Taxation and the distributional impact of inflation: The U.S. post-war experience

• Published in: Economic modelling 2022-06, Vol.111, p.105813, Article 105813
• Main Authors: Süssmuth, Bernd, Wieschemeyer, Matthias
• Format: Article
• Language: English
• Subjects: Bracket creep; Income distribution; Inflation; Progressive income taxation
• ISSN: 0264-9993; 1873-6122
• DOI: 10.1016/j.econmod.2022.105813

Due to a lack of adequate before and after tax time series, the impact of inflation on the income distribution in the presence of a progressive tax system is widely unexplored. Contributions using U.S. data have not reached a consensus about income inequality decreasing, increasing or showing no significant association with inflation. Our study analyzes the relationship across the distribution. We use a recently available dataset on U.S. income before and after taxation on a quintile-by-quintile basis for 1962–2016. We find inflation (i) before taxes to, if any, slightly decrease inequality, (ii) to amplify tax progressivity, and (iii) after taxes to reduce the Gini coefficient by 0.4 of a standard deviation in response to a one percentage point inflationary shock. We attribute (i) to the creditor-debtor channel. Findings (ii) and (iii) indicate missing or incomplete indexation redistributing particularly from the fourth quintile to the two bottom quintiles. •The inflation - income inequality nexus under progressive taxation is underexplored.•We use pre-/post-tax data on a quintile-by-quintile basis for the U.S., 1962–2016.•Inflation pre-tax slightly decreases inequality: nominal debtors win, creditors lose.•Tax progressivity is amplified and, post-tax, the Gini falls through inflation.•Without proper indexation net income redistributes from 4th to 1st and 2nd quintile.