The Distributional Implications of the Tax Changes in the 1980s

Abstract

This paper studies changes in the United States as a consequence of the Economic Recovery Aa of 1981 (ERITA), the Tax Equality and Fiscal Responsibility Act of 1982 (TEFRA), and the Tax Reform Act of 1986 (TRA). The effects of ERITA, TEFRA, and TRA are demonstrated via measures of pre-tax and post-tax inequality based on gross household income and disposable household income. Thus, the distribution of income, and also the tax payments, consist of components that are attributed to tax changes and components that are driven by the pre-tax income. Typically, most analysts view the distribution of pre-tax and post-tax income based on GINI coefficients. However, this analysis employs the decomposable Generalized Entropy measure, which enables the distribution of the between and (weighted average) effects of taxation. Moreover, this approach allows for a more accurate assessment of tax progressivity in the long run. This process provides a better framework to evaluate the policy implications of future tax changes. The results illustrate that long-run income tax progressivity has been declining over time. Concurrently, we witness a relative rise in pre-tax and post-tax income inequality over the latter portion of the accounting interval. It is further evidenced that a number of exemptions and the type of tax table used create more equalization within each group, but cross- group equalization is minimal. When decomposed by quintile, the data reveal more cross-group equalization than within-group equalization.