Based on a spate of recent posts (see here and links therein), a commenter (HT: Greg) asks a good, tough question of yours truly: on the one hand, I've argued long and hard that while we definitely need more progressive tax policies, the fact that the growth of inequality is largely a pretax phenomenon implies that tax changes alone won't reverse the trend.
Yet, in this post reviewing the recent CRS inequality report, I point out that a) the increase in capital gains plays a large role in driving inequality trends, and b) if we taxed such gains as regular income (instead of at much reduced rates), that would help to reduce inequality.
So how can I argue on the one hand that tax policy is inherently limited as a tool against rising inequality, and on the other, that we should employ tax policy to push back on inequality?
I could invoke Walt Whitman: "Do I contradict myself? Very well, then I contradict myself, I am large, I contain multitudes" -- and leave it at that.
But better yet, let me explain. First, the evidence as shown in the chart here shows that increased inequality is a pretax story. Whether it's the increase in earnings or wealth inequality, the latter including outsized gains from assets, that's all occurred in the so-called primary distribution of income, before taxes and transfers get into the mix.
Now, that doesn't mean that more progressive taxes and transfers can't help offset higher inequality. They can, they should, and they do. Unfortunately, as I stress here, they've become less effective in that regard over time.
But there's another policy constraint here -- it's the "building-a-damn-against-an-ever-rising-river" problem. As long as market outcomes become increasingly unequal almost every year, whatever redistribution we're accomplishing through the tax code will have to be constantly ratcheted up. That's tough even in a rational political environment -- it's impossible in the current one.
Then there's the question of how much of a direct difference we could make in the growth of inequality by just depending on taxes (the word "direct" is important, as I'll get show in a moment). Using table B-1 from the CRS report, I can simulate what the Gini index might have been in 2006 if the tax system hadn't become less progressive. And the answer is: it wouldn't have directly changed measured inequality much at all -- it lowered the Gini by only 0.005 compared to its actual 2006 level.* More progressive taxation will help, but at the end of the day, you can't bring a knife to a gun fight.
There are, however, very good indirect reasons to think that taxes matter a lot more in terms of moving inequality than the above rap would suggest, and I should be more careful to reflect this insight. Important work on this question by Saez et al (see here; paper here), for example, shows strong correlations across time and place between higher marginal tax rates and reduced income concentration.
With higher taxation, they argue, there's less "rent seeking" (economese for rich people figuring out ways to claim more riches -- ways that don't lead to better overall economic outcomes). As Saez et al put it, "Lower top tax rates induces top earners to bargain more aggressively for higher pay" and bargaining here mean using their clout, power, friends on the board, etc., to claim pay packages that go well beyond their productive contributions to the firm's output. This is a classic zero-sum outcome-the execs gain is someone else's loss.
Of course, the notion that there's separable independence between the primary distribution (market outcomes) and the secondary (post-tax and transfer) is wrong. Tax policy itself affects market outcomes, for better or worse.
The trickle-downers have way overdone this for decades, arguing, against evidence to the contrary, that tax cuts unleash torrents of growth. What Saez et al are identifying is a new pattern that looks like it has a lot to do with inequality: trickle-up economics.
*I did this by substituting the 1996 terms for taxes into the 2006 table and recalculating the Gini index. One wrinkle here is that you have to rescale the income shares so that they sum to one.
This post originally appeared at Jared Bernstein's On The Economy blog.
Wealth always "trickles up" to capital owners unless there is a mechanism to equalize that considerable societal expenditure to those providing labor - which is what taxes are supposed to, but no longer, do.
http://www.rationalrevolution.net/articles/capitalism_economy.htm
Why would people want to employ their capital in America to create jobs. Taxing capital reduces economic activity and growth, and ultimately jobs.
Kai
The reason is that the chart does not include the top 0.1% bracket. It is not the top 1% - but the top 0.1% - that pay much lower taxes because of the low capital gains rates and because of tax shelters.
The big problem in this country is that the super rich have rigged the system so that they hide their income via tax shelters and loopholes. And the income that they fail to hide is taxed at only 15%. Thus there is huge income redistribution - via taxes - from the middle/upper-middle class - to the super rich.
The only way to fix this income redistribution is:
1. Tax all income at exactly the same rates. The income of the super rich (capital gains and dividents) should be taxed at the same rates as regular income - just as when federal taxes were originally introduced in the USA.
