Do Lower Top Marginal Tax Rates Slow the Income Growth of Workers?

Abstract

Top marginal tax rates are positively correlated with the pretax income growth of the bottom 90 per cent — those who are not subject to the top rates. To explain this correlation, this paper presents and tests a model in which executives can increase firm profitability by (i) increasing the firm's level of technology and (ii) decreasing labor costs. In the model, higher marginal tax rates may reduce pretax inequality by increasing the average income growth of workers. This hypothesis is tested by examining the effect of top marginal tax rates on (unobserved) relative bargaining power between labor and firms and, therefore, on the income growth of workers in the USA. Bargaining power, in both the theoretical and the empirical models, is proxied by private‐sector unionization and use of offshore labor resulting in higher imports.

The minimum wage, bargaining power, and the top income share

“…The top state marginal tax rate is also associated with lower inequality, mainly by reducing the share of income going to the top 10 percent. This is in contrast to Malloy (2015) which finds the effect of the top federal income tax rate in reducing the top 1 percent income share and increasing growth among the bottom 90 percent of households.…”

“…Piketty, Saez, and Stancheva (2014) believe that top marginal tax rates affect the relative bargaining position, through what they refer to as the bargaining elasticity, or e3 in their model, between workers and executives and show that top income shares shrink as the top marginal tax rate increases. Malloy (2015) takes this one step further and suggests that lower top marginal tax rates, falling unionization rates, and increasing imports all reduce the income growth of the bottom 90 percent of the income distribution, presumably by decreasing labor's bargaining power.…”

“…Instead we have to look at the variables that we expect will change the relative bargaining power between workers and firms. These variables include union membership, international trade (if offshore production is being used as a substitute for domestic production), the tax structure (Malloy 2015), and, the focus of this paper, the minimum wage. Our hypothesis is that an increase in the minimum wage will decrease the share of income going to the top 1 percent.…”