Essays on Inequality X – Optimal Inequality

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(Image by McPhail Watmore Associates Limited, London)

I always remember that America was established not to create wealth—though any nation must create wealth which is going to make an economic foundation for its life—but to realize a vision, to realize an ideal.  America has put itself under bonds to the earth to discover and maintain liberty now among men, and if she cannot see liberty now with the clear, unerring vision she had at the outset, she has lost her title, she has lost every claim to the leadership and respect of the nations of the world.  — Woodrow Wilson, “The Coming On of a New Spirit”, Speech to Chicago Democrat’s Iriquois Club  (February 12, 1912)

In the councils of government, we must guard against the acquisition of unwarranted influence, whether sought or unsought, by the military-industrial complex. The potential for the disastrous rise of misplaced power exists and will persist.  * * *  We must never let the weight of this combination endanger our liberties or democratic processes. — Dwight D. Eisenhower, Farewell Address (January 17, 1961).

The outstanding faults of the economic society in which we live are its failure to provide for full employment and its arbitrary and inequitable distribution of wealth and incomes. * * * For my part, I believe that there is social and psychological justification for significant inequalities of incomes and wealth, but not for such large disparities as exist today.  —  John Maynard Keynes , The General Theory of Employment, Interest, and Money (first printing 1935, Harvest/Harcourt, Inc., 1953, 1964 ed., 1991 printing, p. 372, 374);  See an earlier (4/8/11) post on this blog, Keynesian Economics and Marriner Eccles.

Human history, it is fair to say, has been mostly about the struggles between the “haves” and the “have-nots” and the allocation of resources and wealth.  These three famous quotations underscore important truths about human societies. As former U.S. Presidents Wilson and Eisenhower understood, great wealth leads to great power, endangering the liberty and economic freedom upon which American democracy is based.  And Keynes, the father of modern economics, understood that unrestrained capitalism naturally fosters this concentration of wealth and power.   Thus, unfettered capitalism inevitably destroys freedom and leads to despotism.  As bluntly put by the great former Supreme Court Justice Louis D. Brandeis, it boils down to this: “We can have democracy in this country, or we can have great wealth concentrated in the hands of a few, but we can’t have both.”

This appears to be as close to a universal truth as exists in the social sciences. Indeed, the stand taken by ordinary people against the tyranny of wealth, as Woodrow Wilson reminded us, is the fundamental point of our nation’s existence, as expressed in The United States Declaration of Independence, adopted by the Continental Congress on July 4, 1776:

We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty and the pursuit of Happiness.

I have belabored this point, because given its connection to our unalienable rights, to our liberty, prosperity (and even to our survival), maintaining a reasonable level of inequality ought to be considered the highest collective priority of the American people.   Over the past 30 years, however, we have failed to understand its importance and, in that task, so far we have failed.

Understanding Inequality and Why It Matters

The level of inequality is important, to put it simply, because the more that wealth and incomes are concentrated at the top the harder it is for everyone else to make ends meet and the more everyone else loses control of their lives and their governments.

Massive income and wealth transfers to the top 1% from the bottom 99% have taken place since 1979.  Although the process was gradual, by 2011 the cumulative effects of these decades of wealth and power concentration, which included fresh assaults on personal freedoms, democracy, and collective bargaining, had become starkly apparent.  Americans in great numbers began awakening to their loss of incomes, wealth, financial security, educational opportunities, and career prospects — to the loss in effect of their “unalienable rights” to “life, liberty, and the pursuit of happiness.”

Unfortunately, information showing the dangerous growth of inequality over the last 30 years has only recently become publicly available (mostly since July, 2010), and adequate inequality data and computations remain unavailable for the years following 2008.  Thus, Americans are only recently starting to learn the hard truths about income and wealth inequality, and beginning to ask what levels of inequality would be reasonable, and what associated income tax and other government policies would be fair.

These are urgent questions for 2012: After the last four years, the bottom 99% (and especially the bottom 90%) has descended into a depression, while the wealthy have continued to flourish excessively as their incomes grow at extraordinary rates and corporations return record profits.  Some inequality is expected and normal, [1] but abolishing such a harmful degree of inequality has become imperative for the bottom 99%:  Even Ronald Reagan emphasized that another Great Depression must be avoided at all costs.

