Economic Inequality in the United States is by Design

A revealing new examination of the top 1 percent in a variety of countries brings into focus how the American government’s tax, union bargaining, inheritance and other rules widen the growing divide between those at the top and everyone else.

Four economists found that such wealthy and technologically advanced countries as Japan, France and Germany have seen growth at the top, but not the chasm of inequality created in recent decades in the U.S. and Britain.

That is significant because it means that new technologies and the ability of top talent to work on a global scale cannot explain the diverging fortunes of the top 1 percent and those below, since the Japanese have access to the same technologies and global markets as Americans. The answer must lie elsewhere. The authors point to government policy.

The paper’s authors include Emmanuel Saez, the UC Berkeley economist who has won renown for his work examining more than a century of global data on top incomes. The lead author is Facundo Alvaredo of the Paris School of Economics. The other two authors are British economist Anthony B. Atkinson and French economist Thomas Piketty.

The four authors looked at four big issues to see how they drive growing inequality:

—Do lower taxes on the already wealthy, which allow them to save more, make their fortunes snowball?

—Do current rules redistribute more wealth to executives and managers, perhaps at the expense of the companies they run?

—Does inherited wealth, which is on the rise in Europe as well as the United States because of tax rules that make it easier to pass fortunes to heirs, reinforce inequality?

—Does having income from work juice the growth of fortunes, because the savings can be reinvested rather than spent?

Cutting tax rates has become the signature issue for Republicans in Washington. Whatever economic issue arises, their answer is to lower tax rates, which they say will spur the economy.

What the authors find should raise questions about that mantra. They looked at tax rates and economic growth in advanced countries around the world:

If we look at the aggregate outcomes, we find no apparent correlation between cuts in top tax rates and growth rates in real per capita GDP. Countries that made large cuts in top tax rates, such as the United Kingdom or the United States, have not grown significantly faster than countries that did not, such as Germany or Denmark.

The authors note that for more than five decades starting in 1928, at the end of the Roaring 20s bubble that produced the Great Depression, top American incomes were a much smaller share of all incomes. Those at the top began gathering a rapidly growing share of national income when the first Reagan tax cuts took effect.

In 1981 the top 1 percent had 10 percent of all reported income, but by 1999 they were at 20 percent. That share has risen and fallen with the economy since, but the 12-year average shows the top 1 percent enjoying a fifth of all income since 2000.

For those at the top, a great deal of economic gain is not reported as income. Among the economic gains not treated as taxable income is the rising value of stocks and other assets. In addition, under a little-known federal tax law, executives, movie stars, athletes and top salespeople can save unlimited amounts pre-tax. Some of them have salted away multi-billion-dollar untaxed fortunes, as I have been showing since 1996.

Saez has shown that in the two years of recovery for which we have data, 2009 to 2011, 121 percent of the income gains went to the top 1 percent. That means the 99 percent saw its share of the national income pie sliced more thinly.

These gains were so highly concentrated that 40 percent of all the increased income in our nation of 314 million went to fewer than 16,000 households.

On the rise of CEO and other executive pay, while that of most workers is flat to falling, the authors find that “tax cuts may have led managerial energies to be diverted to increasing their remuneration at the expense of enterprise growth and employment.”

In plain English, that means some executives are lining their own pockets at the expense of the enterprises they run. In a country where they can keep most of their increased pay because of tax rate cuts, executives have an incentive to focus on their wealth, while if tax rates were at pre-Reagan levels, pushing for much higher pay results in much less personal after-tax gain.

Cuts in gift and estate taxes, the authors show, also fuel inequality as those who chose their parents with an eye towards wealth do better than those born to less-wealthy parents.

High tax rates, including on assets passed on to heirs, “reduced the capacity of large wealth-holders to sustain their pre‐eminence.” In other words, it is hard to maintain a dynasty if you have progressive taxes, in which those who benefit the most from a society in economic terms repay that society with their taxes.

The authors caution that it is too early to tell, across many countries, just how reduced taxes are affecting inequality.

Perhaps the most powerful finding in the paper is that people who have a lot of assets tend to also earn a lot for their labors. “Today, a CEO may be both better paid and more able to accumulate,” the authors write.

And at the heart of that ability to make more from work and make investments grow more are lowered tax rates on those at the top. With lower rates, boards of directors are willing to pay more, executives get to keep more and of the money they save, they also get to keep more — all of which would be fine if society as a whole were better off as a result, something the American economic data has shown is not the case.

In short, what the paper shows is this: Inequality is a product of government policy.

David Cay Johnston has won the Pulitzer Prize and George Polk Award. He is the author, most recently, of The Fine Print: How Big Companies Use "Plain English" to Rob You Blind. He wrote this piece on inequality originally for nationalmemo.com. Reprinted with permission.