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Title: The Role of Federal and State Taxes in Mitigating Wage Inequality

Citation Type: Miscellaneous

Publication Year: 2011

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Abstract: Wage inequality has risen dramatically in the United States since at least 1980. This paper examines the role that the tax policies of the federal and state governments haveplayed in mitigating wage inequality. The analysis, which isolates the contribution of federal taxes and state taxes separately, employs two approaches. First, cross-sectionalestimates compare before-tax and after-tax inequality across the 50 states and the District of Columbia. Second, inequality estimates across time are calculated to assessthe evolution of the effects of tax policies. The results from the first approach indicate that the tax code reduces wage inequality substantially in all states. Most of this compression of the income distribution is attributable to federal taxes. Nevertheless, there is substantial cross-state variation in the extent to which state tax policies compress the income distribution. Cross-state differences in gasoline taxes have a surprisingly large impact on income compression, as do sales tax exemptions for food and clothing. The results of the second approach indicate that the mitigating influence of tax policy on wage inequality has increased very modestly since the early 1980s. The increase is due to the widening of the pre-tax wage distribution interacting with a progressive tax structure. In contrast, legislated tax changes over this period decreased income compression somewhat.

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Authors: Palumbo, Michael G.; Lutz, Byron F.; Cooper, Daniel H.

Publisher: Federal Reserve Bank of Boston

Data Collections: IPUMS USA, IPUMS CPS

Topics: Labor Force and Occupational Structure, Other

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