Tax Progressivity, Economic Booms, and Trickle-Up Economics

Jackson, Laura E.; Otrok, Christopher; Owyang, Michael T.

doi:10.20955/wp.2019.034

Working Paper

Tax Progressivity, Economic Booms, and Trickle-Up Economics

Abstract: We propose a method to decompose changes in the tax structure into a component measuring the level of taxes and a component orthogonal to the level that measures progressivity. While our focus is on the progessivity results, we find that the level shock is similar to standard tax shocks found in the empirical literature in that a rise in the level is contractionary. An increase in tax progressivity sets off an economic boom. Those at the bottom of the income distribution (who are constrained hand-to-mouth consumers) set off a consumption boom that expands the overall economy. Those at the top of the income distribution benefit disproportionately from expansions, and their income gains more than offset the increases in tax from higher marginal rates. The net result is that an increase in progressivity leads to an increase in inequality, not a decrease as conventional wisdom would suggest. We interpret these results as evidence in favor of trickle-up, not trickle-down, economics.

Keywords: Taxes; Gini coefficients; income and consumption inequality;

JEL Classification: C32; E62;

https://doi.org/10.20955/wp.2019.034