Do redistributive state taxes reduce inequality?

I am grateful to Garry Barrett, Howard Chernick, John Creedy, Russell Hillberry, Therese McGuire, Francesc Ortega, Sher Verick, two anonymous referees, and seminar participants at the ANU/IZA Social Policy Evaluation Annual Conference, the Public Policy Institute of California, the University of Melbourne, and the University of New South Wales for comments on earlier drafts, to Stephen Jenkins for assistance in applying his ineqdeco Stata routine, and in particular to Daniel Feenberg for many suggestions and valuable discussions on this topic.

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Andrew Leigh

Economics Program, Research School of Social Sciences, Australian National University, ACT 0200, Australia

(1) Although the effect of taxes on wage inequality is determined at the margin, it is worth noting that in 1990, the middle year of the data range covered by this paper, 67 percent of native-born Americans lived in their state of birth (Census Bureau, 1994).

(2) From a social welfare perspective, the income distribution measure that is most commonly utilized is the post-tax distribution of income across families or households, adjusted for household size. That measure will be affected by hourly wage inequality, but also by differences in labor supply and non-labor income, by whether the household is single-headed or partnered (and the extent of assortative matching in the latter case), and by the number of children in the household.

(3) Since the focus here is on hourly wages, there is less reason to be concerned about teenagers biasing the results than if the dependent variable was family income inequality. Nonetheless, the results are not significantly affected if the sample is restricted to those aged 25-55.

(4) Note that the measure of inequality here is based purely on earnings. Since the CPS does not contain information on fringe benefits, it is conceivable that employers may respond to changes in taxation by shifting remuneration from earnings into fringe benefits. To the extent that the redistributive effect of taxes and the propensity of employers to remunerate high--skill workers through fringe benefits are positively correlated, mine will be an underestimate of the effect of redistributive taxes on inequality.

(5) The year fixed effects do not perfectly purge the data of the effects of changes in federal tax rates, since state and federal income taxes interact through deductibility rules.

(6) Two plausible explanations for [beta] < 0 are that states with more redistributive taxes use the additional revenue to create jobs for low-skilled workers, or that the inflow of low-skill workers leads to the formation of a union which raises the wages of all low-skilled workers. A possible explanation for [beta] > l is that more redistributive taxes lead to an economic slump, which harms low-wage workers more than high-wage workers. In addition, either result could occur if tax redistribution is endogenous with respect to some other policy that affects wage inequality, and is not controlled for in the regressions.

(7) For the specification in which wage inequality is regressed on current taxes, the results are similar if the sample is broken into the pre-TRA86 period (1983-1985) and the post-TRA86 period (1987-2002).

(8) The linear sum is estimated using the lincom command in Stata. Roger Newson describes the calculation of the standard error on a linear sum as follows: If b is the vector of coefficients, V is the covariance matrix of b, and a is a vector defining the linear combination, then the standard error of the linear combination is calculated as [(a'Va).sup.0.5] So the standard error of the average of n coefficients is 1/[n.sup.*][(a'Va).sup.0.5].