Rising Inequality: Transitory or Permanent? New Evidence from a Panel of U.S. Tax Returns 1987-2006

63 Pages Posted: 26 Jan 2011 Last revised: 3 Jan 2012

Jason Matthew DeBacker

University of South Carolina - Darla Moore School of Business

Bradley T. Heim

Indiana University Bloomington - School of Public & Environmental Affairs (SPEA)

Vasia Panousi

University of Montreal, Department of Economics

Ivan Vidangos

Board of Governors of the Federal Reserve System

Date Written: January 2, 2012

Abstract

We use a new, large, and confidential panel of tax returns from the Internal Revenue Service to shed light on the permanent versus transitory nature of rising inequality in individual male labor earnings and in total household income, both before and after taxes, in the United States over the period 1987-2006. Due to the quality and the significant size of our dataset, we are able to conduct our analysis using rich and precisely estimated error-components models of income dynamics. Our main specification finds evidence for a quadratic heterogeneous income profiles component and a random walk component in permanent earnings, and for a moving-average component in autoregressive transitory earnings. We find that the increase in inequality over our sample period was entirely permanent for male earnings, and predominantly permanent for household income. We also show that the tax system, though reducing inequality, nonetheless did not materially affect its increasing trend. Furthermore, we compare our model-based findings against those of simpler, non-model based inequality decomposition methods. We show that the results for the trends in the evolution of the permanent and transitory variances are remarkably similar across methods, whereas the results for the shares of those variances in cross-sectional inequality differ widely. Further investigation into the sources of these differences suggests that simpler methods produce erroneous decompositions because they cannot flexibly capture the relative degree of persistence of the transitory component of income.

Keywords: Income Inequality, Permanent Inequality, Transitory Inequality, Income Volatility, Male Earnings, Family Income

JEL Classification: C61, D31

Suggested Citation

DeBacker, Jason Matthew and Heim, Bradley T. and Panousi, Vasia and Vidangos, Ivan, Rising Inequality: Transitory or Permanent? New Evidence from a Panel of U.S. Tax Returns 1987-2006 (January 2, 2012). Indiana University-Bloomington: School of Public & Environmental Affairs Research Paper Series No. 2011-01-01. Available at SSRN: https://ssrn.com/abstract=1747849 or http://dx.doi.org/10.2139/ssrn.1747849

Jason Matthew DeBacker

University of South Carolina - Darla Moore School of Business ( email )

The Francis M. Hipp Building
1705 College Street
Columbia, SC 29208
United States

Bradley T. Heim

Indiana University Bloomington - School of Public & Environmental Affairs (SPEA) ( email )

1315 East Tenth Street
Bloomington, IN 47405
United States

Vasia Panousi (Contact Author)

University of Montreal, Department of Economics ( email )

C.P. 6128 succursale Centre-ville
Montreal, Quebec H3C 3J7
Canada

HOME PAGE: http://https://sites.google.com/site/panousi/

Ivan Vidangos

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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