Rising income inequality has had an adverse impact on tax revenues. Income inequality is rising not only because wage inequality has been rising but also because capital income inequality has been rising. High-income individuals own the great majority of capital and receive most capital income.

National income is split between labor’s share and capital’s share of income. As the figure below shows, capital’s share of income has been rising over the past four decades and stands at about 40 percent of total income. Before 1975, capital’s share was approximately 33 percent of total income with some year to year variation around that average. Rising income inequality is due to the rising inequality of the various components of income and to the increasing importance of capital income.

Now, how does this affect tax revenue? It starts with two important facts. The first I have already mentioned—capital’s share of income has been rising. Second, capital income is taxed more lightly than labor income. Remember Mitt Romney? When he ran for President, he released some information on his taxes; the major take away was his effective tax rate was less than the tax rate paid by many lower- and middle-income taxpayers. An increasing proportion of national income—that is, capital income—is being taxed at low tax rates and, consequently, tax revenue has suffered. Increasing taxes on capital income will increase tax revenues and help reduce income inequality.