Essays on Inequality XI – Taxes and Inequality

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Think about the America within our reach: A country that leads the world in educating its people.  An America that attracts a new generation of hi-tech manufacturing and high-paying jobs.   A future where we’re in control of our own energy, and our security and prosperity aren’t so tied to unstable parts of the world.  An economy built to last, where hard work pays off, and responsibility is rewarded.  * * *  At the end of World War II, when another generation of heroes returned home from combat, they built the strongest economy and middle class the world has ever known.  * * * They understood they were part of something larger; that they were contributing to a story of success that every American had a chance to share – the basic American promise that if you worked hard,  you could do well enough to raise a family,  own a home,  send your kids to college,  and put a little away for retirement. * * *

The defining issue of our time is how to keep that promise alive.  No challenge is more urgent.  No debate is more important. We can either settle for a country where a shrinking number of people do really well, while a growing number of Americans barely get by.  Or we can restore an economy where everyone gets a fair shot, everyone does their fair share, and everyone plays by the same set of rules. What’s at stake are not Democratic values or Republican values, but American values.  We have to reclaim them.  – Barack Obama, State of the Union Address, 1/24/12 (Emphasis added.)

In the beginning of his remarkable State of the Union Address, President Obama just about said it all.  He talked about keeping alive the promise of American prosperity; about achieving an economy built to last; and about not settling for a country where a shrinking number of people do really well, while a growing number of Americans barely get by.

In these remarks, he refers to the growth of income and wealth inequality in America and, the threat it poses to America’s future.

I am now more certain than ever that Barack Obama really gets it (as does his friend Warren Buffett):  Growth of economic inequality led to the Great Depression in the 1930s, and the growth of inequality over the last thirty years has led to the Great Recession (an actual depression for the bottom 99%).  Unless this growth of inequality is stopped, Great Depression #2, which could last for years, is inevitable.  So, as the President said: No challenge is more urgent.  No debate is more important.  America’s economic survival is at stake.

This is all about understanding and properly applying the science of economics, so Obama is correct that this is not about differences “in Democratic values or Republican values” – at least traditional Democratic and Republican values.  Up to and including Ronald Reagan and George H.W. Bush, at any rate, Republican and Democratic presidents alike have all sought to avoid recessions and depressions.   Ronald Reagan, facing a deep recession early in his presidency, said this in his October 13, 1982 Address to the Nation on the Economy (emphasis added):

I have a special reason for wanting to solve this problem in a lasting way. I was 21 and looking for work in 1932, one of the worst years of the Great Depression. And I can remember one bleak night in the thirties when my father learned on Christmas Eve that he’d lost his job. To be young in my generation was to feel that your future had been mortgaged out from under you, and that’s a tragic mistake we must never allow our leaders to make again

That’s worth repeating:  Ronald Reagan believed that allowing a depression would be a tragic mistake that we must never allow our leaders to make again And, as president, Reagan said he wanted to solve the recession in a lasting way.  Do you doubt that Reagan then, as much as Obama today, understood that it is up to the federal government to correct a recession, or to prevent a depression?   I don’t.  In Reagan’s day conservatives and progressives agreed that maintaining economic stability is the function and responsibility of government.

I think most people still know this today.  Republicans, in fact, presume that it’s government’s role to manage the economy when they attack Obama in this election year for not reducing unemployment.  He’s the “food stamp” president, according to Newt Gingrich.  He’s responsible for growing poverty, they all say, and for the recession, and for the growing budget deficits.  It’s his job, they argue, to manage the economy and the federal budget.

Stuck In A Fantasy

Republicans today do not, however, see the task of managing the economy as a matter of applying the science of economics.  When they vote to slash government programs and eliminate government jobs, for example,  they conveniently forget that the government and its employees are a part of the economy, and that balancing the budget depends in large measure on how well the economy is doing.

As Obama has repeatedly agreed, once again in this State of the Union Address, efficiency in government and trimming waste are virtues.  But wholesale slashing of spending for austerity’s sake is absolutely the wrong thing to do in a recession or a depression.  When thousands of government employees are laid off, the effect is just the same as when thousands of jobs are lost in the private sector.  Unemployment increases, people spend less money, the economy declines, and inequality grows.

