Panel Paper: Income Mobility in Federal Income Tax Data: Understanding the Stabilizing Effect of Federal Income Taxes and Decomposing the Paths to Mobility

Saturday, November 8, 2014 : 8:50 AM
Taos (Convention Center)

*Names in bold indicate Presenter

Jeff Larrimore1, Jacob A. Mortenson2,3 and David Splinter2, (1)Federal Reserve Board, (2)Joint Committee on Taxation, (3)Georgetown University
In addition to addressing distributional concerns, progressive income tax schedules mitigate the effect of income mobility. That is, income taxes provide income stabilization by dampening downward and upward income changes. This paper estimates how various “income stabilizer” features of the tax code – including progressive tax rates, the earned income tax credit (EITC), and child credits – explain the difference between before and after-tax income mobility.  It also contributes to income mobility research by investigating the causes of income mobility and whether the mechanisms through which mobility is achieved differs based on industry, income, or demographic characteristics.

We explore these questions using a large panel of Internal Revenue Service (IRS) tax returns from 1999 through 2012, merged with information returns that provide detailed information on wages, employers, and other income sources.  These administrative data allow us to precisely measure the magnitude of before and after-tax income movements and the specific impact of “income stabilizers”, rather than just whether before tax incomes cross a fixed threshold in the distribution as has largely been the focus of the previous work considering these questions.  Moreover, this panel allows us to decompose income changes by different shocks, such as whether mobility is more strongly correlated with growth within a job, movement between employers, or changes in family structure.

 Preliminary results from tax filers in 2001 and 2011 suggest that the refundable portions of the EITC and child credit are important “income stabilizers” and identify a number of factors associated with large income increases.  Among those experiencing downward income mobility and claiming the respective refundable portion of each credit, the EITC and child credit each offset approximately a third of income losses.  Among those who experience substantial upward mobility, increasing their income by at least 50 percent, the most important factors are marriage or remarriage or a second worker starting employment in the family.  Additionally, while some individuals achieve upward mobility through job changes, individuals were more likely to achieve this substantial upward mobility through income growth while working for the same employer than from switching jobs.