Paul L. Caron

Wednesday, December 28, 2011

Look Past Taxes to Fix Puzzle of Inequality

Bloomberg, Look Past Taxes to Fix Puzzle of Inequality:

Democrats in the U.S. have decided to make inequality a central issue in next year’s elections. I’d question whether that’s good politics. Even in hard times, American voters aren’t easily persuaded by appeals to class interests.

Yet even setting electoral tactics aside, a focus on inequality seems unlikely to lead to better policy, especially if you look at how current U.S. policy choices stack up against those of other advanced industrialized economies.

The reason is that inequality isn’t one issue but a writhing bundle of issues. Unpack it and you see there’s no easy remedy. It demands more thought and humility than most politicians can muster.

For the American left, the question comes down to the incomes of “the 1 percent” and their taxes. Even if, like me, you think that a rapidly widening gap between rich and poor calls for a response and that progressive taxes are ethically correct, this obsession with the peak of the income pyramid is much too simple-minded.

Growth in the highest U.S. incomes has been stunning, to be sure. A recent study by the Congressional Budget Office found that the after-tax incomes of the top 1 percent of U.S. households almost quadrupled in real terms between 1979 and 2007. The income of the median household -- again after taxes and transfers, and adjusted for inflation -- went up just 35 percent. On the same basis, incomes of the lowest 20 percent of households managed an increase of only 18 percent.

In less than three decades, the 1 percent’s share of after- tax U.S. incomes more than doubled, from 8 percent to 17 percent. The change is not unique to the U.S. -- inequality has increased almost everywhere -- but the surge in the very highest incomes is especially startling in America.

Why is it happening? Nobody quite knows. ...

The point is, some instances of very high pay are fair and efficient, and some aren’t. Do you raise taxes on all high incomes, regardless?

If that’s all you do, you leave the underlying failures (of corporate governance, financial regulation and so on) unaddressed. Also, heavier taxes have practical limits. There’s collateral damage to incentives. The rich can afford to be clever about tax shelters, so higher rates raise less revenue than you think. Push tax rates too high and the super-rich can simply leave.

Perhaps you think the U.S. taxes the rich so lightly these issues don’t apply. Think again. By international standards, the overall tax burden in the U.S. is low -- mainly because there’s no national sales tax -- but contrary to popular opinion the top marginal rates of income tax (adding in state income taxes, where applicable) are not much out of line.

If anything, rich Americans contribute a greater share of taxes than do their peers in other industrialized nations. The top 1 percent of U.S. taxpayers paid 40 percent of federal income taxes in 2007. The top 1 percent of British taxpayers paid 24 percent of the corresponding total.

A new report by the Organization for Economic Cooperation and Development shows that in the middle of the last decade -- i.e., after the Bush tax cuts were introduced -- the U.S. income tax was about as strongly redistributive as income taxes in Canada, Denmark, Finland, the Netherlands and Sweden. You might have noticed that the CBO report on top incomes was widely quoted, but one finding got less attention: Between 1979 and 2007, “the federal individual income tax became slightly more progressive.”

The awkward truth is that the U.S. income tax system is anomalous not because it taxes the rich lightly but because it taxes everybody else lightly. ...

American liberals find high incomes more upsetting than poverty. It’s an instance of how distorting the preoccupation with inequality can be. An enlightened liberal agenda should include higher taxes on the rich -- and higher taxes on the middle class as well. That agenda needs those revenue streams not to punish the 1 percent but to pay for low-wage subsidies, other supports for the working poor and a more effective safety net. It would prioritize K-12 education, vocational training and other main avenues of opportunity for the less well-off. It would attack rent-seeking, broken corporate governance and hidden subsidies to industries that don’t add value.

These things would narrow the gap between rich and poor. Focus too narrowly on inequality, though, and you might forget the rest. If you do that, you will have forgotten why inequality matters.

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Most of the 1% are Democrats. Have at it.

Posted by: Buck O'Fama | Dec 29, 2011 7:43:09 AM

Instead of grouping people on 'what' (They have lots of wealth, vs. no wealth), they need to group people on 'how' (They earned it, vs. using rent seeking & other governmental disturbances in the marketing force).

Some may think all wealth is evil, but the majority is probably okay with someone getting filthy rich *IF* they did it legitimately. Someone makes a new lightbulb that is better, that makes humanity better. However, if they 'cheat' their way to the top, such as... say, I don't know... maybe having the goverment BAN all other forms of lightbulbs except yours.... well, people realize the fix is in.

