Tax Progressivity, Economic Booms and Trickle-Up Economics

Laura Jackson Young, Christopher Otrok, Michael Owyang and Nora Traum

No 2514, Working Papers from Federal Reserve Bank of Dallas

Abstract: We propose a method to decompose changes in the tax structure into orthogonal components measuring the level and progressivity of taxes. Similar to tax shocks found in the existing empirical literature, the level shock is contractionary. The tax progressivity shock is expansionary: Increasing tax progressivity raises (lowers) disposable income at the bottom (top) end of the income distribution by shifting the tax burden from the bottom to the top. If agents’ marginal propensity to consume falls with income, the rise in consumption at the bottom more than compensates for the decline in consumption at the top. The resulting increase in output and consumption leads to rising capital gains for those at the high end of the income distribution that more than offsets their losses from higher income taxes. The net result is that an increasing progressivity leads to an increase in income inequality, contrary to what conventional wisdom might suggest. We interpret these results as evidence in favor of trickle up, not trickle down, economics.

Keywords: taxes; income inequality; FAVAR (search for similar items in EconPapers)
JEL-codes: C32 C38 E62 (search for similar items in EconPapers)
Pages: 55
Date: 2025-04-24
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Working Paper: Tax Progressivity, Economic Booms, and Trickle-Up Economics (2022)
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DOI: 10.24149/wp2514

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