America’s 30-year economic decline has been far worse than implied by most of the discussions I have seen, certainly before the last couple of months. Discussions of inequality continue to suffer from problems of limited perceptions:

(1) Especially in connection with framing “Occupy” issues, the inequality-based complaints of the bottom 99% are often discussed as though the economic harm that has befallen Main Street has been pretty much limited to Wall Street’s actions and the effects of the 2008 Crash and the Great Recession.  As horrendous as those effects were, the 2008 Crash did not trash a healthy economy, but one that had already been in significant decline for the bottom 99% for nearly thirty years;  

(2) The growth of inequality over the earlier 1979-2007 period and its effects on the bottom 99% have been enormous, but using data ending in 2007 (a) obscures the fact that the underlying structural conditions creating inequality have continued to drive inequality growth since 2007, and (b) fails to account for the additional impacts on inequality of the Crash and its aftermath.

More fundamentally, discussions of inequality suffer from people’s widespread unfamiliarity with the topic.  Let’s face it, “inequality” is not a phenomenon that can be directly observed in our daily lives, nor can we even imagine the full scope of its consequences when we are talking about trillions of dollars.  The topic has been shrouded in mystery.

In a 2005 study, Building a Better America – One Wealth Quintile at a Time, by Michael I. Norton (Harvard Business School) and Dan Ariely (Duke University) individuals in a nationally representative online panel were asked to (1) estimate the current U.S. distribution of wealth and (2) describe what they thought would be the “ideal” wealth distribution.

Here are the results: 

The chart shows that those taking part thought wealth inequality should be reduced from what they estimated, but more importantly it shows that they dramatically underestimated the then-current level of wealth inequality: The top 20% actually held about 25% (about $16 trillion) more of total wealth, and the bottom 60% actually held only about 20% as much as they estimated. And they were not aware that the bottom 20% is broke.  In an October 21, 2010 commentary on this study, The Inequality Delusion, Drake Bennett states:

In part, this work fits into a proud tradition of social science research demonstrating the basic ignorance of the average American. (Ariely and Norton conducted a small follow-up survey of economists and found that though their estimates were better than average, they also got it wrong.) 

But how could anyone be expected to get it right? And beyond that, anyone’s estimate of what might be an “ideal” level of inequality is essentially meaningless without an analysis of actual inequality’s effects, which was not provided to the participants.

You get the idea: We’re in mostly uncharted territory here.  In fact, focusing on the wealth of the top 20% won’t help us — it will actually be misleading. [2]  We need to focus on the top 1%, because that’s where the action is.  We need to identify the nature and severity of the inequality problem in the United States, identify its causes and effects, and then consider potential remedies.

I need to say this up front:  This post advances my analysis and appreciation of the economics of inequality.  Putting the growth of income inequality in the context of traditional economic “equilibrium” analysis, I can better describe how and why inequality grows, and more importantly, develop a better understanding of what is needed to combat the growth of inequality.  This leads to important (and to some readers perhaps surprising) findings about the income tax policies needed to stem the economy’s headlong plunge into depression, and to restore prosperity.    

How Inequality Grows

Inequality of incomes grows as the wealthiest Americans find ways to increase their incomes relative to everyone else.  The widening disparity in incomes increases their ability to save money relative to others, so over time their percentage of wealth also rises.

The wealthiest Americans claim ownership rights to “capital,” the means of production and distribution of goods and services.  The wealthier you are, the more control you have over what, where, when, and how production takes place.  This control grows as wealth grows. Work product is owned by the corporations that the wealthy own and control. When the sale of work product produces profit, income is produced through investment returns. Unlike ordinary income produced by people when they work, wealth in this way “earns” income that people don’t personally “work” for.

The wealth accumulated through investment returns is actually wealth created by someone else’s work product, and transferred to the wealth owners as “capital’s share” of the work product.  The more wealth you have, the richer you can get without actually contributing work product to the economy.  Those who get the greatest returns in income over time end up with the highest percentages of wealth.  Lower income taxes for high incomes in recent years have enabled after-tax incomes (hence, wealth) to grow even more rapidly.