In a recent Op-ed, Paul Krugman reported on the failure of “the austerity doctrine” in Europe:

Last week the National Institute of Economic and Social Research, a British think tank, released a startling chart comparing the current slump with past recessions and recoveries. It turns out that by one important measure — changes in real G.D.P. since the recession began — Britain is doing worse this time than it did during the Great Depression. Four years into the Depression, British G.D.P. had regained its previous peak; four years after the Great Recession began, Britain is nowhere close to regaining its lost ground.  

Nor is Britain unique. Italy is also doing worse than it did in the 1930s — and with Spain clearly headed for a double-dip recession, that makes three of Europe’s big five economies members of the worse-than club. Yes, there are some caveats and complications. But this nonetheless represents a stunning failure of policy.  And it’s a failure, in particular, of the austerity doctrine that has dominated elite policy discussion both in Europe and, to a large extent, in the United States for the past two years. 

Britain, he states, “was supposed to be a showcase for ‘expansionary austerity,’ the notion that instead of increasing government spending to fight recessions, you should slash spending instead — and that this would lead to faster economic growth.”  This, Krugman observes, is “ideologically convenient wishful thinking”:

Half a century ago, any economist — or for that matter any undergraduate who had read Paul Samuelson’s textbook “Economics” — could have told you that austerity in the face of depression was a very bad idea. But policy makers, pundits and, I’m sorry to say, many economists decided, largely for political reasons, to forget what they used to know.

Krugman might have emphasized that this “stunning failure of policy” has also been dominant in the United States.  Republicans have advocated the “austerity doctrine” with a vengeance in recent years.  They envision economic management as a matter of applying the values embodied in their ideology, a fact not lost on Obama.

For them, it’s all about reducing spending and cutting taxes.

Mitt Romney now touts his venture capitalism experience as a reason for us to believe that, as president, he would create jobs in ways that Obama hasn’t or can’t.  But how?  In general terms, the Republican critique of Obama is that his government does too much:

(1) It regulates too much: Government regulation increases costs and discourages business, they say, but this argument lacks substance – they oppose all regulation ideologically, including regulation of Wall Street profiteering.  There may be instances of businesses fleeing our shores because their work would be more lightly regulated elsewhere, but Obama has plans for encouraging investment in America, plans he mentioned in his State of the Union Address.  How do Romney and the wealthy elite plan to do it? It’s not clear that it’s something the globalists among them even want;

(2) It taxes and spends too much:  Here is where their ideology completely derails.  The truth is that economic stimulus requires government spending. But Congressional Republicans have countered any attempt by the Obama administration to raise more tax revenue from wealthy people, effectively preventing him from financing jobs and economic recovery, and from shrinking budget deficits. 

They want us to believe that Obama is hurting business, and thereby hurting us.  But Obama has actually done a remarkable job in spurring some recent job and economic growth with monetary policy and the short-term stimulus from reducing payroll taxes (which finance Social Security and Medicare).  But as he said in his State of the Union speech, “I could do a lot more” with help from Congress.  That is, if they would permit him to raise more tax revenues from the wealthy.  Meanwhile, corporations are doing extremely well, often bringing in record profits, while the bottom 99% faces continuing unemployment, declining incomes, and increasing poverty.  The truth is, today’s libertarian Republicans have no intention of doing anything but allowing the private sector to continue mostly running itself for the benefit of corporations, and they have had it mostly their way during Obama’s first term.

Over 30 years, the Republican attack on taxation and government has been the basic Reaganomics justification for reducing and holding down taxes on the one available, plentiful source of tax revenues: THE RICH.

Crucially, the proponents of this anti-government ideology ignore the fatal economic death spiral it has created: the growing income and wealth inequality between the wealthy elite and everybody else.  The inequality problem has been caused by too little taxation of the rich and corporations.  Now inequality is the underlying problem in the United States, and stopping and reversing its growth is the urgent task before us.

Ending the Reign of Confusion and Myth

Here’s the truth:  Inequality is not just statistics on a page, it’s a process, with real causes and real effects.  The top 1% has been increasing its share of incomes and wealth in America for the last 30 years, and between 1979 and 2007, the percent of national income going to the top 1%  rose from 8.9% to 23.5%, the level it was at in 1928 at the onset of the Great Depression.  Over this period average household income for the top 1% has almost quadrupled, while the average incomes for the bottom 90% have not gone up at all.  The United States now has the highest income inequality in the world among developed countries. (See Essays on Inequality IX – The Good, the Bad, and the Ignorant, posted January 5, 2012.)

