Marginal Utility

02/25/2013 02:19 pm ET | Updated Apr 27, 2013

Recently the New York Times wondered why a prominent neurologist would provide inside information to a hedge fund manager and thereby risk ruining a sterling reputation built up over a lifetime. Just because the Times wonders doesn't mean the rest of us do--he did it because he wanted to keep up with the Joneses. Watching someone else earn twenty times what you do, though they have less training, do less public good, and work no harder, can lead a person to commit lamentable acts in an effort to even the score. Sidney Gilman, the neurologist, is hardly rare among those in the upper class that desire to be part of the upper upper class. At the height of the internet boom previously contented millionaires wanted to become billionaire internet moguls. George Shaheen tried to make the jump and resigned as head of Andersen Consulting to become CEO of Webvan only to see it become 'the largest dot com flop in history'. Lou Dobbs left a lofty perch at CNN to run Envy does not lead to productive decisions for individuals or society.

But its not envious millionaires that we should worry about. In his short story 'The Loneliness of the Long Distance Runner' Alan Sillitoe alluded to the societal disruption the advent of TV would cause as laborers in 1950s Nottingham would no longer happily settle for their wages when they get a better look at how the other half was living in London. And that was in an era when media consisted of three TV channels that signed off at 11pm.

But the sense of unhappiness over the gap is not just fueled by an enhanced view of it given today's turbo charged media, it is fueled by actual growth in the gap, which is now at a level last reached in 1928. The widening started during Reagan's first term -- since then the income of the top 1% has quadrupled while those lower down have remained flat.

There are two overriding reasons for the growth in the gap. The first is the inexorable advance of technology and globalization. The rewards to the winners in today's global tech driven capitalist economy are far larger than they were twenty years ago. Start a book seller or a photo editor or a flea market in 1985, rise to the top of your industry, and maybe you are the head of the local Kiwanis club and own both a Cadillac and a Ford wood-paneled station wagon. Do it in 1995 and you are Time's man of the year , or you sell your four- person startup for $1bb , or they are naming buildings after you on Princeton's campus. Conversely the losers, so to speak, those without college degrees, are now competing with people that live in 10 x 10 foot shacks in Beijing's hutongs.

If the first cause of growth in the gap, globalization, is inexorable, the second cause is of our own devise--lowering top marginal tax rates. It's not a coincidence that the post 1980 explosion in the gap coincides with the years the top marginal rate dropped from 70 to 39.

Why are our top marginal rates historically low, given the societal upheaval the resulting income inequality can bring? Is there disincentive to create a company if top marginal rates went back to pre- Reagan levels? In terms of monetary gain, today's winners would be far ahead of their 1970 counterparts even after paying away 70%. And beyond the money, it's my suspicion that the tax rate at which people become dis-incented to work, to build something, to be a contributing member of society, to be famous, to be successful (in a non-monetary/CNBC context) is far higher than today's 39.6%. Proof may be found in the fact that real GDP growth in the years when then top rate was at least 70% (1940 to 1980) was higher on average than since.

Given that the byproduct of globalization is increasing rewards to winners and punishment to losers, how do we temper that so that losers aren't indigent (let alone wielding pitchforks)? An increase in top tax rates seems sensible as one arrow in the quiver. I'm not suggesting we go back to 1950s levels, where someone would pay 91% of any income over $1.7mm in today's dollars , but that didn't seem to do us much harm, and there is a lot of room between 39.6 and 91.

No one likes a handout, particularly the givers, but in this case it should be welcome by the giver almost as much as the receiver. Among the upper class, where envy causes professors to commit white collar crime and film makers to lament instapunks, the social cost of the gap may seem bearable. But in the lower levels, who knows? Remember, there is another side to advances in technology. Perhaps the shrinking support republicans garner among the rich shows that they know that yesterday's pitchforks may become tomorrow's surface to air missiles.