Abstract
AbstractTop marginal tax rates are positively correlated with the pretax income growth of the bottom 90 per cent — those who are not subject to the top rates. To explain this correlation, this paper presents and tests a model in which executives can increase firm profitability by (i) increasing the firm's level of technology and (ii) decreasing labor costs. In the model, higher marginal tax rates may reduce pretax inequality by increasing the average income growth of workers. This hypothesis is tested by examining the effect of top marginal tax rates on (unobserved) relative bargaining power between labor and firms and, therefore, on the income growth of workers in theUSA. Bargaining power, in both the theoretical and the empirical models, is proxied by private‐sector unionization and use of offshore labor resulting in higher imports.
Highlights
While income inequality has been the subject of much recent research, there has been little agreement about why inequality in the United States and many other countries has increased so dramatically from the mid-1970s to the present day
The main contribution of this paper is to show how top marginal tax rates (MTRs) may aect the pre-tax distribution of income, by reducing the income of those at the very top and by increasing the growth of income for the bottom 90%
The model presented here suggests that executives will work more to increase bargaining power of the rm and decrease their labor costs when they face lower MTRs, increasing their income and decreasing that of their workers
Summary
While income inequality has been the subject of much recent research, there has been little agreement about why inequality in the United States and many other countries has increased so dramatically from the mid-1970s to the present day. Piketty et al [2014] show that neither the traditional labor supply elasticity nor the possibility of tax avoidance can account for much of the correlation Instead, they nd support for a third elasticity in which executiveswho make up a signicant fraction of those at the top according to Bakija et al [2010]have an incentive to increase their bargaining power when facing a lower MTR in order to increase their total compensation. The changes in bargaining power stem mainly from a reduction in labor unionization and rms' increasing reliance on oshore production, resulting in higher levels of imports These two measures, both of which reduce income growth for workers, are very highly correlated with the MTR, and I show that a signicant fraction of the reduction in the real income growth of the bottom 90% can be explained by the change in the MTRs of the top 0.01%. Especially as union membership has declined, labor nds it much more dicult to exert political pressure than do the handful of groups representing the top 0.01%
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