A key issue in the upcoming (and seemingly interminable) Presidential campaign is supposed to be inequality. Major candidates are already talking about their solutions to the problem of increasing inequality in the U.S. Not surprisingly, most of the proposals are for tired prescriptions from the past. Democrats call for increasing minimum wages while Republicans talk about education and job training to enhance upward mobility of workers. While both of these are both potentially worthwhile economic policies to pursue, neither is likely to reduce inequality dramatically in the U.S. The issue is much more complex.
Income inequality in the U.S. can be measured several ways, most of which show the same story. Below are data from E. Saez from the University of California, Berkeley. These data show the share of income captured by the top 10% of income earners in the U.S. over the past century. Inequality peaked in the late 1920’s just before the Great Depression, with the top 10% of U.S. earners capturing about 45-50% of incomes, depending on whether you include capital gains or not. Inequality declined from this point until the 1970s when it started growing again. By the early 21st Century income distribution in the U.S. was even more unequal than it was at the end of the 1920s. The richest 10% of the population now capture half the income (and the top 0.01% alone get almost 5% of the income). The picture is much more nuanced than this one graphic shows and there are more data at Saez’s web site for you to peruse.
Economists have lots of explanations for the growth in inequality since the 1970s, but it was not supposed to happen. The dominant economic thinking of the time when inequality was declining in the 20th Century was that this was due to overall growth in income. The belief was that “a rising tide lifts all boats,” and rising incomes in growing economies would automatically result in declining inequality. And that largely worked in Western capitalist economies through the 1970s. What was not supposed to happen was what came next. Generally rising incomes from the 1980s onward resulted in most of the gains going to a smaller portion of the population. The tide was coming in but only some of the boats, the really fancy ones, were lifted.
Why? Some economists think it could be free trade and globalization of the economy. Trade created greater competition for U.S. workers by foreigners willing to work for lower wages. The decline of Maine’s shoe and textile industries fit this narrative. Some think equally and more important is the shift in the U.S. economy to service and technology sectors (also part of globalization) which rewards disproportionately those with financial or technology skills. Since those skills are rarer in the workforce, those workers are able to bid up their wages, garnering a greater share of incomes as a result.
Other economists look to tax and public expenditure policy as part of the issue. By reducing our reliance on income taxes to fund public services, lowering the highest marginal income tax rates, and creating more opportunities in an increasingly complex tax code to avoid taxes, higher earners have been able to keep a larger share of their earnings. That gives those people more money to invest which allows them to earn even more in the future. In fact, a big part of these tax code changes was reduction in the tax rate on capital gains, because those earning capital gains were characterized as the “job creators.” The logic was that lower capital gains tax rates would then encourage more investment and thus create more jobs.
Since owners of capital were now able to keep more of their earnings from their capital, they sometimes did invest more. The result was that workers in the U.S. became more productive. They had more and better capital to work with along with their increasing skills. So these more productive workers should have continued to earn a fair share of the country’s income. It did not work out quite that way, as data from the Economist magazine show. Worker output per hour has more than doubled since 1970 and employee compensation as a share of national income has decreased steadily over that time period. Another way of saying this is that capital was earning a steadily larger share of national income. This is a good depiction of what has happened in Maine’s pulp and paper industry. So reducing taxes on the “job creators” by reducing capital gains tax rates has not created jobs, rather it has increased the share of national income that goes to the owners of capital. At the same time inequality has increased.
So what do we do? Certainly we should think about increasing the marginal rate for taxing capital gains. Treating capital gains more favorably than income from work has contributed to growing inequality. It may stimulate some growth, but virtually all the benefits of that growth go to those least in need of more income. We need to stop treating growth as a panacea for all economic problems. It may well be imperative for improving the lives of people in the poorest countries of the world, but for us distribution has become the primary economic problem.
We might also change the way we finance Social Security. Currently the first dollar of income from work is taxed, both the employee and the employer paying a tax of 7.65% per dollar earned. For employees, this payroll tax ends at $118,500 in annual earnings. Above that, no tax is paid to support Social Security. This makes the payroll tax one of the most regressive in our system and discourages employment. We could eliminate the tax on the first $5,000 of earnings funding the costs by eliminating the $118,500 ceiling or by some other form of taxation. (This would be an excellent use of a revenue neutral carbon tax, but that is the subject for another day.)
We could consider how our tax codes, accounting rules, and ethics of corporate governance have allowed executive compensation in the private sector to increase dramatically while wages for non-executive workers stagnate or decline. The ratio of CEO to worker compensation in the U.S. has increased by a factor of 10 since the 1960’s, just the time period when inequality bloomed. Are CEOs contributing that much more to our country’s wellbeing than they were 50 years ago?
It is important to note that all of these issues are matters of public policy. It is not some anonymous market force that explains the inequality story in the data above. Rather it is a series of policy changes at the state and Federal levels that have changed the rules of life and business in America in favor of the very richest. Of course this kind of talk invites the accusation of inciting class warfare. What we have seen is guerilla warfare waged by the richest in our society while we were not looking – and they are winning.