Same deal on the lower strata. You're paralyzed, or have some other disability? That's an honest problem, and generally people would feel charitable to assist. Nobody hiring even with you wearing out your shoes trying to get a job? Same deal. However, if you're having a good ol' time, using the safety net like a hammock, eating food-stamped steak and lobster while surfing on your shiny new iPad, and generally not doing anything productive when there's not a single thing wrong with you? You're in the same boat as the money-bagged moocher above.

Posted by: AnotherAnon | Dec 29, 2011 8:13:46 AM

The left is driven by envy and status anxiety. When they say they want equality, they only want it with people who have more.

The "poor" are simply an excuse for the left to claw money and power away from the "rich."

Posted by: Bruce Bishop | Dec 29, 2011 8:16:16 AM

" It would prioritize K-12 education, vocational training and other main avenues of opportunity for the less well-off. It would attack rent-seeking, broken corporate governance and hidden subsidies to industries that don’t add value."

Talk about contradicting yourself! If you take on rent-seeking and "industries that don't add value", you're inevitably going to have to take on the K-12 education industry and the government's vocational training mess!

Posted by: Rob Crawford | Dec 29, 2011 8:23:44 AM

I thought it was obvious why the top is making a lot more money. Globalization. Before, the top people were drawing most of their money from just one country, now they are getting revenue from all over the world. A lot more buyers of goods means a lot more money for the people who get the profit.

Posted by: Ben | Dec 29, 2011 8:35:34 AM

Brilliantly said, thanks for making a point eaily understood by anyone willing to read it. Unfortunately, it is quite difficult to make a populist political platform out of broadening the tax base into the middle class. "Paying a fair share" has already been so distorted by now it connotes the exact opposite of what it should mean.

Posted by: CR | Dec 29, 2011 8:50:42 AM

"An enlightened liberal agenda should include higher taxes on the rich -- and higher taxes on the middle class as well."

And why is that? The fact is, that no matter what the rate is, taxes remain at the same percentage. That's because the higher tax rates go, the more time and effort is spent on tax shelters and tax avoidance. Higher taxes slow economic growth, leading to reduced tax collections. Lower tax rates lead to higher growth, leading to increased tax collections. As Presidents Kennedy and Reagan both knew and demonstrated.

In a sane society, lower taxes would be a Liberal position, since that would lead to economic growth, higher employment, and greater net tax collections, providing more money to spend on safety net programs.

"It would prioritize K-12 education"

America already spends more on public education than any nation except Switzerland. Over the past decades, the amount of money spent on education has skyrocketed, while the level of educational results has dropped like a rock. More money spent on education is simply throwing good money after bad. Instead, reduce the insane levels of "administration", start firing incompetent teachers, and return education to the task of actually teaching, rather than the propagandizing of liberal "values" that fills most class time today.

More money to government, beyond a basic level we passed decades ago, doesn't mean better government. It simply means more waste, more debt, and more of a drag on the economy. The wealthy can ride out recessions, the poor suffer thru them. For the sake of the lower income classes, it's imperative to increase the health of the general economy.

Posted by: Robert Hanson | Dec 29, 2011 9:02:26 AM

It seems that you are taking the stance that Leftists want to do something about the inequality between rich and poor. There has been no Leftist policy in my lifetime that has addressed that. There have been Leftist policies that have entrenched the poor into a lifetime of poverty over generations, and Leftist policies of backing huge student loans for degrees in "X studies" appear to be a way to move middle-class twenty-somethings into poverty, but everyone I know who has moved from lower income to higher income (myself and my 6 siblings included) have done so without help from the government. The whole income inequality argument now being made may have a basis in fact, as you state, but it has nothing to do with the policies the Left wants passed. They want to punish the rich simply, and only, because marxists, at heart, even the rich ones, despise the rich almost as much as they despise the economic freedom of America.

Posted by: Diggs | Dec 29, 2011 9:12:05 AM

Why is progressive taxation ethically correct? I wonder if the columnist who wrote this column realizes the amount of goodwill he has transferred to the very group he is chastising for being shortsighted on looking at the intricacies of income inequality.

Posted by: Chris Bolts | Dec 29, 2011 9:13:32 AM

I suspect that the "growth of inequality" cited is more a function of the growth of the scope and power of government, which makes rent seeking easier and more profitable for the well connected. The solution is less government and more open competition -- with no such thing as "too big to fail". Wall street remains fabulously wealthy because financial services are one of the most highly regulated industries in America along with pharmaceuticals and biotech. These are not coincidences.

Posted by: Mark | Dec 29, 2011 9:14:52 AM

"inequality has increased almost everywhere -- but the surge in the very highest incomes is especially startling in America"

"Inequality" not only has increased, it should increase! When Steve Jobs and top Apple developers invent the Ipod, Ipad, MacAir, etc. naturally their income goes up. Why else would they spend all of that time and effort to produce new products. Products that even lower income people want to own.

