Order Code RL34155
Income Inequality and the U.S. Tax System
September 4, 2007
Thomas L. Hungerford
Specialist in Public Finance
Government and Finance Division

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Income Inequality and the U.S. Tax System
Summary
While the extent of income inequality is debated periodically, one rarely
discussed aspect of inequality is its impact on the tax system. Given the nature of the
U.S. federal tax system, changes in the distribution of income can have significant
implications for who pays the taxes, how much they pay, and federal tax revenues.
One common measure to characterize inequality or the dispersion of income is
the Gini coefficient, which varies from 0 to 1. A Gini coefficient of 0 indicates that
income is evenly distributed among the population (that is, everyone has the same
income) while a value of 1 indicates perfect income inequality (that is, one individual
has all the income). Between 1980 and 2004, the Gini coefficient for household
income increased from 0.403 to 0.466 — a 15.6% increase. The Gini coefficient for
earnings increased by 22.4% from 0.331 in 1980 to 0.405 by 2004. Inequality has,
therefore, increased over the past 25 years.
The two major sources of federal tax revenues are the individual income tax and
the Social Security payroll tax, accounting for almost 80% of total federal tax
revenue. These two taxes have different tax bases, tax rates, and adjustments to
income. Furthermore, the individual income tax system consists of the regular
income tax and the parallel alternative minimum tax (AMT), which have different
tax bases and tax rates. Consequently, changes in income and earnings inequality
could have very different effects on different parts of the federal tax system.
Many of the parameters of the regular income tax are indexed to inflation.
Nevertheless, with income growing faster than prices and with rising income
inequality, more income falls into higher tax brackets. Individual income tax
revenues as a percentage of GDP, however, do not appear to be associated with rising
inequality because the income tax has become less progressive through legislative
changes as inequality has increased. The parameters of the AMT, however, are not
indexed at all. Consequently, the amount of income and the number of taxpayers
subject to the AMT will increase dramatically over time because of income growth
and rising income inequality in the absence of legislative changes. The actual
increase in AMT taxpayers has been limited because of a series of enacted temporary
“patches.” Although the maximum taxable limit of the payroll tax is indexed for
average earnings growth, rising earnings inequality has pushed more and more of
covered earnings above the limit. Thus, the proportion of covered earnings that is
taxable has fallen over the past 25 years.
This report will not be updated.

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Contents
Trends in Inequality . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Household Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Trends in the Tax Base and Tax Revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
The Regular Individual Income Tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
The Social Security Payroll Tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
The Individual Alternative Minimum Tax (AMT) . . . . . . . . . . . . . . . . . . . 11
Implications of Inequality for Tax Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
Concluding Remarks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
List of Figures
Figure 1. Income and Earnings Inequality, 1980-2004 . . . . . . . . . . . . . . . . . . . . . 3
Figure 2. Real Household Income at the 90th Percentile, Median,
and 10th Percentile . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Figure 3. Real Adjusted Gross Income of the Top 10% of Taxpayers . . . . . . . . . 6
Figure 4. Men’s Real Earnings Inequality, 1980-2004 . . . . . . . . . . . . . . . . . . . . . 7
Figure 5. Women’s Real Earnings Inequality, 1980-2004 . . . . . . . . . . . . . . . . . . . 7
Figure 6. Ratio of Taxable to Total Income, 1980-2004 . . . . . . . . . . . . . . . . . . . . 9
Figure 7. Tax Revenues as a Percentage of GDP . . . . . . . . . . . . . . . . . . . . . . . . . 10
Figure 8. AMT Revenues as a Percentage of Total Individual Tax Revenues
and AMT Taxpayers as a Percentage of All Individual Taxpayers . . . . . . . 13
List of Tables
Table 1. Income Shares for Selected Years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
Table 2. Earnings Shares for Selected Years . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
Appendix A. Parameters for the Individual Income Tax . . . . . . . . . . . . . . . . . . . 20
Appendix B. Distribution of Families . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21
Appendix C. Distribution of Workers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22

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Income Inequality and the U.S. Tax System
Public interest in issues of income inequality appears to wax and wane. Interest
sometimes picks up at election time with a flurry of newspaper and magazine articles
and opinion pieces. After the election, the issue often disappears from the public
consciousness. While the extent of income inequality and income growth is debated
periodically, one rarely discussed aspect of inequality is its impact on the tax system.
Arguments are offered for and against reducing income inequality. The classic
argument against rising income inequality is the rich get richer and the poor get
poorer. This can increase poverty, reduce well-being, and reduce social cohesion.
Consequently, many argue that reducing income inequality may reduce various social
ills. In contrast, there are those arguing that rising inequality is nothing to worry
about and point out that average real income has been rising, so while the rich are
getting richer, the poor are not necessarily getting poorer. In addition, many argue
that some income inequality is necessary to encourage innovation and
entrepreneurship — the possibility of large rewards and high income are incentives
to bear the risks of innovation and entrepreneurship. Therefore, they assert the
economic costs of reducing or eliminating income inequality may be high.
Some researchers are concerned about the consequences of rising income
inequality. Research has demonstrated that large income and class disparities
adversely affect health and economic well-being. Michael Marmot has studied health
and social status disparities, concluding that health follows a social gradient —
people higher in the social hierarchy tend to be in better health than people of lower
status.1 Richard Wilkinson provides evidence that high income inequality — large
income disparities — and less social cohesion have a negative impact on the health
of a country’s citizens.2 Robert Frank argues that even if all incomes are increasing
and rising inequality is due solely to those at the top of the income distribution
pulling away from the rest, the middle class can be hurt by the pressure to keep up
with the upper class.3
Several factors have been identified as possibly contributing to increasing
income inequality. Some researchers have suggested the decline in unionization and
1 Michael Marmot, The Status Syndrome: How Social Standing Affects Our Health and
Longevity (New York: Henry Holt and Co., 2004).
2 Richard G. Wilkinson, Unhealthy Societies: The Afflictions of Inequality (New York:
Routledge, 1996).
3 Robert Frank, Falling Behind: How Rising Inequality Hurts the Middle-Class (Berkeley,
CA: University of California Press, 2007).

