Over the past few decades, U.S. income inequality has grown, with high earners experiencing disproportionate growth. This pattern has increased the top earners’ share of national income and reduced the share of earnings taxable by Social Security from 87.1 percent to 82.7 percent since 1994, weakening the program’s fiscal situation. Yet the drivers of earnings inequality, and thus the taxable share, are poorly understood. This paper combines data from several sources with administrative earnings records from the Social Security Administration to estimate the contribution of two factors to the declining taxable share between 1994 and 2015: industrial automation and trade with China. The effect of each factor on different sections of the earnings distribution is estimated through a series of instrumental variables quantile regressions. The resulting coefficients are used to construct a counterfactual 2015 earnings distribution, assuming the factors had remained constant at their 1994 levels.
The paper found that:
- The two factors had negative effects on earnings throughout the distribution, but the impact was less severe at the very top, accounting for 15 percent of the increase in the top 1-percent share of earnings between 1994 and 2015.
- The two factors alone explain 0.4 percentage points of the 3.4-percentage-point decline in taxable earnings, or 11 percent of the decline.
- Chinese trade was by far the more important factor and accounted for 10 percent of the decline in the taxable share between 1994 and 2015.
- While other factors, like non-automation skill-biased technological change, trade with other nations, the growth of non-wage compensation, and the erosion of norms surrounding executive pay also likely played a role, these factors were harder to quantify.
The policy implications of the findings are:
- As industrial automation and Chinese trade seem poised to increase in the near term, the taxable share will likely decline by another 0.2 percentage points by 2026.
- The large share of the decline left unaccounted for suggests the taxable share will most likely fall even below this linear projection.