Inequality-growth nexus under progressive income taxation

Abstract

Within heterogeneous-household extensions of Romer’s (1986) one-sector representative agent model of endogenous growth, this paper finds that changes made to the U.S. statutory income tax in the past decades account for a substantial portion of the following stylized facts: (i) U.S. income inequality significantly deteriorates since the mid-1980s; (ii) the inequality-growth nexus displays a positive slope before and after the implementation of the Tax Reform Act of 1986 (TRA-86); and (iii) the slope of the inequality-growth nexus sharply declines between the pre- and post-TRA-86-reform periods, indicating less deterioration in real GDP per capita growth when pursuing a more equal income distribution after 1986. In addition to income inequality, the responses of several other measurements of inequality to changes in the tax code parameters are also explored.