Sometimes, a picture is worth a thousand words:

In my last blog post (see Essays on Inequality X – Optimal Inequality, posted January 12, 2012) I reviewed in some detail the enormous damage that the growth of inequality has done to the bottom 99% over the last 30 years.  Income inequality, that is the top 1%’s share of total income, continues to grow because new income is going to the top 1% in much higher percentages.  In fact, from 2002-2007, during the early years of the Bush tax cuts, the top 1% captured an astonishing 60% of all new income, and its share of total income rose from 17% to 23.5%.

Since then median household income has continued to fall:

Between June 2009, when the recession officially ended, and June 2011, inflation-adjusted median household income fell 6.7 percent, to $49,909, according to a study by two former Census Bureau officials. During the recession — from December 2007 to June 2009 — household income fell 3.2 percent.

Because the median is the mid-point figure, a decline in median household income of nearly 10% over this recent 3.5-year period implies a further increase in the top 1%’s share of total income given the virtual certainty, with the stock market recovery and the general increase in corporate profits, that top 1% incomes have continued to grow.  Considering as well that 60% of all new income has been going to the top 1%, we can speculate that the top 1%’s share of total income may have risen to 30% or more by now.

How are we to explain this extreme consolidation of incomes in the top 1%?  Corporations have been outsourcing jobs and cutting wages to save money.  Beyond that, here’s a suggestion that does not seem far-fetched:

Inequality compounds.  Wealth grows through compounding of interest and returns, and the flip side of that is that poverty compounds.  Poverty is growing at an increasing and exponential rate in America, just as the top 1% share of income grows at an increasing, exponential rate.

Consider this tracking of CEO pay during the Clinton years, up to the 2000-2002 recession.  When the economy is growing, top incomes tend to grow at a faster rate:

Thus, it seems, the longer inequality is allowed to keep growing the more it will compound and, like a wildfire, the harder it will be to slow it down and stop it.  Here is the income graph I included in my last post on “Optimal Inequality”:

Top .1% incomes resumed their steep upward climb after 2003.  We can only imagine what that graph looks like extended out to 2011. (The interactive graph, When income grows, who gains?, presented by Economics Policy Institute (EPI), permits one to determine what percent of any income gain or loss between any two dates accrued to the top 1%.)

If my hypothesis that income inequality and poverty compound over time, that would negate (certainly in high ranges of unconstrained inequality growth) my earlier suggestion that there might be a natural “equilibrium” inequality to which the economy is moving (with the qualification that it would have to be somewhere in the ozone). Rather, advanced inequality such as ours is actually a condition of persistent disequilibrium:

Without correcting influences, inequality will always tend to rise, because in a profit-producing, capitalist economy incomes and wealth will always naturally tend to accumulate at the top.

The result, inevitably, is depression, a persistent downturn lasting several years.  For the bottom 99%, the depression is well underway and, I submit, it’s not a mild downturn either.  The bottom 99% is having to make due in its shrunken economy without a lot of income it might otherwise have had.  If the increase in inequality over these years is defined as the growth in the top 1%’s share from 8.9% to 23.5%, then inequality has grown by 14.6% of income, and with GDP at about $13 trillion, then the “gain” of the top 1% (and the loss of the bottom 99%) in annual income has reached a total of $1.9 trillion in 2007.

Let’s consider further the income inequality chart I included in the last post, which produces a more modest estimate of top 1% income inequality growth:

Also, Hacker and Pierson in their book “Winner-Take-All Politics” reported that from 1979-2007, the annual after-tax income of the average top 1% household  increased by $694,298 (updated to 2006) over what it would have been “[i]f the economy had grown at the same rate as it actually did yet inequality had not increased.” [1]  On that basis, the total gain for the top 1% in 2006 was about $780 billion.  Again, that’s the total amount of additional annual income the top 1% receives as a result of the growth of income inequality.

This table also shows, please note, that by 2005 the income share of the bottom half of the top 20% was declining; there was still some growth, excluding the top 1%, in the top 5% and the top 10%, what used to be the upper middle class.  Today, with the 10% drop in median income over the past four years, the bottom half of the top 10% is most likely no longer holding its own, and even the balance of the top 5% may soon no longer be experiencing growth.

