	2.6%	8.0%	12.4%	2.6%		32.3%
100-200,000	2.8%	2.9%	3.1%	12.0%	9.7%	2.2%		32.7%
200-500,000	1.7%	2.4%	3.6%	19.0%	4.9%	1.9%		33.5%
500,000 up	0.9%	1.4%	4.2%	24.0%	1.3%	1.5%		33.3%
Fed Inc Tax 2009, 140 million return, IRS.gov
State and Local Taxes from Institute of Taxation and Economic Policy , Who Pays, 2009

 

A controversial 2012 Congressional Research Service Report contained the following conclusion:

The top income tax rates have changed considerably since the end of World War II. Throughout the late-1940s and 1950s, the top marginal tax rate was typically above 90%; today it is 35%. Additionally, the top capital gains tax rate was 25% in the 1950s and 1960s, 35% in the 1970s; today it is 15%. The average tax rate faced by the top 0.01% of taxpayers was above 40% until the mid-1980s; today it is below 25%. Tax rates affecting taxpayers at the top of the income distribution are currently at their lowest levels since the end of the Second World War

The results of the analysis suggest that changes over the past 65 years in the top marginal tax rate and the top capital gains tax rate do not appear correlated with economic growth. The reduction in the top tax rates appears to be uncorrelated with saving, investment, and productivity growth. The top tax rates appear to have little or no relation to the size of the economic pie.

However, the top tax rate reductions appear to be associated with the increasing concentration of income at the top of the income distribution. As measured by IRS data, the share of income accruing to the top 0.1% of U.S. families increased from 4.2% in 1945 to 12.3% by 2007 before falling to 9.2% due to the 2007-2009 recession. At the same time, the average tax rate paid by the top 0.1% fell from over 50% in 1945 to about 25% in 2009. Tax policy could have a relation to how the economic pie is sliced—lower top tax rates may be associated with greater income disparities.