The consolidation of wealth in larger corporations and relaxation of government anti-monopoly laws over the past 30 years have enabled corporations to exercise “market power” over prices and make extraordinary profits.  This, in turn, has also permitted the salaries and employment compensation of top management officials to grow more rapidly over time.  Thus, incomes of the top 1% have soared due to both higher personal compensation for their corporate jobs and ever growing returns on their wealth.

Income Inequality Growth (1979-2007)

We have previously discussed the growth of income inequality from 1979 to 2007 in some detail on this site. (The 30-Year Growth of Income Inequality, posted April 10, 2011.)  Here is a version of the increasingly familiar graph by income cohorts of changes in average pretax income over that period provided by Dave Gilson and Carolyn Perot (Mother Jones, March/April 2011), along with a graph of percentage shares of after-tax income.

The pre-tax figures show that for everyone outside of the top 1% there has been little growth (the average for the top 20% cohort includes the top 1%).  The after-tax data show that the top 1% more than doubled its share of total income over the last 30 years, and that except for the top 20% (which, again, includes the top 1%) the percentage of incomes declined over the last 30 years for other Americans.  As a practical matter, this means that almost all increases in wealth accrued to the top 1%. It is important to remember that there is also a huge disparity of income gain within the top 1%, as shown by The Economic Policy Institute:

It is always stunning to consider that income inequality, in terms of the percent of income held by the top 1%, had by 2007 reached the level it had earlier reached in 1928  just before the Great Depression., which was nearly 24%. [3]  That fact shows that America, on its current course, is likely headed for a second Great Depression.

At an excellent October 2011 IMF conference in Washington, held to discuss a new book Lost Decades: The Making of America’s Debt Crisis and the Long Recovery by Menzie D. Chinn (University of Wisconsin, Madison) and Jeffry A. Frieden (Harvard University), Gail Cohen of the Joint Economic Committee of the U.S. Congress observed that income inequality has returned to the United States to much greater degree than to any other advanced country, and she commented on the seriousness of the problem:

[I]ncome inequality reached a peak, prior to this one, right before the crash in 1929. And then policies were put into place and income inequality actually dropped until later on … and then rose until the crash in 2007-2008. And, the question for me really is are we going to put policies into place that will lead to a decline in income inequality? Or are the policies that we’re putting into place … going to exacerbate income inequality and will that lead to another crash? 

One of the authors, Jeffry Frieden, observed:

[I]f we look at the 2002-2007 period — in fact, two-thirds of the income growth of the U.S. economy as a whole are realized by the top one percent of the U.S. income distribution.  If you break that down, that top one percent sees its income grow by 60 percent in that 2002-2007 period; the bottom 99 percent by six percent, which is not very rapid. And of course, that six percent is completely eaten away by the crisis [the 2008 Crash] itself.  So, even before the crisis hits, there is both a long-term backdrop of increasing inequality and a sense which I think was fairly widely held that the benefits of the boom were not being equitably or equally distributed.

But talking about the incidence of the crisis, the broader point to make is that as the crisis hits, its effects are also extraordinarily unequal. . . .

. . . So, if we look at the bottom third of the labor force, which if you take into account the entire households involved, we’re talking about 100 million people, households approximately below $40,000 a year, at this time in the middle of 2010, when the national unemployment rate was about 9.8-9.9 percent, in that bottom third of the labor force, the unemployment rate is 18 percent. If you then add on involuntary part-time work and discouraged workers, it raises to 35 percent. 

In short, from 2002-2007, under the Bush administration’s tax cuts for the wealthy, the top 1% realized income gains of 60% while the bottom 99% realized negligible income gains that were wiped out by the Crash (zero gain).  Then, when the recession hit in 2008 the growing inequality magnified its effects, which fell disproportionately on the lowest income groups.  The bottom 1/3 of the labor force (households containing 100 million people) experienced 18% unemployment and 35% underemployment, while the top 10% experienced below average unemployment (and the top 1%, presumably, a negligible amount).

