The Matthew Effect and Federal Taxation

Abstract

This article first examines in detail the increasing concentration of income and wealth in the top one percent, and particularly within much narrower cohorts near the top of the top one percent, that has occurred over the past twenty-five years. It demonstrates the strong Matthew effect in incomes in the United States over that period. The super-rich are pulling away from everyone by so much and at a rate so fast that the fact that incomes of many households at the bottom and in the middle have stagnated, or even fallen in constant dollars, has been obscured by ever increasing per capita income. The article then examines changing effective federal tax rates over the last two decades of the twentieth century. By the close of the twentieth century the tax system was not raising revenue as fairly and was doing less to mitigate inequality than it had in the middle of that century. Tax legislation in the twenty-first century continued this trend by providing tax cuts very disproportionately in favor of those at the top of the income pyramid with very small tax cuts going to everyone else.

The article then demonstrates that economic theory does not support the argument that the tax cuts were necessary to spur incentives to save and invest and to work, and that the empirical evidence of the effect of tax cuts on savings and investment clearly contradicts the claims made by supporters of the tax cuts. It examines the rapidly growing body of economic literature supporting the thesis that economic inequality impedes economic growth rather than fostering it, and concludes that because the tax cuts increase inequality, they probably impede economic growth.

After analyzing the economic issues, the article discusses the philosophical basis for a highly redistributive tax system, arguing that in a modern industrialized democracy, most of what everyone earns is attributable to infrastructure created by society acting as a whole, principally through government. The article then examines the paradox of public concern with increasing economic inequality, thinking it undesirable, and while simultaneously supporting tax cut legislation that in fact delivers vastly disproportionate benefits to the super-rich.

Finally, the article suggests that its time for the tax system to address these problems by substantially increasing progressivity at the top of the income pyramid. Future tax legislation ought to mitigate the Matthew effect, rather than enhance it.

Keywords: Tax Policy, Progressive Taxation, Tax Rates

JEL Classification: D63, E62, H21, K34