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.