Of course unemployment is just one aspect of the problems caused by the Crash.  Consider this April 28, 2010 report by PEW Charitable Trusts of “Key Findings” respecting its effects:

  • Income – The financial crisis cost the U.S. an estimated $648 billion due to slower economic growth, as measured by the difference between the Congressional Budget Office (CBO) economic forecast made in September 2008 and the actual performance of the economy from September 2008 through the end of 2009. That equates to an average of approximately $5,800 in lost income for each U.S. household.
  • Government Response – Federal government spending to mitigate the financial crisis through the Troubled Asset Relief Program (TARP) will result in a net cost to taxpayers of $73 billion according to the CBO. This is approximately $2,050 per U.S. household on average.
  • Home Values –  The U.S. lost $3.4 trillion in real estate wealth from July 2008 to March 2009 according to the Federal Reserve. This is roughly $30,300 per U.S. household. Further, 500,000 additional foreclosures began during the acute phase of the financial crisis than were expected, based on the September 2008 CBO forecast.
  • Stock Values – The U.S. lost $7.4 trillion in stock wealth from July 2008 to March 2009, according to the Federal Reserve. This is roughly $66,200 on average per U.S. household.
  • Jobs –  5.5 million more American jobs were lost due to slower economic growth during the financial crisis than what was predicted by the September 2008 CBO forecast. [15]

As we know, these enormous effects presaged the Great Recession which, I maintain, has become a depression for the bottom 99%, because it is a consistent downturn lasting four years.

These massive effects follow increased inequality of income growth over the last three decades that had already cost the bottom 99% dearly, as shown by Gibson and Perot:

In another set of computations Hacker and Pierson presented in their book “Winner-Take-All Politics,” they showed what income levels would be (from 1979-2007)  “[i]f the economy had grown at the same rate as it actually did yet inequality had not increased.” [4] On this basis, they report, the average annual after-tax income of the top 1% had increased by $694,298 (updated to 2006) through increased inequality. [5]  Thus, the total gain for the top 1% in 2006 was about $780 billion.  Hacker and Pierson summed it up this way: “Few of the benefits of economic growth between 1979 and 2007 trickled down.”

Here is another way to view the unequal growth of incomes from 1979 through 2004, as compared to earlier decades:

On a pre-tax basis, this graph shows a little gain for the bottom 60% (less than 1% per year)  over three decades.  The significant point is that the economy was growing faster, as was even the income of the top 1%, prior to 1979 than thereafter.  After 1979, however, no one in the bottom 80%  experienced material pre-tax income growth; and income growth for the top 20% (with the top 1% excluded) was woefully inadequate.

Note that inequality growth has not created faster growth for the top 1% – it has just caused everyone else’s to decline.  Thus, reality is the exact opposite of the “trickle down” notion that if you cut taxes for the rich, they will get richer and everyone else will benefit too.

Wealth Inequality Growth

This blog has addressed the growth of wealth inequality since 1979. (See Growth in Inequality of Wealth: 1979-2007, posted April 11, 2011;  Growth in Inequality of Wealth: After 2007, posted April 13, 2011.) Wealth and income are closely related, as saved income constitutes wealth. [6]  Most of the growth in top 1% income just discussed is saved, and the additional wealth produces more income over time.  Over the past 30 years, income tax cuts for the rich have enabled the wealthy to save more of their incomes than they otherwise would have, and more of the capital gains generated by corporate profits.  Thus the tax cuts (lowering the top income tax rate) essentially produced a direct transfer of wealth from the bottom 99% to the top 1%, contributing directly to the growth in wealth inequality.

Much of the tax revenue avoided by the rich and corporations has had to be replaced by debt to meet federal budget deficits; thus, government debt created over the last 30 years directly financed much of the wealth increase for the wealthy.

Wealth in the United States, The Working Group on Extreme Inequality observes, is distributed even more unequally than income:

In 2007, the latest year for which figures are available from the Federal Reserve Board, the richest 1% of U.S. households owned 33.8% of the nation’s private wealth. That’s more than the combined wealth of the bottom 90 percent.  The top 1% also owned 50.9% of all stocks, bonds, and mutual fund assets.   

The top 10% held 71.5% of U.S. wealth in 2007, The Working Group notes that “Median net worth in 2007, the latest year for which figures are available, was $120,300. * * * The total inflation-adjusted net worth of the Forbes 400 rose from $502 billion in 1995 to $1.6 trillion in 2007 before dropping back to $1.3 trillion in 2009.”

