A Progressive Income Tax System Is Required for Stable Income Inequality

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Inequality of income and wealth is the most important topic discussed on this site, because the greatly increased inequality stemming from the economics of the “Reagan Revolution” is destroying the American economy and American society.  Its importance cannot be overstated.

Wealth accumulates at the top:

As we go through this, keep in mind the relationship between income and wealth.  The higher one’s income, the greater the opportunity one has to save a portion of the income and increase one’s wealth (net worth).  People with higher incomes tend to accumulate higher amounts of savings (wealth), and those with the highest incomes save the highest percentage of their income.  Accumulated wealth then adds additional earnings (capital gains).  Thus, wealth naturally tends to accumulate at the top.

A progressive tax system is essential to maintain a stable distribution of wealth and income over time.  In such a system, those who are making far higher incomes than others have a greater burden to fund government costs, and collective security.

The stable, healthy income and wealth inequality before 1980:

This was the situation in the United States in the 35-year period from 1945 to 1980.  There was a healthy amount of income inequality:  The top 10% of the population was earning about 33% of total income, and the top 1% took home 10%.  These percentages remained stable over the entire 35-year period.

That was possible because the marginal income tax, that is the percentage of tax paid on all additions to income above the top tax bracket, was at least 70%.  (For a long time, the 1950s through 1964, the rate was at 90%, a period in which the country was reducing the national debt as a percentage of GDP.)

Beginning with the Reagan presidency, the top rate was slashed, and it is now at 35%.  This allowed the percentages of incomes wealth at the top to revive.  By 2007, inequality increased to where it was in 1928, just before the start of the Great Depression: The top 10% had 50% of income and the top 1% had 23.5%.

          This graph shows how incredibly inequitable the income distributions have become, and how they changed during the GW Bush administration.  The incomes of the bottom 90% declined by 4% from 2000 to 2006.  Even within the top 10%, except for the top 1%, there was only slight growth (2% or less).

The average 2006 income of the bottom 90% of Americans of $30,173 in 2006 is not very far above the poverty level ($22,350 for a family of four).  The top .01% of households had average ordinary incomes 575x the average for the entire bottom 90%, and their average income rose 22.2% during the Bush administration.

The official Consumer Price Index (CPI), which many feel vastly understates the actual inflation experienced by ordinary Americans during the Bush years, went up 17% between 2000 and 2006.  Thus, it appears, the rate of growth even of most incomes within the top 1% did not keep up with inflation, even as conservatively measured by the CPI.

It is important to reiterate that the wealthiest people at the top are paying taxes almost entirely on capital gains, at the same 15% rate most of the bottom 90% pays on ordinary income up to $34,000.   And for them, the vast majority of their incomes consist of capital gains:

          It appears from this graph that capital gains asymptotically become a significant percentage of total income for those in the .05-.01% range; it would appear that well over 90% of the incomes of the top .01% are capital gains, which would mean that, conservatively, the total incomes of these households are well over  6,000x the average of the bottom 90% of the population.

This inequitable tax system in far from progressive, and no rational justification is apparent for these massive incomes to be taxed at the same rate as people at or near poverty, most of the bottom 90% of the population.

More importantly, the combination of this unbelievably high degree of inequality with such a regressive tax structure explains why incomes and wealth continue to grow only for the very wealthy.  It also shows, clearly, that inflation erodes the value of the flat nominal earnings throughout the bottom 99%.

The very rich are making far more money than might be a reasonable reward for their contribution.

The wealth that is accumulating at the top is created at the bottom.  This massive redistribution is occurring because of the corporate control of the economy, control that has been perfected over the last 30 years following the demise of anti-trust law enforcement and other business regulations during and after the Reagan Administration, allowing big corporations and their wealthy owners to make money more quickly.  This has not only substantially destroyed middle class prosperity, but it has also increased environmental degradation, poverty, and poor health throughout the entire bottom 99%.

The Reagan Revolution also championed the idea of “small” government.  That amounted simply to reducing the amount of money allocated through government programs to people on the lower end of the income spectrum.  It even includes opposition to Social Security, a retirement income program self-funded through payroll taxes.  Social Security is self-contained; it has generated a surplus and has never been a part of “discretionary” spending.

“Small” government did not, however, mean restraint in military spending or other business-related government spending (such as oil and gas subsidies, or maintaining a huge military-industrial budget).  The effect of the “small” government ideology now is budget cuts to choke off the re-distribution of income and wealth back into the hands of people in the lower-income groups.  Income and wealth are being re-distributed in one direction only – up.

In a separate post, we demonstrate that the optimal income tax rate (including capital gains) for stable income and wealth distribution stability and optimal growth could be as much as 70% or more.  Much broader reform is now required, including revisiting assumptions that allow a privileged few to make enormous fortunes on natural resources such as oil – resources not bequeathed to them by any divine right – while imposing on others the social costs of their profit-driven environmental carelessness.

JMH – 4/12/11

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4 Responses to A Progressive Income Tax System Is Required for Stable Income Inequality

  1. Pingback: The Buffet Rule Explained « Snap!

  2. Pingback: The 30-Year Growth Of Income Inequality | For Economic Justice

  3. Doyl says:

    This is ridiculous. You have MISSED the WHOLE POINT that Our FOUNDERS set up our Republic, with a FREE Market, where Creative Ideas, Improve the value of products ans services for ALL of the people, without ANY TAXES on ANY of OUR OWN people, and that Taxation should ONLY be EQUAL to Representation or NON-Existent. Our Government Revenue was ONLY TAXED from Foreign imports, and that was MORE than enough, since Government was NOT too big, or taking on so much that is NOT within their rightful authority. The Government is now working outside of its jurisdiction, and doing so much that it is not authorized to do. That is why it costs so much. Government should ONLY do, what the people CANNOT do FOR themselves.

    Your measurement of fairness is Extremely Lopsided, not even taking into account the effects of increasing wealth on the incomes of ALL people. Those with Greater wealth, tend to produce MORE, and Invest MORE, and those who are Christians or Conservatives, do MORE charitable giving. Thus Raising the TIDE to raises ALL Boats, including the SMALL ones. The Wealthy create MORE JOBS, and PAY MORE. They Create wealth by adding MORE value to that which they Produce, making Greater value in products available to people who make more, and can pay lower prices for better things… The Standard of LIVING for EVERYONE IMPROVES! You statistics do not take this into account. The question is “What are the figures for the POOR, when the Rich have More or Less Wealth?”. If You are HONEST, you will find that the POOR are LESS Poor, when the Rich are free to acquire more wealth in the Market of Free Ideas, by NOT SQUELCHING their income & LIMITING how much they can make.

    • Even Ronald Reagan opposed depression, pointing out how his father lost his job on Christmas Eve. It was, he said, “a mistake we must never allow our leaders to make again.” The market is not free, unless government works to make sure that it is.

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