Is it reasonable that the income of a 40 hour a week high school dropout janitor at Apple would increase by the same amount as that of Apple developers, most of whom spent many years acquiring their technical skills, and many of whom are probably spending 70 or 80 hours a week working at inventing products that transform the world we all live in ?

"the after-tax incomes of the top 1 percent of U.S. households almost quadrupled in real terms between 1979 and 2007. The income of the median household...went up just 35 percent...incomes of the lowest 20 percent of households managed an increase of only 18 percent"

And the problem here is exactly what? When the economy is booming, as you have just stated, everyone's income is increased. As I pointed out above, there is good reason for the top income to rise faster than the bottom. As long as all levels of society go up, why is it wrong that the top, which includes both job creators, athletes and entertainers, along with the just plain lucky, goes up faster.

Slow down the increase on the top, and you will eliminate the incentive to grow the economy. And as a result, the "lowest 20 percent of households" will find their incomes dropping instead of increasing.

"Throughout history, poverty is the normal condition of man. Advances which permit this norm to be exceeded- here and there, now and then- are the work of an extremely small minority, frequently despised, often condemned, and almost always opposed by all right-thinking people. Whenever this tiny minority is kept from creating, or (as sometimes happens) is driven out of a society, the people then slip back into abject poverty. This is known as "bad luck."
— Robert A. Heinlein

Posted by: Robert Hanson | Dec 29, 2011 9:28:14 AM

Why Hiking the Top Income Tax Rate Won't Fix President Obama's Deficits--September 22, 2011

"The chart below [omitted] plots the ratio of total government Revenue Per Household (RPH) to the Median Household Income (MHI) for the U.S. for each year from 1967 through 2010. The chart also plots the maximum income tax rate that the topmost income earners in the United States have had to pay for each year from 1967 through 2010."

* * *

"What we do see indicates that the maximum tax rate has little to no bearing on how much money the federal government collects per household in any given year. Since 1967, the government's RPH to MHI ratio has risen steadily on average, indicating that the U.S. government is collecting more and more money per household over time, with the changing level of the topmost income tax rate having little to no effect on the rate of that change.

"With that being the case, there is no legitimate reason to set higher income tax rates today, as they are now demonstrated to have little to no effect on how much money the government collects in any given year. Increasing the top income tax rate in the U.S. is simply not an effective strategy for closing the gap between the government's spending per U.S. household and how much it collects in taxes per U.S. household, making any ongoing effort to do so an utter waste of time that could be put to much better use."

Posted by: Walter Sobchak | Dec 29, 2011 9:40:05 AM

Democrats are not really upset that some people have more money than others; they are upset because the government does not have enough of everyone's money. You and me, rich and poor, when the government wastes tax money that is a tragedy. For Democrat politicians and their public employee union base, wasted tax money is their bread and butter.

Posted by: make government smaller | Dec 29, 2011 9:54:29 AM

"That agenda needs those revenue pay for"... 1.5 Billion in subsidies for a Chevy Volt no one wants to buy, half a Billion for Solyndra to build a new factory in Silicon Valley just before going bankrupt, untold Billions to build a high speed train in California that will go from nowhere to nowhere with no high speed trains even on order, Fisker Motors 500 Billion dollar loan to build an EV in Finland which only goes 32 miles on all electric then gets 20 MPG using gas, tens of Billions to buy out a bankrupt GM as a gift to the UAW whose excessive wages and benefits caused the bankruptcy in the first place....

Posted by: Robert Hanson | Dec 29, 2011 9:58:45 AM

YOu almost seemed smart until you approved of progressive income taxes. . . .

Posted by: Ryan M. | Dec 29, 2011 10:04:12 AM

I'm a teacher - the janitor in my school thinks I make the big bucks! I make four times more an hour than he does, yet I don't make enough to pay federal income taxes (wife and three kids, right-to-work union, thank goodness!). How's that for inequality.

The trouble is that too many people feel guilty about their successes. If that's the case, donate more money to charity or the family down the street; otherwise, stop coveting my stuff!

It's not that there is too much inequality, but rather too many people who wished they done things differently; for example, a friend (police officer) was upset that the local state university was giving some professors a 30% raise (1990s)...I told him that he could solve his problem by becoming a professor!

Posted by: MC | Dec 29, 2011 10:28:10 AM

People who complain about "inequality" never complain how much Oprah or Mick Jagger have earned or how little their stage help is paid. Nor do will they mention that Albert Pujols just signed a contract worth $250 million. So who exactly are they complaining about? Times up: they only complain about business leaders who earn a lot of money. Now why would that be?

