Tax Progressivity, Economic Booms, and Trickle-Up Economics

We propose a method to decompose changes in the tax structure into orthogonal components measuring the level and progressivity of taxes. While our focus is on the progessivity results, we find that the level shock is similar to standard tax shocks found in the empirical literature in that a rise in the level is contractionary. We find that an increase in tax progressivity sets off an economic boom. When tax progressivity increases, those at the bottom of the income distribution experience an increase in disposable income; these consumers have a high marginal propensity to consume, and this increase in income results in a consumption boom which expands the overall economy. This overall economic expansion benefits those at the top of the income distribution as well, and the income and capital gains they experience as a result of the economic boom more than offset the losses they experienced due to the increase in tax progressivity. The net result is that an increase in progressivity leads to an increase in inequality, not a decrease as conventional wisdom would suggest. We interpret these results as evidence in favor of trickle up, not trickle down, economics.