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a falling real minimum wage as the primary causes.4 Others have argued that rising
returns to education and skill-biased technological change are the important factors
explaining rising inequality.5 Tax policy, especially the Tax Reform Act of 1986, has
also been identified as a possible cause for rising income inequality.6 Most analysts
agree that the likely explanation for rising income inequality is due to skill-biased
technological changes combined with a change in institutions and norms of which a
falling minimum wage and declining unionization are a part.7 Research suggests that
tax policy, while possibly having short-term effects on inequality, does not have
much impact on longer-term inequality trends.8
Given the nature of the U.S. federal tax system, changes in the distribution of
income can have significant implications for who pays the taxes, how much they pay,
and federal tax revenues. Furthermore, the tax system is one policy instrument used
to change the distribution of economic well-being, which requires an understanding
of how inequality affects the various components of the tax system and how the
various components interact with each other. This report examines how income
inequality interacts with the parameters of the U.S. tax system. The long-term trend
in inequality and how this may be related to taxable income and tax revenues is
4 See David S. Lee, “Wage Inequality in the United States During the 1980s: Rising
Dispersion or Falling Minimum Wage?” Quarterly Journal of Economics, vol. 114, no. 3
(Aug. 1999), pp. 977-1023; and John DiNardo, Nicole M. Fortin, and Thomas Lemieux,
“Labor Market Institutions and the Distribution of Wages, 1973-1992: A Semiparametric
Approach,” Econometrica, vol. 64, no. 5 (Sept. 1996), pp. 1001-1044.
5 See John Bound and George Johnson, “Changes in the Structure of Wages in the 1980s:
An Evaluation of Alternative Explanations,” American Economic Review, vol. 82, no. 3
(Jan. 1992), pp. 371-392; David H. Autor, Lawrence F. Katz, and Melissa S. Kearney, “The
Polarization of the U.S. Labor Market,” American Economic Review, papers and
proceedings, vol. 96, no. 2 (May 2006), pp. 189-194; and Thomas Lemieux, “Postsecondary
Education and Increasing Wage Inequality,” American Economic Review, papers and
proceedings, vol. 96, no. 2 (May 2006), pp. 195-199.
6 See Daniel R. Feenberg and James M. Poterba, “Income Inequality and the Incomes of
Very High-Income Taxpayers: Evidence from Tax Returns,” in James M. Poterba, ed., Tax
Policy and the Economy, vol. 7 (Cambridge, MA: MIT Press, 1993); and Roger H. Gordon
and Joel B. Slemrod, “Are ‘Real’ Responses to Taxes Simply Income Shifting Between
Corporate and Personal Tax Bases?” in Joel B. Slemrod, ed., Does Atlas Shrug? The
Economic Consequences of Taxing the Rich (New York and Cambridge, MA: Russell Sage
Foundation and Harvard University Press), pp. 240-280.
7 See, for example, Frank Levy and Peter Temin, Inequality and Institutions in 20th Century
America, National Bureau of Economic Research, Working Paper no. 13106, May 2007; and
Autor, Katz, and Kearney.
8 See Joel Slemrod and Jon M. Bakija, “Growing Inequality and Decreased Tax
Progressivity,” in Kevin A. Hassett and R. Glenn Hubbard, Inequality and Tax Policy
(Washington, DC: AEI Press, 2001), pp. 192-226; Levy and Temin; Thomas Piketty and
Emmanuel Saez, “Income Inequality in the United States, 1913-1998,” Quarterly Journal
of Economics, vol. 118, no. 1 (Feb. 2003), pp. 1-39; and Edward M. Gramlich, Richard
Kasten, and Frank Sammartino, “Growing Inequality in the 1980s: The Role of Federal
Taxes and Cash Transfers,” in Sheldon Danziger and Peter Gottschalk, eds., Uneven Tides:
Rising Inequality in America (New York: Russell Sage Foundation, 1993), pp. 225-249.

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CRS-3
examined. In addition, the implications of rising inequality for tax policy are
investigated through illustrative tables.
Trends in Inequality
One common measure to characterize inequality or the dispersion of income is
the Gini coefficient, which varies from 0 to 1. A Gini coefficient of 0 indicates that
income is evenly distributed among the population (that is, everyone has the same
income) while a value of 1 indicates perfect income inequality (that is, one individual
has all the income). The 25-year trends of the Gini coefficient for household income
and individual earnings are displayed in Figure 1.
Figure 1. Income and Earnings Inequality, 1980-2004
0.480
0.460
Household Income
0.440
0.420
0.400
i
Gin 0.380
0.360
Earnings
0.340
0.320
0.300
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
Year
Source: Census Bureau.
Between 1980 and 2004, the Gini coefficient for household income increased
from 0.403 to 0.466 — a 15.6% increase (see the top solid line in Figure 1). For the
most part, the Gini coefficient increased in each year. The earnings of full-time year-
round workers also increased between 1980 and 2004. Although earnings inequality
is lower than household income inequality (the dashed line in Figure 1 is below the
solid line), the Gini coefficient for earnings increased by 22.4% from 0.331 in 1980
to 0.405 by 2004. Earlier research shows that the Gini coefficient was fairly steady
in the 1970s, and sharply increased beginning in 1980.9
9 See Lynn A. Karoly, “Trends in Income Inequality: The Impact of, and Implications for,
(continued...)