The lower percentage of total wealth held by the top 1% reflects the more even distribution among income groups of the value of residential homes: [7]

As discussed in our posts, the top 1% has gained at least $10 trillion from the bottom 99% over 30 years.  In addition, the bottom 99% has lost an estimated $8 trillion (up from $5 trillion in our April 13, 2011 post – see fn 22) in the loss of real property and other wealth since the housing market crash, leaving it with about $44 trillion.  Thus, with the loss of roughly $18 trillion, the bottom 99% has lost almost 30% of the wealth it would have had but for the impacts of inequality.  That’s almost $60,000 per person.

To say that the bottom 99% has been hammered over the last three decades would be an obvious understatement.  It is easy to see why there has been so much decline in employment, health care, education, and mobility in recent years.  Income inequality continues to grow, and America continues its downward slide.  The middle class is disappearing as its wealth transfers up.  Technically the bottom 99% is in a depression, and if current trends continue it will eventually become another Great Depression.

With the growth of inequality as extreme as it is today, the changes needed to reestablish a reasonable level of inequality will not be minor tweaks.  Reasonable levels of inequality will be substantially different from those that exist today.  But what, then, would be a reasonable level of inequality, and how can we get there?

The Concept of Optimal Inequality

The United States could and should select an “optimal inequality” (e.g., the top 1% having a 10% share of total income), and then design policies that will move to that level over time. Once those policies are in place, the new level of inequality that would be achieved if the policies and other economic determinants of inequality did not change thereafter would be an “equilibrium” inequality level.  Thus, I would define “optimal inequality” as the “equilibrium inequality” that meets society’s goals.

The Equilibrium Concept 

It’s important to understand the concept of “equilibrium” in connection with inequality: For any given set of structural features or constraints in an economy (e.g., production and consumption characteristics, legal constraints on corporations and profits, foreign trade and investment barriers, income taxes, etc.), over time the degree of income inequality will gravitate toward a balancing point between the rewards to capital and the rewards to labor, that is an “equilibrium” inequality point.  Once achieved, and the forces that constantly tend to increase inequality beyond that point are neutralized, inequality would then tend to change only with changes in the relevant economic constraints.

Thus, “equilibrium” inequality is the inequality that would be achieved with all of the determining factors remaining the same over time (i.e., the ceteris paribus condition). Because these constraints could change radically, we cannot properly expect any equilibrium inequality to be a “stable” equilibrium.  Because the equilibrium point will be constantly changing, frequent adjustment might be needed to maintain optimal inequality.

Here again is the graph of the top 1% income share we have used in previous blog posts on this site.  It will be useful in explaining what I mean:

Note that in the United States the top 1%’s share of income was reasonably stable in the 1953-1980 period, fluctuating around 10% of income, and arguably near an “equilibrium” point given the structural constraints on income distribution effective in those years.  After 1980, however, there were changes that raised the equilibrium inequality level, and inequality has been rising ever since, moving toward a higher potential equilibrium level. At no point did income inequality stabilize around a new equilibrium level (although its growth slowed substantially in the 1985-1995 period when the top 1% share of income trended close to 14%).

The 30-year Disequilibrium

What were the changes occurring in 1980 and the following 30 years that caused drastic increases in inequality?  Let’s start with income taxes, because that is government’s biggest control factor, and there were big changes in taxes. The historical top income tax rate is shown in this graph:

As we have noted, inequality remained fairly stable in the 27 years from 1953-1980.  The top marginal FIT rate was high throughout the period, at 91% from 1953 to 1963, and at 70% over the following fifteen years.  (Effective rates were, of course, lower.)  From 1980 to the present, the top rate was radically lowered, first down to 50% and all the way down to 28%.  It’s now at 35%.

The tax rate reductions after 1980 were significant, regressive changes that tended to generate inequality growth as the top 1% obtained higher after-tax incomes and retained more wealth.  But the top income tax rate was not the only factor that tended to squeeze the middle and working classes.  Here are some others:

(1) Reduced regulation of corporate monopolies and the “financializing” of the corporate economy tended to increase profits, boosting the 1% share;

(2) The growth of global markets and the shift of manufacturing overseas tended to lower labor’s share;

(3) Increased military spending, often wasteful, and emphasis on warfare, tended to increase the 1% share;

(4) Government subsidies for big oil, pharmaceutical, banks, and other companies, aided by increased lobbying and control in Washington, also increasingly benefited the 1%.

