Income inequality and campaign contributions: evidence from the Reagan tax cut

What is the relationship between economic and political inequality? Campaign contributions are often mentioned among the possible channels creating opportunities for richer people to exert disproportionate influence on policymakers. At the same time, by exacerbating economic disparities, public policies that favour the wealthy might also give them a greater relative weight in the donor pool, hence creating a self-reinforcing spiral between material wealth and political influence. We study the effect of the 1986 Tax Reform Act, a remarkable tax cut that, following the prevailing doctrine about optimal income taxation at the time, decreased the marginal tax rates disproportionately at the top of the income distribution. Using data at the census tract level, we show that this policy decision caused a spike in contributions from the groups of citizens that benefited the most from it, namely the top ten percent of the income distribution. The increase in individual donations regards both parties with similar magnitudes and it does not display any heterogenous effect with respect to other observable characteristics of recipients of contributions. This finding is entirely driven by the extensive margin, namely new donors who started to donate after the tax reform, and it holds for donations for House, Senate and Presidential races. Our conclusion is that the erosion of tax progressivity has contributed to rise the political clout of wealthy individuals, via campaign donations, and that the Tax Reform Act, a landmark policy of the second Reagan administration, has been a crucial step in the spiral between economic inequality and uneven political influence of the last four decades.