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Summary measures of inequality, such as the Gini coefficient, while useful in
capturing overall changes in inequality, are less useful in locating where in the
income distribution the changes are occurring. Consequently, more detailed
information is required. Changes in the distribution of household income and
earnings are examined separately.
Household Income
One direct method used to locate where in the distribution changes are occurring
is to focus on income changes at various percentiles.10 Figure 2 displays the 25-year
trends in real (inflation-adjusted) household income at the 10th percentile, median,
and 90th percentile.11 Real household income at the 10th percentile grew modestly by
about 12% between 1980 and 2004 (increasing from $10,097 to $11,271) while
median household income grew by 15% (increasing from $39,739 to $45,817). Real
household income at the 90th percentile, however, increased by 36% over this period,
reaching $124,908 by 2004. Household income at the 90th percentile was equal to 9.1
times household income at the 10th percentile in 1980; by 2004, it had reached 11.2
times household income at the 10th percentile. The increase in household income
inequality between 1980 and 2004 thus arguably appears to be due to those at the top
of the income distribution pulling away from the households lower down in the
income distribution.
9 (...continued)
Tax Policy,” in Joel Slemrod, ed., Tax Progressivity and Income Inequality (Cambridge,
U.K.: Cambridge University Press, 1994), pp. 95-129.
10 A percentile is a value indicating the percent of the distribution that is equal to or below
it. Income at the 10th percentile, for example, is the income level such that 10% of U.S.
households have income at or below this level.
11 Household income includes all cash income received from public and private sources
except realized capital gains. Realized capital gains are not annual income flow and are
very volatile with large variations from year to year. Capital gains are not considered in this
analysis.

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Figure 2. Real Household Income at the 90th Percentile,
Median, and 10th Percentile
140,000
120,000
90th Percentile
100,000
s
80,000
llar
Do
05
60,000
20
Median
40,000
10th Percentile
20,000
0
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
Year
Source: Census Bureau.
The next figure, Figure 3, provides a closer examination of the top 10% of the
income distribution. The figure reports adjusted gross income (AGI), excluding
capital gains, for various percentiles in the top 10% of taxpayers in the income
distribution.12 AGI at the 90th percentile increased by 15% over the 25-year period
while AGI at the 99.5th percentile increased by 75% over this period. The evidence
from Figure 2 and Figure 3 shows that the steady increase in income inequality since
1980 was due primarily to large income gains at the top of the distribution. The poor,
however, were not getting poorer; their real income appears to have been roughly
steady between 1980 and 2004.
12 Adjusted gross income includes income potentially subject to tax. It includes wages,
salaries, tips, dividends, business income, and income from some government programs
(unemployment insurance and some Social Security benefits). Benefits from other
government programs, such as Temporary Assistance to Needy Families and Supplemental
Security Income, are not included in AGI. The unit of observation for tax data is the
taxpayer rather than the household; there may be more than one taxpayer in a household.

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Figure 3. Real Adjusted Gross Income of the Top 10% of Taxpayers
500,000
450,000
400,000
99.5th Percentile
350,000
)
300,000
5 $
00
(2 250,000
e
m
o
99th Percentile
c 200,000
In
150,000
95th Percentile
100,000
90th Percentile
50,000
0
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
Year
Source: Thomas Piketty and Emmanuel Saez.
Earnings
Earnings inequality in real terms increased dramatically between 1980 and
2004.13 As with income inequality, the increase in earnings inequality was mainly
due to those at the top of the earnings distribution pulling away from those lower
down in the distribution (see Figure 4 for the trend for men and Figure 5 for the
trend for women). While earnings inequality increased for both men and women,
there are differences in how inequality increased between the sexes. On the one
hand, for men, those at the top of the distribution pulled away from a largely static
median and 10th percentile. The 90th percentile increased by 30% over the 25-year
period, while the median grew by 1% and the 10th percentile fell by 4%. For women,
on the other hand, the 90th percentile pulled away from an increasing median and 10th
percentile. The 90th percentile increased by 58%, while the median increased by 27%
and the 10th percentile grew by 7% between 1980 and 2004.
13 The unit of observation for earnings is the individual worker; individuals with no earnings
are excluded.

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Figure 4. Men’s Real Earnings Inequality, 1980-2004
$120,000
$100,000
90th Percentile
$80,000
s
llar
$60,000
Do
05
20
$40,000
Median
$20,000
10th Percentile
$0
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
Year
Source: Census Bureau.
Figure 5. Women’s Real Earnings Inequality, 1980-2004
$80,000
$70,000
$60,000
90th Percentile
$50,000
s
llar
$40,000
Do
05
20 $30,000
Median
$20,000
$10,000
10th Percentile
$0
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
Year
Source: Census Bureau.

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Trends in the Tax Base and Tax Revenues
The two major sources of federal tax revenues are the individual income tax and
the Social Security payroll tax, accounting for almost 80% of total federal tax
revenue. These two taxes have different tax bases, tax rates, and adjustments to
income. Furthermore, the individual income tax system consists of the regular
income tax and the parallel alternative minimum tax (AMT), which have different
tax bases and tax rates. Consequently, changes in income and earnings inequality
could have very different effects on different parts of the federal tax system.
The Regular Individual Income Tax
The tax base for the individual income tax consists of wages and salaries, tips,
interest and dividend income, business income, realized capital gains, pension
income, and other income.14 The tax base is reduced by selected adjustments such
as “above the line” deductions to produce adjusted gross income (AGI). AGI is
reduced by exemptions (personal and dependent) and deductions (itemized or
standard) to produce taxable income on which tax is assessed.
The U.S. federal regular income tax has a progressive rate structure with
marginal tax rates increasing with income.15 Gross tax liability can be reduced by
various tax credits, such as the child tax credit and the earned income tax credit.
Since 1984, personal exemptions, the standard deduction, and the tax brackets have
been indexed to inflation, although they have also been periodically changed by
legislation.
The ratio of taxable income to AGI has fluctuated somewhat since 1980
between a low of 65% and a high of 71% (see the solid line in Figure 6). Some of
the fluctuations are due to the business cycle, to changes in tax law, and the
increasing deferment of income through defined contribution pension plans (e.g.,
401(k)s). Additionally, some the changes in this ratio could be due to changes in
income inequality. The correlation between this ratio and the income Gini coefficient
is 0.666, suggesting that as income inequality rises so does the proportion of AGI that
is taxable.16 Income tends to grow faster than prices over time; combining this
income growth with rising income inequality suggests that over time more income
will be above the personal exemption and standard deduction and, therefore, taxable.
Consequently, although exemptions and the standard deduction are indexed to
inflation, taxable income will grow with respect to AGI, holding other parameters of
the tax system fixed.
14 Not all interest and pension income is taxable. For more information on the individual
income tax, see CRS Report RL32808, Overview of the Federal Tax System, by David L.
Brumbaugh, Gregg A. Esenwein, and Jane G. Gravelle.
15 See Appendix A for the key parameters of the regular income tax since 1980.
16 This correlation is statistically significant. The correlation between this ratio and the 90th-
10th percentile ratio is 0.505. The estimated correlations do not control for other factors that
may affect the taxable income-AGI ratio, and do not indicate causality.

