Do redistributive state taxes reduce inequality?

In the previous two sections, I found that the redistributive effect of state taxes had no significant impact on the pre-tax distribution of hourly wages. Here, I consider three other parts of the story: the impact of tax redistribution on mobility, post-tax inequality, and personal income.

First, does the redistributive effect of taxation tax drive interstate mobility? (11) To test this, I use six measures of population mobility: the fraction of a state's adult population that moved in from another state during the year, the fraction of a state's population that has moved out to another state during the year, the ratio of in-movers' hourly wages to non-movers' wages, the ratio of out-movers' hourly wages to non-movers' wages, the change in the state's log population in that year, and the log of the state population. The first four variables are taken from the March CPS, so measures in year t relate to migration not from January t to December t, but from March t until March t + 1. (12) Details of variable construction are provided in the Data Appendix.

As in earlier tables, all these specifications include state fixed effects, year fixed effects, and region--specific linear time trends. Note that state fixed effects have a different effect in columns 5 and 6. In column 5, the state fixed effect absorbs unobservable state--specific factors affecting the growth rate of a state's population, while in column 6, the state fixed effect absorbs unobservable state-specific factors affecting the level of a state's population. Each of the specifications includes the current tax redistributivity variable, and six lags of tax redistributivity.

Recall that in Tables 1, 2, and 3, I estimated one-tailed F-tests, against the null hypotheses that the tax coefficients were [less than or equal to]0 or [greater than or equal to]1. Here, I estimate standard two-tailed F-tests, against the null hypothesis that taxes have no aggregate impact on interstate migration.

Overall, the results in Table 4 suggest that--in sum--tax changes do not impact interstate population flows, nor do they affect the relative wages of movers. Only three of the 18 F-tests are statistically significant: in the lagged specification, more redistributive taxes are associated with a fall in the relative wages of incoming migrants, and in the current and summed specifications, more redistributive taxes are associated with a smaller population. However, the relationship between population size and tax redistributivity becomes statistically insignificant when the model is specified with log population in differences (column 5) rather than levels (column 6). The association between population and taxes is, therefore, fragile at best. (13)

I now turn to the question of how redistributive taxes affect income and the post-tax distribution of income. This question is particularly pertinent in the light of Feldstein and Wrobel's (1998, p. 392) conclusion:

"[T]here can be no trade-off at the state level between distribution goals and economic efficiency. Shifts in state tax progressivity, by altering the structure of employment in the state and distorting the mix of labor inputs used by firms in the state, create deadweight efficiency losses without achieving any net local redistribution of real incomes."

Using a similar empirical approach to that used to analyze migration, it is possible to directly test the impact of more redistributive state taxation systems have on post-tax inequality and mean per-capita income. Post-tax inequality is measured from the same March CPS surveys as were used to calculate pre-tax inequality. However, in this case, annual earnings and family characteristics are first used to calculate each individual's average tax rate (ATR), and the pre-tax hourly wage is then multiplied by {1 -ATR} to arrive at a post-tax hourly wage. Within each state, I then calculate the distribution of these post-tax hourly wages. Figure 5 shows the post-tax Ginis, which have a mean of 0.33 and a standard deviation of 0.015. As a measure of personal income, I use the log of real state personal income per capita. In both cases, I estimate two-tailed F-tests against the null that tax redistribution has no impact on the dependent variable.

With regard to the distribution of post-tax hourly wages, the results from column 1 of Table 5 suggest that more redistributive taxes do (with some lag) lead to a more equal distribution of income. From years t - 6 to t, a tax system that mechanically reduces wage inequality by one standard deviation (0.3 Gini points) leads to a 0.8 point drop (0.003 x -2.5) in the post-tax Gini, an effect that is statistically significant at the one percent level.

As to the potential efficiency cost of more redistributive taxes, the results in column 2 do not support the theory that more redistributive taxes harm a state's economy. Indeed, more redistributive taxes appear to be associated with slightly more rapid economic growth. A tax system that is one standard deviation more redistributive is associated with a four percent increase (0.003 x 14.6) in the growth rate over the years t - 6 to t, an effect that is statistically significant at the five percent level. (14)

[FIGURE 3 OMITTED]

THE POLITICAL ECONOMY OF TAXATION AND INEQUALITY

Until this point, I have assumed that taxes drive inequality. But might the reverse be true? Discussing the conclusions of Feldstein and Wrobel (1998), Bakija and Slemrod (2004, p. 56, n5) argue that observing a positive relationship between tax redistribution and inequality of gross hourly wages would also be consistent with a "stabilizing" political economy explanation, under which states with more unequal wage distributions implement more redistributive taxation systems.

It is also possible that politics operates in the opposite direction, and that states with more equal wage distributions tend to implement more redistributive taxation systems. One reason that this might occur is if the average value of public goods to members of a community increases as heterogeneity decreases (as suggested by Alesina, Baqir, and Easterly, 1999). Another possibility is that if the rich experience an increase in their incomes, they may channel part of this into campaign contributions to candidates who prefer less redistributive taxation.

One way of testing these two theories is to estimate almost the reverse regression to that presented in equation [2]. Instead of looking at the effect of current and lagged taxes on inequality, I now explore whether lagged inequality appears to have any aggregate impact on tax redistribution. Of course, it is not possible to test whether inequality in the current period affects tax redistribution in the current period. But inherent in the political economy explanations is some notion of a lag, so this test should be fairly robust. (15)

Table 6 indicates little evidence of a relationship between inequality and the tax structure that states choose. Although the linear sum of the inequality coefficients is positive in the second and third columns (consistent with Bakija and Slemrod's critique of the findings of Feldstein and Wrobel), it is not statistically significant at conventional levels. As a result, the claim that policymakers opt for redistributive taxes as a brake on rising wage inequality remains merely suggestive.

CONCLUSION

This paper has sought to estimate the extent to which interstate migration thwarts attempts by states to reduce inequality via more redistributive taxes. Using a Gini-based index of tax redistribution for U.S. states over the period 1977-2002, I find little evidence that--in aggregate--more redistributive state taxes lead to a more unequal distribution of pre-tax hourly wages. This remains true when alternative measures of redistribution are used, placing more weight on the bottom or on the top of the distribution. Evidence from population flows helps corroborate this: overall, more redistributive state taxes do not appear to have a substantial impact on the composition or volume of interstate migration.

Given that the pre-tax wages distribution does not adjust to offset the effect of redistributive taxes, it should be unsurprising that more redistributive taxation is associated with a more equal distribution of post-tax hourly wages. Regarding the efficiency cost of taxation, I find no evidence that states with more redistributive taxes experience slower growth in per capita personal income. (If anything, states with redistributive taxes grow faster.) Looking at the effect of inequality on redistribution, I find that past inequality is positively associated with more redistributive taxes in the current period, though the effect is not statistically significant.

While this paper presents evidence that migration does not undo the effects of redistributive taxes at a state level, it nonetheless seems plausible that at a sufficiently small geographic level, this effect will occur. For example, it may be that at a city level, redistributive taxes are unable to affect the post-tax distribution of income.

DATA APPENDIX

Inequality