I could take a different tack: the fact that people like J.K. Rowling can earn so much indicates how powerful and valuable a good idea can be in the free marketplace. Never in human history has any private citizen been able to do what Rowling has done, or Bill Gates or a host of other people. And it may be that Rowling's first draft of her first book was not even typed on a computer, but written by hand in a coffee shop while tending for her infant child. Nothing stops anyone from developing a good story for publication, nor someone from writing good software.

And when they "hit a home run", they earn every penny and they don't make anyone poor by enjoying the fruits of their own labors.

"Income inequality" joins Peak Oil and Global Warming as frauds of the left that are really aimed at advancing ideological agendas rather than advancing prosperity and liberty.

Posted by: theBuckWheat | Dec 29, 2011 12:14:35 PM

I frankly think this is a bad assumption. If you listen to their rhetoric, Democrats are almost never opposed to higher pay for people in government service. They might occasionally oppose a pay raise for military personnel (they're all Republicans anyway) but other than that, union or no, they generally think that higher pay "attracts better people." Of course, what it really does is attract people who want a job where they're well-paid and can't get fired, but that's a different kettle of fish.

Here in California, one of the state's two public employee pension systems announced earlier this year that the number of six-figure (over $100,000/year) pensions it distributes went from just over 9,000 in 2009 to just over 12,000 in 2010. This doesn't include anyone employed by any flavor of school in the state, from primary and secondary schools up through community colleges to the state's 2 university systems. Before you tell me that teachers are underpaid, let me observe to you that when Governor Brown was inaugurated, one of the first things he had to confront was a threat by *administrators* who work for the University of California system, to sue the board of regents of their organization. They were mad that their pensions, which are calculated as a percentage of their rate of pay, are capped at about $180,000/year. They wanted this lifted, so that if their pay was substantially above this, so would be their pension. Since their pensions are calculated as ca. 80% of their paychecks, this meant that in order for this to affect them, the individual had to be earning about $235,000/year. Though only about 3 dozen of these administrators complained, if the rule were overturned, about 200 people would see their prospective pensions increase. Remember, this is one of the two university systems we have; there's another one, a community college system, and various school boards and districts up and down the state.

Democrats have no problem with high salaries. If you work in the government, and your taxes go up, don't worry, your paycheck will too. The only problem they have with high salaries is if they're earned in the private sector, exploiting the poor and ripping off other citizens. Then the taxes need to be prohibitively high...

Posted by: DavidN | Dec 29, 2011 1:23:51 PM

Well, if you look at households, then yes - upper quintile households are bigger and have more people in the workplace than lower quintile households. There's an average of 3.1 people in the top fifth, compared with 2.5 people in the middle fifth and 1.7 in the bottom fifth. So the smaller household almost by definition will make less - because fewer people are working. Can't have two incomes if there are only 1.7 people. And more women participate in the workforce now than in the 1970s.

Now let's look at percentage of taxes paid:
Bottom 20%: 0.8 (all federal taxes) and -2.8 (income taxes - they got $ back)
Next 20%: 4.1 and -0.8 (they also got $ back)
Middle 20%: 9.1 and 4.4
Next 20%: 16.5 and 12.9
Top 20%: 69.3 and 86.3%.

No matter how you slice it, the US tax code is steeply progressive, taxes any dollar that a two-income household earns more heavily than a one-income household, penalizes extra effort, and gives back far more to low income households than it takes.

Posted by: orthodoc | Dec 29, 2011 2:52:11 PM

Another knucklehead conflates household income inequality with INDIVIDUAL income inequality.

Consider the impact of single parent households (both those that never made it to two parent, and those destroyed by divorce) on "average household income." Look at the distribution of single parent vs two parent households along the income spectrum. hmmmm.....

let's not even both with considering consumption, which is far more important than income.

Posted by: Bikerdad | Dec 29, 2011 4:29:13 PM

Leftists like to have money. They just don't want others to have it. Leftists like
to spend money. Not their money but other people's money.

Posted by: PTL | Dec 29, 2011 4:54:17 PM

The reason nobody knows why the top 1% are getting richer is because nobody knows who is in that top 1%. The ones who were in there 30 years ago are not the same as the ones who were in the top 1% 20 years ago; or 10 years ago, or even five years ago. Looking at the top 1% as a single group over the three decades is the same, error-laden static analysis that so plagues every economic forecast.

The earnings ratios are not static because the people comprising the income groups - howsoever you choose them - are not a static group. This is supposedly a problem? Give me a break.

Posted by: Steve S. | Dec 29, 2011 5:59:56 PM

"An enlightened liberal agenda..." = oxymoron

Posted by: bill | Dec 30, 2011 4:49:32 PM