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Editor: Paul L. Caron, Dean
Pepperdine University School of Law

Thursday, March 27, 2008

CB&PP: New Data Show More Income Inequality

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This study would give a more accurate picture if it did two things: 1) include tax exempt income, and 2) include corporate income of privately held companies. By using personal income tax returns, these two issues are masked. I am a CPA who has advised wealthy clients. Wealthy people respond to tax incentives in structuring their investments and work. When marginal tax rates were in the 50-70% range, more wealthy people invested in tax exempt bonds. As tax rates were reduced, they moved investments to taxable investments. This exposed more of their income to the income tax, but did not change actual income as much as this study suggests. Also, wealthy people with their own businesses have changed from C corporation status to S corporation status, starting in the early 90's. C corporation income shows up on the personal income tax return when salary or dividends are paid. These are controlled by the owner, and are usually less that the total profit of the corporation. S corporation income shows up on the personal tax return when salary is paid, and when profits are earned. There is no opportunity to defer the timing of income on the personal tax return. This has had the effect over time of exposing more income to the personal income tax, without necessarily increasing wealth. Alan Reynolds has noted these two points repeatedly, but Pikettey and Saez have not added these aspects to their study.

Posted by: Caleb Standafer | Mar 28, 2008 8:57:16 AM

Sorry to have to belatedly add another point, but it would be important to know whether the identify of the taxpayers in the top 1% had significant or only minor change each year. If different people are in the top 1% each year, there is a much smaller concentration problem than if the same people are in the top 1% each year. If I sell my house or company and have a large gain, I could be in the top 1%, but that is not repeatable. My other earnings would keep me below the top 1% in a normal year.

Posted by: Caleb Standafer | Mar 28, 2008 2:26:56 PM