Corporate Tax Cuts Increase Income Inequality

October 25, 2018

Suresh Nallareddy studies income distribution changes after corporate tax code revisions

Professor Suresh Nallareddy found corporate tax cuts increase income inequality

Income inequality has been growing steadily in the U.S. over the last four decades, with income continuing to rise faster for those already making the most.

Debates continue over the causes. Corporate tax policy is one possible factor, and Suresh Nallareddy, an accounting professor at Duke University’s Fuqua School of Business, studies the specific effects of corporate tax changes on income disparity.

In a working paper for the National Bureau of Economic Research, Nallareddy found evidence that corporate tax cuts increased income inequality. Nallareddy worked with Juan Carlos Suárez Serrato, also of Duke, and Ethan Rouen of Harvard Business School on the research.

Nallareddy discusses the findings in this Fuqua Q&A.

Q: What effects did you find are associated with changes to corporate tax rates?

We find that when there is a tax cut, that’s associated with higher income inequality. Specifically, we found a 1 percent cut in corporate taxes results in a 0.93 percent increase in the share of income going to the top 1 percent earners over the subsequent three years.

Overall, we find that a corporate tax cut of 0.5 percentage points explains about 7.8 percent of the average rise in the share of income accruing to the top earners between 1990 and 2010.

When there’s a corporate tax cut, high earners can shift their earnings from salary to capital income to get maximum tax relief from the cut. There’s income relabeling that happens. But people who don’t make a lot of money can’t do that.

The last change to the federal corporate tax rate before 2018 was in 1986. How did you get at this finding?

Because the last federal corporate tax change was in 1986, there’s not much data there. So we looked at state level corporate taxes. States have frequent tax increases and decreases, and there are periods when one state has a tax change and a neighboring state does not, which allowed us to make comparisons. We used adjusted gross income data from the IRS Statistics of Income.

There are several different measures that can help capture income inequality – the Gini coefficient, the Theil index, the relative mean deviation, Atkinson's measure – and we used them all. But our main variable of interest was the proportion of state income going to the top earners: the top 0.1 percent, 1 percent, 5 percent and so on. We had corporate tax change data from 1979 to 2012, and also analyzed a subset of data spanning 1990-2013 that did not interact with the 1986 federal tax reforms.

What can policymakers learn from this research?

There is a big disconnect between the performance of corporations and the performance of the overall economy. I’m interested in how accounting information can help us better understand that, and was not aware of any research exploring the link between corporate taxes and inequality.

There are a lot of arguments that are thrown around about the effects of corporate tax cuts. Supporters say cuts lead to an increase in average wages. But we also know that in most countries, the capital rests with only a few people, so when taxes are cut, the direct benefits flow mostly to those people.

We’re not making recommendations for tax policy. There are different ways policymakers can stimulate the economy that may not increase income inequality, such as government spending at the local level, or income tax cuts for lower-income workers. But if there is a corporate tax cut, we now know more about the effect it has on the distribution of income.

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