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CRS-9
Figure 6. Ratio of Taxable to Total Income, 1980-2004
100
Social Security Payroll
Tax
90
80
ge
ta
n
e
rc
Pe
70
Individual Income Tax
60
50
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
Year
Source: Internal Revenue Service and Social Security Administration.
Revenues from the individual income tax have also fluctuated over the past 25
years. The solid line in Figure 7 displays the 25-year trend of individual income tax
revenues as a percentage of gross domestic product (GDP). Most of the variation in
revenues is due to the business cycle and tax law changes. Individual income tax
revenues as a percentage of GDP fell in the early 1980s, the early 1990s, and 2001
because of recessions. Revenues increased in the 1990s due to tax increases and the
long economic expansion with the latter having a more powerful effect. Revenues
fell dramatically in the early 1980s because of the tax rate reductions enacted in
1980-1983 and also fell after 2001 because of the 2001 and 2003 tax cuts. Increasing
income inequality appears to have had little association with tax revenues — the
estimated correlation between the Gini coefficient and the ratio of tax revenues to
GDP is close to zero. Part of the explanation for this lack of association could be
while rising income inequality has pushed more income into higher tax brackets, the
top marginal tax rates have fallen over the past three decades. Recent research has
shown that the regular income tax has become less progressive since 1960.17
17 See James Alm, Fitzroy Lee, and Sally Wallace, “How Fair? Changes in Federal Income
Taxation and the Distribution of Income, 1978 to 1998,” Journal of Policy Analysis and
Management, vol. 24, no. 1 (Spring 2005), pp. 5-22; and Thomas Piketty and Emmanuel
Saez, How Progressive is the U.S. Federal Tax System? A Historical and International
Perspective, National Bureau of Economic Research, Working Paper no. 12404, July 2006.

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Figure 7. Tax Revenues as a Percentage of GDP
12
10
Individual Income Tax
Revenues
8
P
D
of G
ge
6
a
Social Security
ent
Contributions
rc
Pe
4
2
0
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
Year
Source: IRS and SSA.
The Social Security Payroll Tax
The Social Security payroll tax rate is 12.4%, half of which is paid by the
employee and the other half paid by the employer (the self-employed are responsible
for the entire amount).18 The payroll tax has a constant tax rate, which applies only
to covered earnings below the maximum taxable limit of $97,500 for 2007.19
Covered earnings above the maximum taxable limit are not subject to the Social
Security payroll tax. Since 1983, the maximum taxable limit has been automatically
updated as annual average earnings increase.20 The Social Security payroll tax rate
18 For a more detailed description of the payroll tax, see Thomas L. Hungerford, “How
Increasing the Payroll Tax Base Affects Tax Burdens,” Tax Notes, vol. 115, no. 7 (May 14,
2007), pp. 643-648. Before 1984, the self-employed faced a tax rate that was lower than the
combined employee and employer tax rate. Self-employed person can take an above the line
deduction for one half of self-employment taxes they pay.
19 Covered earnings are earnings from employment covered by the Social Security program.
Covered earnings below the maximum taxable limit are called taxable earnings. See U.S.
Congressional Budget Office, Differences in Wage and Salary Income Included in Various
Tax Bases, Background Paper, June 2005 for a discussion of differences in earned income
used in various tax bases. The Medicare payroll tax is not considered in this report. The
Medicare payroll rate is 2.90% and since 1994, there has been no taxable maximum limit
for this payroll tax.
20 The Social Security Trustees note that the real-wage differential (that is, the difference
(continued...)