2. Close ALL tax shelters and loopholes that the super rich use.
3. Reform the AMT to only target the super rich - as originally intended! Now the AMT mostly targets the middle class!
4. Introduce new tax brackets for incomes over $1M and $10M. When federal taxes were originally introduced in the USA only incomes of over $1.2M (in 2011 adjusted $) were taxed, at progressive rates, but now there is not even a separate tax bracket for incomes larger that $1M.
Germany and Switzerland both have a wealth tax.....Sweden has high tax rates, and they have been able to reduce their debt by 40% in the last 4 years AND STILL have universal healthcare and 6 weeks of vacation and a year of PAID MATERNITY leave....
"building-a-damn-against-an-ever-rising-river". Ouch.
The second is that historically America has been a land where the goal is equal opportunity, not equal outcome. We do not confiscate anyone's assets, other than by taxation, in order to give them to someone else. Someone who is risk-averse is never going to make the kind of money as will the individual who quits his job to start his own business which becomes successful. What reward should be given to the guy who works 16 hours a day, 6 or 7 days a week, for five years to build up his company?
If there is no spectacular reward there will be very little business formation, and we will simply become California with a view of the Parthenon.
I believe a far better approach would be to provide incentive to not extract (realize) gains -- most likely by a tax scheme that penalizes bulk realizations (extractions) while rewarding continual reinvestment and slow realization (delayed, partial extractions).
"... incentive to not extract (realize) gains ... tax scheme that penalizes bulk realizations (extractions) ... rewarding continual reinvestment and slow realization (delayed, partial extractions)"
However, perhaps you simply advocating that by permitting the wealthy to exist, we ensure that the wealthy will influence society. in this case, you should have just written such.
In either case, your comment speaks of a poor ability to comprehend and understand issues and comments
UNTAXED international corporate interest, as huge mountains of equity, can be wielded as government buying influence. Treason for despots is by definition acting in that interest in usurpation of our property and rights.
http://seekingalpha.com/article/209386-modern-monetary-system-there-is-another-way
to get rid of fractional reserve banking (which produces uncontrolled money leading to corruption of democracy) by separating the functions of storage, money creation and commercial risky banking. He suggests :
a) Remove government bank deposit protection such as FDIC and allow “Free Banking”. Allow banks to fail. This will greatly reduce the ability of banks to create bank deposit private money.
b) Give the public the option to “store” money electronically risk-free in a government owned bank which can only “store” electronic money and clear checks but not lend it out. 100% reserve credit risk-free money storage for a small fee.
c) Allow new money creation in all forms (coins, paper bills or bank deposits) by the treasury department directly
d) The new money should be put into circulation by spending it on legislature approved government expenses and projects and/or the new money can simply be credited to the citizens’ bank accounts, the states and the public itself can decide what to do with it.
e) The object of the government will be no deflation and no inflation (stable purchasing power). I realize purchasing power is hard to measure and the process can be gamed by the government but benefits are so great that this risk should be taken and managed.Inflation or deflation can be controlled by removing or adding money.
USA will fight this but France might initiate it.
a higher marginal rate and higher capital gains taxes encourage longer range thinking and investing.
wheres lower rates encourage short term profit taking and discourages reinvestment
one need look no furhter than the US post war boom years - a time of higher taxation, greater protectionism and stronger labor representastion to see a period of strong growth, wages increases and higher domestic demand
demand side economics works
supply side as Bush I referred to it is merely voodoo (or doo doo for that matter)
This article is a needed "share" for those still waiting for results as more equity and needed capital is heaved out of the REAL economy.
WHY is this not spoken by the PORTFOLIO owning candidates? By the candidates ho rely on campaign cash and easily grow rich from tax favored inflation and outsourcing?
Even Romney stupidly revealed that those in govt have wielded government as a tool to our property. Yes those embedded in government using UNTAXEd mountains of corp cash to buy tax code and deregulation. Where would Mitt be without UNTAXED interest backing him? Untaxed oil inflating, outsourcers.
But the statistics are misleading for two reasons:
1) 2007 is not up to date, and there were significant economic events since then.
2) About 30% of income for the top 1% is capital gains, which tends to be events like your company went public, or you sold significantly appreciated assets. So my suspicion is that the 1% of one year may not be the 1% of the next year.
http://www.taxfoundation.org/publications/show/151.html
I say that is significant.
We focused upon taxing income rather than taxing wealth.