POLITICS APRIL 19, 2012
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Two topics have dominated economic discussion in recent months—income inequality and tax fairness. The Piketty-Saez chart demonstrating the dramatic rise in the income share of top earners since 1980 is this decade’s Laffer Curve, and the super-rich who pay taxes at lower rates than their secretaries are liberals’ riposte to the Reagan-era welfare queens.
It’s natural to assume that these two tropes are connected: Surely changes in the tax code since Ronald Reagan took office have contributed substantially to post-tax income gaps between the top and the rest of us. After all, top rates have been slashed, and lobbyists have been busily working to carve out special deals for taxpayers who can afford their services. If we still had the pre-Reagan tax code, surely the rise in inequality would have been much smaller.
Most commentators have accepted this narrative, though some, including TNR’s own Tim Noah, have questioned it. And a recent high-quality study suggests that it’s the skeptics who are right: Rising inequality, it turns out, does not have much to do with tax policy.
Last December, the Federal Reserve published a working paper by four researchers—one university-based, one from Treasury, two from the Fed—based on a large, confidential file of tax returns: a one-in-5000 random sample of the population of U.S. taxpayers, comprising 30,000 households. They found that the rise in income inequality mostly reflects permanent as opposed to transitory changes in household income.
But the federal tax system didn’t contribute to that rise. From the beginning of the period studied to the end, our moderately progressive tax system reduced pre-tax inequality by roughly the same amount. Overall, the authors conclude, the tax system “does not seem to have altered the trend toward rising inequality.”
The authors are aware that their conclusion is counterintuitive: “The finding of little change in the effect of the federal tax system on the evolution of inequality in recent years might appear surprising in light of the well-publicized reductions in marginal tax rates, especially at the high end of the income distribution, in 2001 and 2003.” Here’s how they explain their finding: “Changes in top marginal rates were accompanied by (smaller) reductions in marginal rates for other income groups as well as by significant expansions of the earned income tax credit and the child tax credit.” The net effect of all this, they conclude, was “small.”
I don’t expect readers to take my word for it. So go to federalreserve.gov/pubs to find the paper by Jason DeBacker, Bradley Heim, Vasia Panousi, and Ivan Vidangos, called “Rising Inequality: Transitory or Permanent? New Evidence from a Panel of U. S. Tax Returns 1987-2006.” You can judge for yourselves. (My economist colleagues at Brookings, who discussed this paper in their seminar series, consider it to represent high-quality research.)
If this finding is valid, the economic framework that has recently defined our politics should be replaced by a new narrative, one that runs as follows: In recent decades, changes in the structure of our economy and politics have created a dramatic increase in income inequality; while changes in our tax code did not contribute materially to this increase, they did nothing to mitigate it; if we want to use taxation to reduce this alarming gap between the top and the rest of us, we’ll have to broaden the debate far beyond its current bounds.
This is precisely the conclusion that the Nobel prize-winning economist Peter Diamond has reached. In a recent New York Times interview, he put it this way: “The debate in Washington is between the Bush-era and Clinton-era tax rates. [It] should be between the pre-1986 Reagan [top] tax rate, which was 50 percent, and the rates that existed from Johnson until Reagan,” which were higher.
This may strike some readers as the basis of a renewed fighting creed for liberals. It may strike others as demonstrating the need to moderate our hopes for tax reform as a way of reducing inequality and look in other directions for policies that can improve the well-being of middle and working-class households. (You may not be surprised to learn that I incline toward the latter view.)
Still, the impending expiration of the Bush tax cuts and of the alternative minimum tax creates an opening for a broader reexamination of our tax code than we’ve had since 1986. And there are two basic strategies on offer. One is to go back beyond 1986 to a world of high top marginal rates; the other is to use 1986 as a template. However difficult the latter strategy may be, it’s a lot more politically feasible than the former. And we could do it in a way that is at once simpler, more progressive, and more pro-growth than is the current code. It seems we’ll have to accept that such changes won’t do much to reduce persistent income inequality. But it would accomplish a substantial amount in its own right, and it may allow us to concentrate our energies on the true causes of that vexing problem.
William Galston is a senior fellow at the Brookings Institution and a contributing editor for The New Republic.
7 comments
Poor William Galston. Trying to hawk an earnest Third Way centrism. Aghast at the audacity of Occupy Wall Street. Desperately trying to rope Timothy Noah into your thesis. Look. Taxes aren't everything. Tax expenditures and explicit spending programs are crucial. These are the building blocks of government. In a very real sense, then, government does tax and redistribute income. Tea Partiers are crazy enough to believe "their Medicare" is just that: a health savings account. France and northern European nations have income inequality. And yet magically, the post-tax-and-transfer Gini makes their societies much more equal. That's what this system is for--the provision of highways to the populace on an equal, non-discriminatory basis can be understood as income redistribution but is better understood as building the infrastructure of one nation and promoting civil society. Now, it is an arithmetic fact that to reliably fund transfers (i.e., government programs), we need more in taxes. That means that rich people need to pay a lot more in taxes. It's just not possible to fund the government that Americans want on post-1986 rates. They didn't fund the government of 1986 (there were still deficits then) and this was at a point where defense spending was a little lower, health care costs were a lot lower, and the population was just younger. So don't kid yourself about this point. If you invoke good research saying that the top rate needs to be either at least 50% or at least 70%, then you can't just go ahead and say you favour a 1986 redo. That means 28% rates, which means raising taxes on the middle class and poor people beyond all capacity for affordability. It also means effective reductions in regular income rates for rich people. It also means that you pre-emptively give these points up in order to try to fight the right over raising capital gains rates. It's always better to bring some fungible positions to a negotiation, you know. For these reasons and more that I am too lazy (and I other commenters are only too eager) to supply, your argument and stated position are both hooey. Get over yourself. Make peace with the notion that Democrats stand for responsible budgeting, progressive taxation, and serious policies to promote economic growth, manage the government, and reduce the debt over the medium term.