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CRS-11
increased periodically between 1980 (tax rate of 10.16%) and 1990, but has been
steady at 12.4% since 1990.
Although the maximum taxable limit is indexed for growth in average earnings,
the ratio of taxable earnings to covered earnings has fallen from 90% in 1983 to 85%
in 2004 (see the dashed line in Figure 6). The estimated correlation between the
ratio of taxable to covered earnings and the Gini coefficient is -0.860.21 As earnings
inequality has increased, a greater proportion of covered earnings falls above the
maximum taxable limit and is thus not subject to the Social Security payroll tax.
Social Security contributions (tax revenues) as a percentage of GDP have varied
between 4.2% and 5.1% since 1980 (see the dashed line in Figure 7). In 2004,
contributions were equal to 4.7% of GDP. Although this ratio has not followed an
upward trend like earnings inequality, the estimated correlation between the two is
0.676. It would appear that as earnings inequality increased since 1980, payroll tax
revenues also increased, but not by much.
The Individual Alternative Minimum Tax (AMT)
The individual AMT operates parallel to the regular income tax. It has a broader
tax base but a lower tax rate.22 The original rationale for the AMT (and its
predecessor) was to make sure high-income individuals paid at least a minimum of
taxes. Higher income taxpayers calculate their regular tax liability and then their
AMT tax liability; they pay whichever is greater.23 Unlike the regular individual
income tax, the parameters of the AMT are not indexed to inflation, but rather fixed
in nominal terms. Consequently, over time the number of taxpayers subject to the
AMT and AMT tax liability will increase due to income growth. While the AMT
was established in its current form by the Tax Reform Act of 1986, Congress has
20 (...continued)
between the percentage change in the average wage minus the inflation rate) averaged 0.9
percentage point over the past 40 years. Consequently, average earnings have grown faster
than inflation. See The Board of Trustees, Federal Old-Age and Survivors Insurance and
Federal Disability Insurance Trust Funds, The 2007 Annual Report of the Board of Trustees
of the, Federal Old-Age and Survivors Insurance and Federal Disability Insurance Trust
Funds, Apr. 27, 2007, p. 87.
21 The estimated correlation is statistically significant. Similarly, the 90th-10th percentile
ratio is negatively correlated (and statistically significant) with the taxable-to-covered-
earnings ratio.
22 See CRS Report RL30149, The Alternative Minimum Tax for Individuals, by Gregg A.
Esenwein; and Greg Leiserson and Jeffrey Rohaly, The Individual Alternative Minimum
Tax: Historical Data and Projections, Tax Policy Center, Nov. 2006 for detailed
descriptions of the AMT.
23 See CRS Report RL30149, The Alternative Minimum Tax for Individuals, by Gregg A.
Esenwein for details on calculating AMT tax liability.

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CRS-12
made several changes to the AMT since then, recently enacting temporary “patches”
so as to limit the number of taxpayers subject to the AMT.24
AMT tax revenue and the number of taxpayers affected by the AMT has
fluctuated over the past 25 years, and has steadily increased since 1988 (see Figure
8). Both the proportion of taxpayers paying the AMT and the proportion of
individual income tax revenues due to the AMT increased after 1982 with the
enactment of the Tax Equity and Fiscal Responsibility Act of 1982, which expanded
the individual AMT tax base. The Tax Reform Act of 1986 substantially modified
the AMT by changing the tax rate and expanding the tax base, among other changes.
The dramatic reduction in AMT taxpayers and tax revenues after 1986, however, was
due to changes in the tax treatment of capital gains under the regular income tax.
After 1986, capital gains income was fully taxed under the regular individual income
tax and no longer taxed as a tax preference item under the AMT, thus reducing the
number of taxpayers with capital gains income subject to the AMT.25
Both the number of AMT taxpayers and AMT tax revenue steadily increased
after 1988 with a slight dip in 2001 due to the 2001 recession and tax changes in the
Economic Growth and Tax Relief Reconciliation Act of 2001. Increasing income
inequality since 1980 is correlated with AMT taxpayers as a percentage of all
taxpayers; the estimated correlation is 0.714 and is statistically significant. The Gini
coefficient, however, is not correlated with AMT revenues as a percentage of total
income tax revenues (the estimated correlation is 0.339 and is not statistically
significant).
24 The most recent patch to the AMT increased the AMT exemption amount for 2006. See
CRS Report RL30149, The Alternative Minimum Tax for Individuals, by Gregg A. Esenwein
for more details. Leiserson and Rohaly, The Individual Alternative Minimum Tax:
Historical Data and Projections, estimate that if the temporary changes for 2006 expire,
then the number of taxpayers subject to the AMT will increase from 3.5 million to over 23
million in 2007.
25 See CRS Report RL30149, The Alternative Minimum Tax for Individuals, by Gregg A.
Esenwein.

---

CRS-13
Figure 8. AMT Revenues as a Percentage of Total Individual Tax
Revenues and AMT Taxpayers as a Percentage of All Individual
Taxpayers
3.0
2.5
2.0
AMT Revenue
ge
ta
n 1.5
e
rc
Pe
1.0
AMT Taxpayers
0.5
0.0
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
Year
Source: Tax Policy Center.
Implications of Inequality for Tax Policy
The regular individual income tax, the individual alternative minimum tax, and
the payroll tax all have different tax bases and tax parameters. On the one hand,
many of the parameters of the regular income tax and the payroll tax are annually
updated for inflation and average earnings growth, respectively. On the other hand,
the parameters of the AMT are not indexed at all. To illustrate how rising income
and earnings inequality can interact with the various forms of indexation, the
University of Michigan’s Panel Study of Income Dynamics is employed.26
Table 1 shows the distribution of income among families in eight income
categories for selected years between 1982 and 2002. The percentages displayed in
26 The Panel Study of Income Dynamics (PSID) is a nationally representative longitudinal
data set of the U.S. population that has been ongoing since 1968. The replacement
mechanism of the PSID for births is designed to yield a representative sample of the
nonimmigrant population in each year. The PSID oversamples low-income households
because it was created by combining the Survey of Economic Opportunity (SEO), a survey
of low-income households, with a representative group of households from the Survey
Research Center (SRC) national sampling frame. Consequently, family weights are used
throughout the analysis. See Martha S. Hill, The Panel Study of Income Dynamics: A User’s
Guide (Newbury Park, CA: Sage Publications, 1992).