As wealthy people increase their incomes, of course, their wealth increases, transferring up from below.  My most comprehensive estimate of the loss of wealth by the bottom 99% attributable to the growth of inequality since 1979 is $18.4 trillion. (See Essays on Inequality V – Deepening Recession/Looming Depression, posted September 27, 2011.)  This estimate, which includes the loss of home values following the 2008 crash and makes some allowance for the impact of declining incomes since 2007, amounts to more than $60,000 for every man, woman and child in the bottom 99%.  That’s $60,000 each, for over three hundred million people.

A Stark Choice

It truly has become a matter of the top 1% against everyone else.  President Obama has identified the choice facing America:

We can either settle for a country where a shrinking number of people do really well, while a growing number of Americans barely get by.  Or we can restore an economy where everyone gets a fair shot, everyone does their fair share, and everyone plays by the same set of rules.

The first choice – the continuing rise of inequality – is worse than can yet be imagined for the bottom 99%.  There’s no need to debate whether another Great Depression would be “fair,” because in my opinion we simply cannot go there.  So our challenge is to stop and reverse the rise of income inequality.

As discussed in “Optimal Inequality” a number of factors (like the development of monopoly capitalism, the decline of unions, and the outsourcing of manufacturing) have contributed to growing inequality, but the most significant cause is the great reduction of the tax burden on the top 1% and, more gradually, the decline in corporate income taxes. America can try to correct these other factors, but what it can most easily and effectively do, and what it must do, is correct the main problem by increasing taxes on the rich.

I have advocated a return to the 70% top marginal rate, as does Robert Reich.  Significantly, based on the expectation that reversing the Bush tax cut for the wealthy would produce about $180 billion more revenue from the top 1%, in “Optimal Inequality” I calculated that a top income tax rate somewhere in the 55-60% range (with appropriate treatment of capital gains) might be enough to stop the growth of inequality by stanching the annual transfer of about $780 billion from the bottom 99% to the top 1%.

These are rough estimates, but they demonstrate a crucial point: Merely letting the Bush tax cuts expire, lifting the top rate from 35% to 40%, is not nearly enough to stop the growth of inequality.  Similarly, President Obama’s proposed 30% minimum tax for millionaires would be a desirable first step, but revenue estimates are not yet available for his proposal, and it would have to cover millionaires’ capital gains or it would not likely accomplish much.

The Theatrics of the Election-year Circus

In the Republican debates, all of the presidential candidates are behaving as though we were back in the 1960s.  When they discuss jobs and unemployment they are oblivious to the damage their laissez-faire government has created, and are blissfully unaware that their ideological prescription of more of the same, heightened by tough austerity programs and tax decreases for the wealthy, will only make things much, much worse.  This has never been more clear: The difference between economic reality and fantasy is like the difference between night and day.

The likely Republican candidate Mitt Romney, a Wall Street venture capitalist who creates profits by dismantling and repackaging troubled firms and stranded assets, is completely out of touch with this reality.  After the Florida primary, he remarked “I’m not concerned about the very poor. We have a safety net there.”  I think it’s too cynical, as recently argued by Bill Sher, to suspect Romney of trying to stir up middle-class resentment for the government assistance received by people in poverty, even though his party wants to dismantle even that increasingly shrinking safety net.

We must remember that Republican top 1% favoritism is hurting the entire bottom 99%, relentlessly shrinking incomes and jobs and destroying educational opportunities and social systems, and the Occupy movement properly reminds us to direct our resentment at them.  A traditional Republican would, sensibly, insist that poor people work hard and do their best to provide for themselves and not rely on government welfare; but any traditional conservative would also acknowledge that poor people, just like the rest of us, need a functional, non-depressed economy within which to do it.   As poverty rises in America, we must remind Mitt Romney that even Ronald Reagan understood it’s government’s job to protect and defend the economy; and that it was Ronald Reagan who said a depression is “a tragic mistake we must never allow our leaders to make again.”