What all of these changes did was substantially raise the potential equilibrium inequality level, if not eliminate it altogether.   Consider that the top FIT rate has remained at 35-40% since the mid-1990s.  However, income inequality growth has accelerated in the last fifteen years.  The top 1% income share  increased in the decade from 1995-2007 from 15% to 23.5%; and as shown above (See the graph “Change in the Share of Income – vs. 1979, after taxes”) the top 1% income share was 30% higher than 1979 in the mid-1990s, but has since skyrocketed to over 120% higher than 1979.

This is the salient point: The economy is not approaching a new inequality equilibrium, or even experiencing a slower growth of inequality.  Instead, the rate of inequality growth is accelerating.  So whatever the theoretical new equilibrium inequality point might be, it is substantially higher than present levels.  That’s scary, since the economy is already in a 4-year-long recession that has turned into a depression for the bottom 99%.

So, if such an “equilibrium” inequality point is even theoretically reachable, given the 99% depression, it would appear to be somewhere in the vicinity of a complete “turn out the lights, the party’s over” economic collapse.  As income inequality continues its accelerating growth today, it has already surpassed historical depression-era levels. (The top 1% share fell from 24% in 1928 to about 16% seven years later, in the heart of the Great Depression.)

Corrective Action 

No rational case can be made for not initiating urgent corrective action immediately.  In the deep state of disequilibrium that inequality is in today, however, it’s hard to pick a sensible target.  The percent of income held by the top 1%, I believe, is the proper guideline for targeting an optimal inequality level, and any ultimate target should be selected considering what income should be available to the bottom 99% to meet consensus goals in such areas as reducing  unemployment, restoring a basic level of prosperity, ensuring widespread education and economic opportunity, establishing a more energy-independent future, achieving substantial environmental progress, reducing wasteful military spending, restoring an adequate level of health care, and so on.  A 14% level, roughly the level existing at the time of the Clinton Administration, might be a reasonable target, at least initially.  Whatever objective level is set, however, it will take a long time to actually get there.

If America cannot agree on its goals, at least it should use use additional tax revenues to raise lower- and middle-class incomes, put people to work, and reduce income inequality as quickly as possible.

Higher Taxes on Top Incomes are Required

That will require a substantial increase in the top FIT rate.  This blog has advocated a return to something approximating the 70% top rate in effect in the 1970s. (See Essays on Inequality IV – Taxing the Rich is Essential, published September 22, 2011.)  Robert Reich is one public policy expert supporting a return to the 70% tax rate. (See The Flat-Tax Fraud, and the Necessity of a Truly Progressive Tax, October 21, 2011.  Although doubling the top rate might seem radical, the additional revenues from a 70% top rate would stop the current growth of inequality, and likely begin a gradual movement toward the percentage of total income held by the top 1% 30 years ago.

In defending his support for a 70% top rate as realistic, Robert Reich recently wrote (See Why We should Raise Taxes on the Super Rich and Lower Them on the Middle Class, February 15, 2011):

[B]etween the late 1940s and 1980 America’s highest marginal rate averaged above 70 percent. Under Republican President Dwight Eisenhower it was 91 percent. Not until the 1980s did Ronald Reagan slash it to 28 percent. (Many considered Reagan’s own proposal a “fantasy” before it was enacted.)

Incidentally, during these years the nation’s pre-tax income was far less concentrated at the top than it is now. In the mid-1970s, for example, the top 1 percent got around 9 percent of total income. By 2007, they got 23.5 percent. So if anything, the argument for a higher marginal tax should be even more realistic now than it was during the days when it was taken for granted. 

* * * More importantly, it will soon become evident to most Americans that the only way to reduce the budget deficit, preserve programs deemed essential by the middle class, and not raise taxes on the middle, is to tax the top. [24]

Reich’s proposal, of course, has provoked criticism from advocates for the rich.  However, the only argument I have seen is that if you raise the tax rate you collect fewer revenues. (See Alan Reynolds, Why 70% Tax Rates Won’t Work, June 16, 2011.) That argument is even more absurd than the “trickle down” myth, as it lacks even an incorrect behavioral theory to support it.  Clearly, if you raise my tax rate, all that will do, unless I cheat, is raise my taxes.  Whatever the data presented shows, it does not show that a higher tax rate translates into a lower tax obligation.