---

CRS-14
the table show the share of aggregate total family income (realized capital gains are
omitted from this measure) for all the families with annual income in the indicated
income category or bracket. There are three scenarios:
! Scenario 1: the income bracket cutoffs remain fixed at the 1982
levels shown in the first column of the table.
! Scenario 2: the income bracket cutoffs are indexed to inflation in
much the same way many of the regular individual income tax
parameters are indexed. For example, by 2002, the cutoff for the first
income bracket (denoted “Less than $10,000” in the table) had
increased to $18,642.
! Scenario 3: the income bracket cutoffs are indexed to average
earnings growth in much the same way the maximum taxable limit
for the Social Security payroll tax is indexed. For example, the
cutoff for the first income bracket had increased to $22,883 by 2002.
Panel A of Table 1 shows how income shares have changed between 1982 and
2002 under scenario 1. The share of income to families in the first income category
fell from 4.8% in 1982 to 0.7% by 2002.27 At the other end of the income
distribution, the share of aggregate income received by those in the highest income
category ($120,000 or more) increased from 5.2% to 36.5% between 1982 and
2002.28 In general, income shifted from the lower-income categories to the higher-
income categories between 1982 and 2002. Consequently, in the case of a tax system
with fixed parameters, such as the AMT, more income and more taxpayers will be
subject to the tax over time because of income growth and rising income inequality.
27 The share of families in the lowest income category also fell from 24.4% in 1982 to 9.3%
in 2002. See Appendix B for the distribution of families across the income categories for
the selected years.
28 The percentage of families in the top income category also increased from 0.8% to 10.4%
between 1982 and 2002.

---

CRS-15
Table 1. Income Shares for Selected Years
1982 Income
1982
1986
1990
1994
1998
2002
Categories
A. Fixed Income Ranges
Less than $10,000
4.8
2.4
2.0
1.8
1.0
0.7
$10,000 to $19,999
14.5
9.4
7.4
5.9
3.9
2.9
$20,000 to $29,999
19.9
14.3
10.5
8.9
6.9
5.2
$30,000 to $44,999
25.4
22.4
17.3
15.7
11.6
10.2
$45,000 to $59,999
14.4
16.4
17.1
13.3
11.4
10.8
$60,000 to $79,999
9.6
13.3
14.0
15.8
13.3
13.3
$80,000 to $119,000
6.1
12.1
15.7
16.0
18.8
20.4
$120,000 or more
5.2
9.8
15.9
22.7
33.0
36.5
B. Income Ranges Keep Pace with Inflation
Less than $10,000
4.8
3.3
4.1
4.5
3.3
3.1
$10,000 to $19,999
14.5
11.8
12.7
12.8
11.4
10.8
$20,000 to $29,999
19.9
17.2
15.8
15.7
13.6
12.6
$30,000 to $44,999
25.4
23.5
22.3
20.1
17.8
19.0
$45,000 to $59,999
14.4
16.0
14.5
13.4
13.9
14.7
$60,000 to $79,999
9.6
11.0
11.4
11.7
11.7
12.4
$80,000 to $119,000
6.1
9.2
9.4
8.3
10.6
11.2
$120,000 or more
5.2
7.8
9.9
13.5
17.7
16.3
C. Income Ranges Keep Pace with Income growth
Less than $10,000
4.8
3.6
4.7
5.0
4.9
5.0
$10,000 to $19,999
14.5
13.3
14.0
14.1
14.3
14.7
$20,000 to $29,999
19.9
17.5
17.0
16.4
15.4
16.1
$30,000 to $44,999
25.4
24.9
23.4
20.6
19.2
20.5
$45,000 to $59,999
14.4
14.8
14.1
13.4
12.8
13.5
$60,000 to $79,999
9.6
10.4
10.4
10.4
10.6
9.6
$80,000 to $119,000
6.1
8.7
7.6
7.6
7.5
7.7
$120,000 or more
5.2
6.8
8.9
12.4
15.2
12.9
Source: Author’s analysis of the PSID

---

CRS-16
The income shares for selected years under scenario 2 (when the income
category cutoffs are indexed to inflation) are shown in panel B of Table 1. Over time
income tends to shift from the lower income categories to the higher income
categories, but not to the same extent as when the category cutoffs are fixed in
nominal terms (see panel A), since income tends to increase faster, on average, than
prices over time. The percentage of aggregate income of families in the top income
bracket more than tripled between 1982 and 2002, from 5.2% to 16.3%.29 Even when
tax parameters, such as exemptions and tax brackets for the regular income tax, are
indexed to inflation, income growth and rising inequality will lead to more income
being taxed and at higher marginal tax rates over time.
The results for scenario 3, with the income category cutoffs indexed to average
earnings growth, are displayed in panel C of Table 1. Even under scenario 3, there
is some evidence of income shifting up to higher income categories. Most of the
shift, however, appears to be from the middle income categories toward the higher
categories. The percentage of income in the bottom two categories remained fairly
steady at about 20% between 1982 and 2002. The share of income of the next four
categories ($20,000 up to $79,999) fell from about 70% in 1982 to 60% by 2002.
The share for the top two categories increased over this period from 11% to over
20%, with the share of income received by families in the top income category
increasing from 5.2% to 12.9%.
The distribution of individual earnings for the selected years under the three
scenarios is reported in Table 2.30 Although the earnings categories or brackets are
different from the income categories in Table 1, the results reported in panel A are
broadly similar to the results for family income. With inflation-indexed earnings
bracket cutoffs, there is a general shifting of aggregate earnings toward the higher
earnings categories over time (see panel B in Table 2).
29 The percentage of families in this bracket increased from 0.8% to 2.3%. See panel B in
Appendix B.
30 Earnings includes wage and salary income and earnings from self-employment.

