Recap of Part I: The rising income of the top .01% of earners has driven surging inequality in the US over the last three decades. So why did the income of the top .01% go up so much?
Partly as an artifact of the 1986 federal tax reforms. These reforms reduced the top personal income tax rate so that it was less than the top corporate rate, creating an incentive for business owners to change their businesses to “pass-through” entities. With pass-through entities, income is taxed only once at the personal level. In contrast, owner income of non-pass-through “C” corporations can be taxed twice: on the corporation's own tax return and once again on one’s individual return. No surprise then that after 1986, the number of C corporations dropped while pass-through entities like S corporations and partnerships went way up:
Per Fatih Guvenen and Greg Kaplan in their NBER Working Paper, Top Income Inequality in the 21st Century: Some Cautionary Notes:
“Put simply, so far in the 21st century, all the action in top income shares has been S-corporation income at very, very high income levels.”
And here's Edward N. Wolff in yet another NBER Working Paper: Household Wealth Trends in the United States, 1962 to 2016: Has Middle Class Wealth Recovered?
"The increase in top income shares observed in the IRS data since 1981 is mostly a reflection of an increase in entrepreneurial income, and most of that increase is due to income accruing to flow-through entities, such as S corporations and partnerships."
Is that it? Is rising inequality mostly an illusion, a matter of how income is being categorized and counted? A shift in accounting practices? No. There's more to the story. Next.
References:
Bakija, Jon, Adam Cole, and Bradley Heim. Jobs and Income Growth of Top Earners and the Causes of Changing Income Inequality: Evidence from U.S. Tax Return Data,“ Working Paper, Williams College, April 2012.
Fatih Guvenen and Greg Kaplan Top Income Inequality in the 21st Century: Some Cautionary Notes. NBER Working Paper No. 23321 Issued in April 2017
McBride, William America’s Shrinking Corporate Sector January 6, 2015 https://taxfoundation.org/america-s-shrinking-corporate-sector/
Wolff, Edward N. Household Wealth Trends in the United States, 1962 to 2016: Has Middle Class Wealth Recovered? NBER Working Paper No. 24085 Issued in November 2017