- chaitless
April 19, 2012 at 12:40am
Let's go to the tape: "To put it another way, the pre-tax share of income for the top 0.1 percent rose from 2.6 percent in 1970 to 9.3 percent in 2000. The rise in after-tax income shares was from 1.2 percent in 1970 to over 7.3 percent in 2000. In percentage point terms, the increase in pre-tax incomes is slightly greater than the increase in post-tax incomes. But in terms of observing what those with very high incomes can afford to consume, the after-tax share of income for those in this income group multiplied by a factor of 6.1, while the pre-tax share of income multiplied by a factor of 3.5. The tax reductions enacted in 2001 and 2003 have further weakened the redistributive power of the federal income tax today." Piketty and Saez, "How Progressive is the U.S. Federal Tax System? A Historical and International Perspective", National Bureau of Economic Research, July 2006 (page 15). "A number of factors may help explain this increase in inequality, not only underlying technological changes but also the retreat of institutions developed during the New Deal and World War II - such as progressive tax policies, powerful unions, corporate provision of health and retirement benefits, and changing social norms regarding pay inequality." Piketty and Saez, "Striking it Richer: The Evolution of Top Incomes in the U.S." (Update, March 2, 2012).
- rayward
April 19, 2012 at 8:04am
"if we want to use taxation to reduce this alarming gap between the top and the rest of us..." TNR's economic content has become overwhelming based on the premise that this gap is "alarming," but Galston, Noah, et al. never argue for this premise. They just assume it. I'm not alarmed by the fact that some people's incomes are much higher than mine or most people's. To the extent I can even understand what's driving TNR's writers, they seem to be assuming that there's a fixed amount of wealth in society, so all you can do is slice the pie into different proportions. Therefore, a rich person's wealth could only have been taken away from someone else, leaving that person poor. If that's the assumption, then Galston, Noah, et al. should make that explicit and argue for it.
- jaltcoh.blogspot.com
April 19, 2012 at 11:50am
Let's go back to classic solutions for income inequality: http://www.poetryfoundation.org/poem/171940 ["The Highwayman"] Or, of course, the most classic of all: Lythe and listin, gentilmen, That be of frebore blode; I shall you tel of a gode yeman, His name was Robyn Hode. Robyn was a prude outlaw, Whyles he walked on grounde: So curteyse an outlawe as he was one Was nevere non founde.
- skahn
April 19, 2012 at 12:28pm
Raising taxes on the very wealthy won't bring in a lot of new revenue. But denying rich individuals and corporations tons of subsidy money and bloated government contracts would cut spending dramatically. Will it happen? Never. Claiming discrimination, the rich and the corporate will fight like tigers to keep their huge slice of the free-money pie.
- magboy47.
April 19, 2012 at 12:30pm
Something to consider from a social perspective is what those rich people are doing with all that extra money they have been making these past few decades, and on which they have been paying tax rates lower than they were since before the Great Depression. Sure, they have been donating a lot of it to charity, here and abroad, though there are charities and there are charities -- there is a measure of difference between funding anti-retroviral drugs for Sub-Saharan Africa and girls schools in Afghanistan and helping the Old Alma Mater build a new basketball arena or funding another LDS Temple in Scottsdale. But that kind of spending only goes so far, and certainly charitable giving is hardly taking up the entire disposable income of the 1%. Some of it goes to increased living expenses, and there is certainly some collateral benefit to the rest of the public from building or remodeling houses for the wealthy, caring and feeding their children and building their yachts, cars and helicopters (though much of that work is not done in America). But that still leaves a lot of money out there -- and the evidence shows that lots of that money, at least until the last recession, went sloshing into dubious investments here and abroad, especially investments related to real estate and subprime lending. That sort of excess wealth had catastrophic effects on the world economy, and continues to bedevil both American and European budgets today (just ask the Spanish, the Irish or the Nevadans). While I am normally of the firm belief that people have the right to earn as much money as they want from honest work or legal investments, and that income inequality per se is no more of a problem than the inequality of climate and weather, those who care about the ability of our country to have a functional government need to be aware of the pernicious effects of excess money on the broader economy -- and attempt to craft both tax and fiscal policy accordingly.
- wildboy
April 19, 2012 at 1:16pm
I don't understand how cutting a tax rate to 15% for people who accumulate wealth compared to FICA, medicare and highere income taxes for workers cannot create disparity from the compounding of reinvested gains and dividends. Further, investing in the stock market, where people accumulate wealth is subsidized by lower taxes, while investment in small business is implicitly discouraged by higher taxes. The accelerator which results from lower rates and the tilt away from small business, has moved money into accumulations of wealth.
- Nusholtz
April 19, 2012 at 9:45pm