---

CRS-17
Table 2. Earnings Shares for Selected Years
1982 Earnings
1982
1986
1990
1994
1998
2002
Categories
A. Fixed Income Ranges
Less than $10,000
11.4
7.1
5.3
3.7
2.9
2.5
$10,000 to $14,999
12.1
9.3
6.3
5.0
3.1
2.4
$15,000 to $19,999
14.4
10.4
8.9
6.4
4.6
3.2
$20,000 to $24,999
13.4
11.2
9.0
8.0
6.0
4.9
$25,000 to $29,999
11.9
11.4
9.9
8.8
6.3
5.4
$30,000 to $39,999
15.3
18.3
16.7
15.6
14.1
13.7
$40,000 to $54,999
10.3
13.7
18.3
16.2
17.5
16.3
$55,000 or more
11.3
18.6
25.6
36.3
45.5
51.7
B. Income Ranges Keep Pace with Inflation
Less than $10,000
11.4
9.8
9.8
8.8
8.0
7.4
$10,000 to $14,999
12.1
12.1
12.2
10.4
9.8
8.9
$15,000 to $19,999
14.4
12.0
13.1
12.9
11.2
13.1
$20,000 to $24,999
13.4
13.1
12.1
11.5
12.6
11.4
$25,000 to $29,999
11.9
11.9
11.6
10.4
10.1
9.0
$30,000 to $39,999
15.3
16.1
15.3
14.4
12.2
12.2
$40,000 to $54,999
10.3
10.3
9.4
11.8
14.2
11.8
$55,000 or more
11.3
14.7
16.5
19.7
21.9
26.3
C. Income Ranges Keep Pace with Income growth
Less than $10,000
11.4
10.2
11.2
9.8
10.6
10.8
$10,000 to $14,999
12.1
12.6
12.5
11.3
12.4
14.9
$15,000 to $19,999
14.4
13.2
14.0
14.1
14.0
14.3
$20,000 to $24,999
13.4
13.4
14.5
12.6
12.3
11.1
$25,000 to $29,999
11.9
12.1
9.9
9.2
8.6
7.3
$30,000 to $39,999
15.3
15.1
14.3
15.2
13.4
11.7
$40,000 to $54,999
10.3
10.0
8.6
9.6
11.3
9.9
$55,000 or more
11.3
13.5
15.1
18.2
17.4
20.0
Source: Author’s analysis of the PSID.

---

CRS-18
The Social Security maximum taxable limit is indexed to average earnings
growth. The final panel of Table 2 (panel C) reports the distribution of earnings
among the earnings categories under scenario 3 where the bracket cutoffs are indexed
for average earnings growth. The proportion of earnings received by workers in the
four lowest earnings categories remains almost the same between 1982 (51.3%) and
2002 (51.1%). The proportion received by workers in the next three categories fell
from 37.5% in 1982 to 28.9% in 2002. Lastly, the share of aggregate earnings
received by workers in the top earnings category increased from 11.3% in 1982 to
20.0% in 2002. Overall, the share of aggregate earnings received by workers with
annual earnings above the maximum taxable limit increased from 29.5% to 33.2%
between 1982 and 2002. Consequently, even indexing the maximum taxable limit
to average earnings growth, the proportion of covered earnings that are taxable will
fall when earnings inequality is rising.
Concluding Remarks
Income and earnings inequality have steadily increased since 1980. Research
has demonstrated that rising inequality is due to those at the top of the income
distribution pulling away from those lower down in the distribution — the rich are
getting richer, but the poor appear to be holding their own. Since various federal
taxes have different tax bases, tax rates, adjustments to income, and methods for
updating the tax parameters over time, changing income inequality can have different
effects on who pays the different taxes, and how much they pay. The two major
components of the U.S. federal tax system are the individual income tax and the
Social Security payroll tax. Additionally, the individual income tax system consists
of the regular income tax and the alternative minimum tax (AMT).
In order to help protect taxpayers from bracket creep, many of the parameters
of the regular income tax are indexed to inflation. Nevertheless, with income
growing faster than prices and rising income inequality, more income is pushed into
higher tax brackets. Individual income tax revenues as a percentage of GDP,
however, do not appear to be associated with rising inequality, because the income
tax has become less progressive as inequality has increased (that is, the top marginal
tax rates have fallen).
The parameters of the AMT are not indexed, but rather are fixed in nominal
terms. Consequently, the amount of income and the number of taxpayers subject to
the AMT will increase dramatically over time because of income growth and rising
income inequality in the absence of legislative changes. The actual increase in AMT
taxpayers has been limited because of a series of enacted temporary “patches.”
Although the maximum taxable limit of the payroll tax is indexed for average
earnings growth, rising earnings inequality has pushed more and more of covered
earnings above the limit. Thus, the proportion of covered earnings that is taxable has
fallen over the past 25 years.
Rising income inequality can be ameliorated through the tax system and
government transfers. Transfers to the poor and a progressive tax system can help

---

CRS-19
limit rising inequality. But, given that the parameters of the various components of
the tax systems differ, using the tax system to reverse rising inequality would argue
in favor of a comprehensive understanding of how inequality affects the various
components and how the various components interact with each other.

---

CRS-20
Appendix A. Parameters for the Individual Income Tax
Personal Exemptions
Deductions
as
Range of
Lowest
Highest
Year
Percentage
Tax Rates
Bracket
Bracket
Single
Married
of AGI
14.0%-
1980
$1,000
$2,000
22.6%
$3,400
$215,400
70.0%
13.825-
1981
1,000
2,000
22.6
3,400
215,400
69.125
1982
1,000
2,000
23.0
12.0-50.0
3,400
85,600
1983
1,000
2,000
23.1
11.0-50.0
3,400
109,400
1984
1,000
2,000
23.3
11.0-50.0
3,400
162,400
1985
1,040
2,080
24.1
11.0-50.0
3,540
169,020
1986
1,080
2,160
24.6
11.0-50.0
3,670
175,250
1987
1,900
3,800
21.9
11.0-38.5
3,000
90,000
1988
1,950
3,900
22.3
15.0-28.0
29,750
29,750
1989
2,000
4,000
22.7
15.0-28.0
30,950
30,950
1990
2,050
4,100
23.2
15.0-28.0
32,450
32,450
1991
2,150
4,300
23.6
15.0-31.0
34,000
82,150
1992
2,300
4,600
23.4
15.0-31.0
35,800
86,500
1993
2,350
4,700
23.4
15.0-39.6
36,900
250,000
1994
2,450
4,900
22.8
15.0-39.6
38,000
250,000
1995
2,500
5,000
22.5
15.0-39.6
39,000
256,500
1996
2,550
5,100
22.0
15.0-39.6
40,100
263,750
1997
2,650
5,300
21.4
15.0-39.6
41,200
271,050
1998
2,700
5,400
21.0
15.0-39.6
42,350
278,450
1999
2,750
5,500
20.6
15.0-39.6
43,050
283,150
2000
2,800
5,600
20.3
15.0-39.6
43,850
288,350
2001
2,900
5,800
22.1
15.0-39.1
45,200
297,350
2002
3,000
6,000
23.0
10.0-38.6
12,000
307,050
2003
3,050
6,100
23.5
10.0-35.0
14,000
311,950
2004
3,100
6,200
23.0
10.0-35.0
14,300
319,100
2005
3,200
6,400
22.6
10.0-35.0
14,600
326,450

