Has U.S. Income Inequality Really Increased?

There are frequent complaints that U.S.
income inequality has increased in recent
decades. Estimates of rising inequality that are
widely cited in the media are often based on federal
income tax return data. Those data appear to
show that the share of U.S. income going to the
top 1 percent (those people with the highest
incomes) has increased substantially since the
1970s.
However, there have been large changes in
U.S. tax rules over time that have made a dramatic
difference on what is reported as income
on individual tax returns. Tax changes induced
thousands of businesses to switch from filing
under the corporate tax system to filing under
the individual tax system. Corporate executives
switched from accepting stock options taxed as
capital gains to nonqualified stock options taxed
as salaries. The huge growth in tax-favored savings
plans, such as 401(k)s, has resulted in billions
of dollars of investment income disappearing
from tax returns. Meanwhile, studies of
inequality that are based on tax return data usually
exclude transfer payments, which results in
exaggerating the shares of income received by
those at the top by ignoring growing amounts of
income at the bottom.