Keeping taxes down for rich people and their corporations is the main goal of Republican electioneering.  Most Republican legislators have signed the “Norquist pledge” never to raise taxes.  However, they are breaking that pledge today by allowing the payroll taxes on lower incomes to increase, reducing economic activity and contributing to inequality.  In so doing, they reveal clearly that they are not interested in creating jobs or reducing income inequality:  To them, tax cuts for the rich are commendable, but tax cuts for anyone else are unaffordable.   It’s revealing that, when Grover Norquist was a guest on Real Time, his quick answer when Bill Maher asked him if he thought any amount of inequality might be too great was to assert that “it’s not government’s job” to control inequality.

Americans must keep reminding themselves that when we increase taxes on lower incomes, we lower spending and growth and increase the growth of inequality, but when we increase taxes on higher incomes, we put money to work increasing economic demand, increasing spending and growth, and decreasing the growth of inequality.  This is Keynesian economics, and it is an essential job of government.

The top 1% derides Warren Buffett’s argument that it is not fair for billionaires like him to pay a lower tax rate than his secretary. The majority of Americans agree with Buffett, objectively believing that the wealthiest Americans are not paying a fair share of taxes, but the conversation on tax issues bogs down on the fuzziness of the fairness question.

This video of an  interview of Rep. Tim Huelskamp, R-Kan  by Reverend Al Sharpton on his MSNBC show Politics Nation illustrates the problem.  Reverend Al asked Huelscamp whether he would agree that it is “unfair” for Warren Buffett to pay a lower tax rate than his secretary.  Huelscamp pointedly refused to agree, advancing the argument that many people don’t pay any income taxes at all.  But many people don’t pay income taxes because they have little or no income: In fact, 35% of the bottom 20% of households today contain unemployed or underemployed workers.

So what is Huelscamp’s point?  Is he arguing that people in poverty should also be paying more income taxes?  Is he arguing that people in the lower income brackets, who are disproportionately affected by sales taxes and other regressive taxes, should pay the same income tax rate as billionaires and millionaires, who can easily afford to pay a higher rate?   Or is he arguing that because many people don’t have to pay income taxes at all, billionaires shouldn’t have to either?

This exchange demonstrates how easy it is to obfuscate “fairness” questions, and it doesn’t help that so far progressives have not framed the issue well.  Would they now have to agree that if Buffett were to be taxed at the same rate as his secretary, that would be fair?

This “fairness” issue is one that billionaires simply cannot win:  If billionaires are going to argue that it’s “fair” for them pay taxes on tens of millions of dollars of capital gains at the same 15% marginal rate that people in poverty pay on ordinary income, they had better also be prepared to demonstrate that it’s fair for them and the rest of the top 1%, in an economy rigged for the purpose, to collect nearly $1 trillion per year in wealth transfers from the bottom 99%.

More to the point, this “fairness” issue arises only in the context of a fantasy economy that does not exist.  If we are unwilling to live through another Great Depression, it is simply pointless to ask whether rich people are paying a “fair” share of income taxes.  The question we must ask is whether they are paying enough income taxes.  What most Americans have yet to understand is that raising taxes on the wealthy isn’t just a question of fairness:  It’s a matter of economic survival.

JMH – 2/2/12

________

[1]  Jacob S. Hacker and Paul Pierson, “Winner-Take-All Politics,” Simon & Schuster, 2010, p.25.

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2 Responses to Essays on Inequality XI – Taxes and Inequality

  1. Pingback: Wealth and Income Inequality |

  2. vorfahrt says:

    Hi authors,

    Wanted to thank you for bringing the topic of income inequality and particularly showing the long-term trends. I would not have thought that is was THIS bad over the last 30+ years, but noticed for my family that things have gotten a lot tighter in the last ten years even without unemployment – just lose a bit in real income for more than ten years and you will feel the pinch. I agree the average Joe has lost for decades and particularly so in the last 10 years. I would disagree on taxation being the more or less lone root cause of the issue, but agree on it being a factor. The key going forward is to help the average Joe by any means possible: fiscal, monetary, education, anything. The focus cannot be in the rich and how they may better trickle down something to us (or NOT as the numbers show).
    I personally witness that my employer shows considerable profits year in year out, crisis or not, but the merit increases for employees are very meager at 2% and way below inflation. Couple this with steadily higher health premiums and deductibles and you see how we all lose a little bit more every year. While at the same time listening to the the bigwhigs proudly presenting how they plan on 16% or so every year for the shareholders… and how great they and we do to deliver this now for years. We deliver, but no fair share returns to us any more. A big issue IMO is the lack of unions and employee negotiation strength.

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