The debate regarding equity of tax policy becomes increasingly important in a world were inequality is growing. In United States, for instance, the richest 1 % received 18 % of pre-tax income in 2008, rising from 8 % in 1980 (OECD 2012). The debate is often associated with the degree of progressivity in a country’s tax structure.
A valuable input in the debate may be a measure of tax progressivity that can reveal the differences in progressivity across competing tax schemes. The Stroup index (or tax progressivity index) measures the effective progressivity of tax policy and reflects changes in tax rate structure, income brackets of tax policy, and income distribution in the society (Stroup 2004).
Stroup (2004) stresses that if we use the average tax progressivity as a basis for discussing the equity of tax schemes, measures of tax progressivity should relate income tax shares borne by a given income percentile in a society to the income share distribution earned across all income levels in society. Then a change in average tax rate progressivity can occur without a change in the actual marginal tax rate structure. Thus the construction of the Stroup index implies that it reflects changes in tax progressivity even when tax policy remains unchanged (Stroup 2004, p.207).
The figure below illustrates how the index measures the degree of progressivity in US from 1980 to 2000 (Stroup 2004, p.211). During these two decades four major federal income tax policy changes influenced the structure of the marginal tax rate and/or the income tax brackets. For instance, the 1986 Tax Reform Act (TRA’86), or Reagan era tax cuts, which decreased the total number of tax brackets and the marginal income tax rates for each brackets (especially for households with highest income). Previous reports claim that rising tax shares after the tax reform were borne by the highest income earners. However, by estimating the tax progressivity index Stroup finds that the tax progressivity is actually decreasing.
Stroup discovers that the increase in tax share for the richest 1 % was smaller than the increase in adjusted gross income earned (AGI) share in the years after 1986. Hence, Stroup concludes that this group’s income share increase was five times higher than their tax share growth, creating a lower average tax rate and a lower tax progressivity index (Stroup 2004, p. 211).
The example above demonstrates the importance of relating tax share to income share across all income levels in order to have a correct picture of changes in the progressivity of a tax system and inequality regarding the income tax burden. It also illustrates another useful characteristic of the index, that is can be used to decompose an observed increase in total tax revenues into the portions attributable to either an increase in total income or increase in income inequality (Stroup 2004, p.207).
To reveal the differences in progressivity across competing tax schemes, a reliable and accurate measure of tax progressivity is useful, especially if the goal is to have a normative analysis of tax progressivity. Furthermore, the fact that it reflects the issue of inequality makes it even more relevant in today’s growing economic differences among households and individuals.
By: Birgitte Ringstad #816
M.D. Stroup 2004. An index for measuring tax progressivity. Economics Letters 86 (2005), 205–213.
Hoeller, P. et al. (2012). Less Income Inequality and More Growth – Are They Compatible? Part 1. Mapping Income Inequality Across the OECD. OECD Economics Department Working Papers, No. 924, OECD Publishing.
M.D. Stroup & K. Hubbard (2013). An Improved index and estimation method for assessing tax progressivity. Working Paper No.13-14 August 2013. Mercatus Center: George Mason University.