Friday, April 20, 2012

Taxes, Tuition, and Inequality

Our chapter on economic policy describes various tax deductions and credits, and presents data on how the tax burden falls on various income groups. Inside Higher Ed reports:
A report by Education Sector shows how rapidly the federal government has increased its spending on tax credits and deductions for college tuition -- tax breaks that disproportionately help upper-income taxpayers. Financial aid experts have noted that amid many complaints about the exploding costs of the Pell Grant Program, which mostly assists low-income students, relatively little attention has been paid to tuition tax breaks. In addition to documenting the growth of the tax breaks, the Education Sector report urges their elimination.
Overall, however, the tax system does not contribute to income inequality, as William Galston explains at The New Republic:
Last December, the Federal Reserve published a working paper by four researchers—one university-based, one from Treasury, two from the Fed—based on a large, confidential file of tax returns: a one-in-5000 random sample of the population of U.S. taxpayers, comprising 30,000 households. They found that the rise in income inequality mostly reflects permanent as opposed to transitory changes in household income.
But the federal tax system didn’t contribute to that rise. From the beginning of the period studied to the end, our moderately progressive tax system reduced pre-tax inequality by roughly the same amount. Overall, the authors conclude, the tax system “does not seem to have altered the trend toward rising inequality.”
The authors are aware that their conclusion is counterintuitive: “The finding of little change in the effect of the federal tax system on the evolution of inequality in recent years might appear surprising in light of the well-publicized reductions in marginal tax rates, especially at the high end of the income distribution, in 2001 and 2003.” Here’s how they explain their finding: “Changes in top marginal rates were accompanied by (smaller) reductions in marginal rates for other income groups as well as by significant expansions of the earned income tax credit and the child tax credit.” The net effect of all this, they conclude, was “small.”
I don’t expect readers to take my word for it. So go to federalreserve.gov/pubs to find the paper by Jason DeBacker, Bradley Heim, Vasia Panousi, and Ivan Vidangos, called “Rising Inequality: Transitory or Permanent? New Evidence from a Panel of U. S. Tax Returns 1987-2006.” You can judge for yourselves. (My economist colleagues at Brookings, who discussed this paper in their seminar series, consider it to represent high-quality research.)