Reversing the Bush tax cut for the rich (increasing the top tax rate from 35% to 40%) would be a more modest, though necessary, step.  As reported by the National Priorities Project, the Bush tax cuts for the rich (top 5%) cost $229 billion in the one-year 2011-2012 Obama extension.  I estimate that roughly 80% of that is top 1% money, so the impact of reversing the Bush Tax cut on the top 1% would be additional annual revenues of about $180 billion.  This suggests that a top rate in the 55-60% range might counter the additional $780 billion per year the top 1% now gets as a result of inequality growth over the past three decades.

Reducing Income Inequality

What we can say now about a return to the proposed 70% top rate is that it would stop the rise of inequality and, as it did in the 1960’s and 1970’s, serve to preserve a stable, and more optimal inequality level.  Together with reduced military spending, it would also bring our federal budget under control and reverse the decades-long expansion of federal debt.

I do not have a reliable current estimate of the amount of additional tax revenue the top 1% would need to contribute to stop income inequality growth.  The top 1% reportedly takes in 60% of all new income, so as income grows its share of total income continuously increases.  It is possible that the top 1% share of total income, which was at 23.5% in 2007, rose to as much as 30% by 2011, especially given that, as the IRS reported in 2011, the median income fell about 10% over the past four years.  To say the least, I am looking forward to the publication of comprehensive post-2007 income inequality data.

Based on the high rate of new income going to the top 1%, to prevent further growth of income inequality top tax rates will need to increase by enough to reduce the top 1% share of annual after-tax new income about 30%.  I am unable today to compute the effective rate(s) that will have that result.   I would note, however, that the effective rate for the top 1% was around 50% in the 1950s, when the top rate was at 91%.  It is possible that raising the top rate to 50-60% would suffice to stop the growth of inequality, assuming the current capital gains rate of 15%, which applies to the vast majority of billionaire and multi-millionaire income, is also raised significantly.

We plan to present more detailed tax analyses in the future.  The other structural causes of inequality need to be addressed as well, but right now increasing tax revenues from the top 1% sufficiently to halt the growth of income inequality is a necessary, and urgent, first step.

JMH – 1/23/2012 (rev. 1/30/2012; format rev. 2/23/2012)

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[1] As Keynes argued, a certain degree of inequality is tolerable, indeed desirable.  That is because a marketplace with freedom of opportunity is far preferable to a marketplace in which all production and distribution outcomes are controlled by a central, all-powerful entity, or entities.  (On this score, with corporate governorship, there is no practical distinction between the effects of “private” and “public” control.)  OWS and companion groups are starting to articulate proposals for reform, and there are dozens of proposals for reigning in capitalism’s excesses, starting with Wall Street reform.  I have, however, seen virtually no support for abandoning a free-market economy, nor will we likely see it.

[2] The bottom half of the top 20% has actually been harmed by the growth of inequality, so looking at the entire top 20% as the “winning” income class is misleading and dulls our perception of inequality.  It is for this reason, it appears, that supporters of the top 1% frequently use top 20% income and tax data.

[3] Robert Reich’s book “Aftershock: The Next Economy and America’s Future,” Knopf, 2010, is must reading for anyone concerned about America’s economic future.  On p. 21 he provides the graph of the top 1%’s share of income over the past century as shown here.

[4] Jacob S. Hacker and Paul Pierson, Winner-Take-All Politics, Simon & Schuster, 2010, p.24.

[5] Id. at 25.

[6]  Wealth is equivalent to “net worth,” the total of assets minus liabilities.  Assets include money and liquid assets like stocks, bonds, mutual funds and retirement accounts, as well as physical assets such as works of art or musical instruments, vehicles, and real estate.  Liabilities include all debt obligations, such as consumer loans and mortgages, and credit card debt.

[7]  The top 10% held 90.3% of all securities wealth in 2007, and the bottom 50% had virtually none.   Arthur B. Kennickell, “Ponds and Streams: Wealth and Income in the U.S., 1989 to 2007,” Federal Reserve Board Working Paper, January 7, 2009, Figure A3a, p. 63. (The data excludes assets held in money market mutual funds or tax-deferred retirement accounts.)

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