THE BLOG
09/16/2009 05:12 am ET Updated May 25, 2011

Income Inequality: Can We Tax Our Way Out of Trouble?

Emmanuel Saez just published his study on income inequality, and people are going ballistic about it.

Incomes may not be equal, but neither is the tax burden. Consider this: In 2007, the last year for which IRS data is available, the top 1% of incomes in the country, with a minimum of $400,000 in AGI, paid 40% of all personal income tax. And the top 5% paid more than the other 95%.

You might think this is fair, and maybe it is. However, if higher taxes on the top income earners are enacted, it will spawn a different problem.

The fact is the majority of Americans currently barely feel the burden of income tax, as 40% of Americans pay no income tax at all. Having a populace that thinks everything Congress spends money on is not their problem is damaging to democracy. People are likely to support any new expenditure, knowing it won't burden them. That support feeds even more spending from caviling politicians looking for popular measures.

And maybe this is the reason why people are so callously loutish and indifferent about the federal debt, even as it is now at levels unprecedented since World War II, at about 80% of GDP, or over $11 trillion. They think they have no skin in this game.

But they do. Our fiscally reckless policies have major adverse consequences. They will inevitably cause the dollar to devalue, interest rates to rise, and inflation to increase.

This already spooks investors. International investors are so worried that Secretary Geithner had to publicly state the administration is committed to shrinking the deficit back to sustainable levels. His words may not be relevant because it is Congress that holds the purse strings, but the concern is there nonetheless.

Buyers of U.S. Treasuries are also showing their discomfort. Recently, rumors spread that a Capitol Hill vote on a health care deal is further delayed. Interest rates immediately declined and the dollar strengthened. This is no coincidence. Regardless of your personal opinion on health care reform, the fact is that health care could add another trillion dollars to the deficit over the next ten years. By pushing the health care debate back, that danger is alleviated.

The national deficit problem is exacerbated by substantial household debt. There are approximately 110 million households in the U.S. Of those, about 75 million are homeowners. Of those 75 million homeowners, approximately 68%, or 51 million, have mortgages. As of the end of the first quarter of 2009, about 14 million U.S. homeowners, or approximately 27% of all homeowners with mortgages, had negative equity.

That is a staggering number. And it is getting worse by the day. Before home prices stabilize, perhaps 25 million homeowners will have negative equity, or close to half of all mortgagors.

Borrowers with negative equity may be forced to default if they lose their job (unemployment is at 9.5% and trending higher) but they also may be "strategically" defaulting even if they still have a job, as they lose hope of recouping the purchase price of their home and can now rent a similar house at a price lower than their mortgage payment. So our runaway spending has real life consequences for everyday Americans.

I would argue that when people want to keep what they earn, they are not being greedy or unenlightened. And wanting to take what you earn is not progressive. But we digress. The point is, you can't raise taxes on the rich without negatively impacting their productivity and enervating their will to work. And without the most financially productive members of society, the poor will simply be left with more of the burden.

Federal outlay as a percentage of GDP is going to be 27% in 2010. Higher taxes are not a sustainable policy. Instead, there is simply no alternative other than aggressively cutting back spending.


Alan Schram is the Managing Partner of Wellcap Partners, a Los Angeles based investment firm. Email at aschram@wellcappartners.com.