---

CRS-21
Appendix B. Distribution of Families
1982 Income
1982
1986
1990
1994
1998
2002
Categories
A. Fixed Income Ranges
Less than $10,000
24.4
19.5
16.3
16.4
12.3
9.3
$10,000 to $19,999
24.8
20.3
19.2
17.0
14.5
12.1
$20,000 to $29,999
20.2
18.5
16.4
15.4
14.9
13.0
$30,000 to $44,999
17.5
19.4
18.1
18.4
17.1
17.3
$45,000 to $59,999
7.0
10.2
12.6
11.1
12.0
12.8
$60,000 to $79,999
3.6
6.3
7.9
9.9
10.5
12.0
$80,000 to $119,000
1.6
4.1
6.4
7.2
10.7
13.0
$120,000 or more
0.8
1.6
3.1
4.5
8.1
10.4
B. Income Ranges Keep Pace with Inflation
Less than $10,000
24.4
22.3
23.3
25.7
21.9
19.8
$10,000 to $19,999
24.8
22.6
24.4
24.2
24.7
24.2
$20,000 to $29,999
20.2
19.8
18.1
18.0
17.6
17.1
$30,000 to $44,999
17.5
18.1
17.1
15.6
15.6
17.3
$45,000 to $59,999
7.0
8.8
8.0
7.4
8.7
9.4
$60,000 to $79,999
3.6
4.5
4.8
4.9
5.5
6.0
$80,000 to $119,000
1.6
2.8
2.8
2.5
3.6
3.9
$120,000 or more
0.8
1.1
1.5
1.7
2.4
2.3
C. Income Ranges Keep Pace with Income growth
Less than $10,000
24.4
22.9
24.9
27.1
26.7
25.4
$10,000 to $19,999
24.8
24.3
25.3
25.4
26.7
27.2
$20,000 to $29,999
20.2
19.2
18.4
17.8
17.2
17.8
$30,000 to $44,999
17.5
18.3
16.9
15.0
14.3
15.2
$45,000 to $59,999
7.0
7.8
7.2
7.0
6.8
7.1
$60,000 to $79,999
3.6
4.1
4.0
4.1
4.3
3.8
$80,000 to $119,000
1.6
2.5
2.1
2.1
2.2
2.2
$120,000 or more
0.8
0.9
1.2
1.5
1.8
1.4
Source: Author’s analysis of the PSID.

---

CRS-22
Appendix C. Distribution of Workers
1982 Earnings
1982
1986
1990
1994
1998
2002
Categories
A. Fixed Income Ranges
Less than $10,000
44.1
34.8
30.2
24.7
23.0
21.6
$10,000 to $14,999
15.1
14.8
12.1
11.3
8.5
7.6
$15,000 to $19,999
12.7
11.9
12.2
10.5
9.1
7.2
$20,000 to $24,999
9.2
9.9
9.5
10.2
9.1
8.4
$25,000 to $29,999
6.7
8.2
8.6
9.2
7.8
7.7
$30,000 to $39,999
7.0
10.5
11.6
12.9
13.8
15.5
$40,000 to $54,999
3.4
5.8
9.3
10.0
12.7
13.5
$55,000 or more
1.9
4.1
6.6
11.3
16.1
18.6
B. Income Ranges Keep Pace with Inflation
Less than $10,000
44.1
39.7
39.4
36.2
35.8
35.0
$10,000 to $14,999
15.1
16.6
16.9
15.9
15.4
14.6
$15,000 to $19,999
12.7
11.8
12.8
14.1
12.6
15.6
$20,000 to $24,999
9.2
10.0
9.3
9.8
11.1
10.4
$25,000 to $29,999
6.7
7.4
7.3
7.3
7.2
6.7
$30,000 to $39,999
7.0
8.0
7.6
7.9
7.0
7.3
$40,000 to $54,999
3.4
3.8
3.5
4.9
6.1
5.2
$55,000 or more
1.9
2.8
3.2
3.9
4.8
5.2
C. Income Ranges Keep Pace with Income growth
Less than $10,000
44.1
40.4
41.6
38.0
40.5
41.2
$10,000 to $14,999
15.1
16.9
16.5
16.3
16.9
20.0
$15,000 to $19,999
12.7
12.5
13.1
14.6
13.7
13.8
$20,000 to $24,999
9.2
9.8
10.5
10.1
9.4
8.3
$25,000 to $29,999
6.7
7.3
5.8
6.1
5.4
4.5
$30,000 to $39,999
7.0
7.2
6.8
7.9
6.6
5.7
$40,000 to $54,999
3.4
3.5
3.0
3.7
4.2
3.5
$55,000 or more
1.9
2.4
2.8
3.4
3.3
3.0
Source: Author’s analysis of the PSID.

---