Yesterday I promised to do some spitballing about things that could be done about income inequality and today I’ll try to make good on that promise. For the purposes of this post I will only talk about federal adjusted gross income. Not wealth; not gross income. Just AGI. All of my info on incomes is derived from this IRS report, Table 1.
As I also said yesterday most prescriptions use a one-size-fits-all approach that I think is counter-productive so I’ll divide my prescriptions into three categories: the top .1% of income earners, the top 1% of income earners, and the rest of us. To put those categories into some perspective there are roughly 1.4 million people in the top 1% of income earners and 140,000 people in the top .1%. To be in the top .1% of income earners you’ve got to have an AGI of about $2.2 million or greater; to be in the top 1% of income earners you’ve got to have an AGI of $485,000 or greater.
Most of the people in the top .1% are either prodigies, the Michael Jordans ($100 million annual income) or Dwayne Johnsons ($65 million annual income) of the world, CEOs of large to medium-sized companies, or people in the financial sector. They account for about 11% of all income.
The most frequently encountered prescription for reducing income inequality, increasing the marginal tax rates, purports to address those ultra-rich. No proof is ever presented for the effectiveness of high marginal tax rates in reducing income inequality. It’s merely assumed.
IMO increasing the marginal tax rate on the prodigies is not warranted and for the rest of the top .1% I doubt it would be effective. They can just leave, as the Rolling Stones famously left the UK. And when you have that much money there will always be friendly politicians to write handy loopholes into the tax code for you.
It would probably be much more effective for reducing the income of the top 1% of income earners than of the ultra-rich. Amazingly, a lot of the top 1% are W2 employees and most of their income is in the form of salaries. Basically, they’re captives.
CEO salaries haven’t always been as stratospheric as they are now. That started in 1993, the perverse result of a reform to the tax law. The deductibility of CEO salaries from corporate income taxes was capped at $1 million with the the exception of incentive pay which included things like stock options.
Big companies receive government subsidies in thousands of forms. The provision above in the tax law is just one of them. If you take the king’s penny you are the king’s man, so IMO capping executive pay is perfectly legitimate. The reforms I would propose would be to cap the deductibility of executive pay at $3 million indexed for inflation (that should keep them in the top .1%) and eliminate the exemption of incentive pay. It just hasn’t worked. Companies could continue to pay CEOs whatever they cared to. It just wouldn’t be tax deductible.
My prescription for curbing the sky-high compensation in the financial sector is to stop subsidizing it. Prohibit quantitative easing by law. Tax the compensation as ordinary income.
What about the 1%? Most of the top 1% of income earners excluding the ultra-rich are either professionals, upper management in big companies, or in the financial sector. This is the group where a higher top level income tax bracket would be most effective.
My preference over increasing the marginal tax rate would be to stop subsidizing them. If you can’t bear to end the subsidies cap their wages and index that to inflation. I honestly think that this group should be left alone. That greatly reduces your options for greater income equality.
They say if you can’t raise the bridge lower the river and IMO that’s a better solution for producing greater income equality, too. Let’s break that down into pieces.
First, if anyone has a prescription for income equality when 15% of the population are immigrants, mostly without skills or good command of the English language, I’m all ears. I don’t think there is one but I’m willing to listen.
Consequently, I think that immigration reform is a vital component of producing a society with greater income equality. We should have serious workplace enforcement and enforcement at the borders. We should abandon diversity quotas and family reunification as a primary goal of immigration policy.
The chances of doing any of those things are approximately zero which I believe means we should start getting our heads around a non-egalitarian society with substantial income inequality.
However, let’s continue. The graphic at the top of the page is from a Pew Research report and it illustrates three factors behind income mobility, i.e. making the poor richer rather than making the rich poorer. In summary they are race, education, and married status.
IMO the education point is bogus—cargo cult thinking. It might be that if we had much more narrowly focused higher education subsidies they would be effective in boosting the incomes of the people in the lowest income quintiles if
- They finished high school.
- They finished college.
- We created more jobs that required higher education.
- We stopped importing people to fill those jobs and thereby allowed the wages for those jobs to increase.
That’s a lot of ifs.
That leaves us with race and married status. I’ve been saying we should have much more narrowly tailored programs aimed at creating more prosperity among native-born African Americans, the descendants of slaves, for decades. Many of the policies and programs that have been put in place have the perverse effect of boosting the fortunes of immigrants from sub-Saharan Africa and the Caribbean and leaving our native-born black population to fend for themselves.
I’ll leave it to you to come up with policies to encourage marriage that are effective, narrowly tailored, and would be politically possible. Hey, if this stuff were easy we wouldn’t have the problems.
I encourage you to put your own prescriptions in comments.
I think corporate taxes need to be lowered. The Carrier deal was another example of a business willing to relocate with taxation being a consideration or using it for a bribe. I don’t know enough about federal and state corporate taxation to make a specific proposal, other than I don’t think it should be a zero-rate, and it should probably be as flat as possible. But a major consideration should be that the rate cannot be so high as to reduce employers.
What are the jobs that are most likely to be able to lift someone from a lower quintile of income to the next one or two? Its probably working for a corporation. It might be working for a company like Carrier, but this is not really about Carrier itself. Large established businesses don’t tend to be great jobs creators; but Carrier got a subsidy, while Acme Widgets, Inc. down the road got nothing.
While I’m on the topic, I think the taxation advantages from building on the other side of the Rio Grande need to be eliminated. I think that might be something that is going to happen during the next Congress. It will not prevent job movement based upon lower labor costs, which is fine; I don’t think the U.S. should be trying to build an economy based around having the lowest labor costs around. But we shouldn’t maintain tax incentives to encourage production elsewhere.
Really interesting posts, David, I actually made a point to read this as soon as the coffee penetrated.
I think looks like the problem is education, marriage and race in part because we measure those things relative to the economy. The reason education-worship is as you correctly say, a cargo cult mentality, is that there is a necessary connection between intelligence and education, and higher education – professional level – is simply never going to be of any use to be people on the bottom half of the bell curve. More and more of society’s lucrative jobs amount to managing data (financial, medical,) while fewer and fewer of our jobs have to do with the moving or directing of objects (plows, trucks, machine tools.) Brains are worth far more than hands, and at least half the population have brains not suited for brain work. Insisting that these folks just need to buckle down and become engineers is as ridiculous as demanding that little people play for the NBA.
The .1% may have inherited their money, but I think if we had good data we’d see that the 1% is essentially a hierarchy of intelligence. You don’t get an MD or a JD or a PhD without being above, and usually well above, IQ 100. In a sci fi scenario we could theoretically start playing with DNA to raise IQ, but of course that’s a silly game, you’d just displace 120s with 130s and so on – IQ inflation.
Marriage (when talking money) is about cost-cutting and burden-sharing. When my wife makes money I’m more secure, when I make money she’s more secure. If she gets sick, I still earn. If I run away from home (unless you have teenagers don’t judge) then my wife still earns. Rather than larding that economically robust relationship up with emotional attachment, I wonder if there’s a way to duplicate the economic advantages through voluntary associations other than marriage per se. Again, maybe a sci fi scenario, but no less likely than some of the more traditional suggestions. Marriage used to be more explicitly about money and the creation of little heirs/farmhands. It became much more about emotion as the large family lost much of its economic usefulness. We should be able to regain some of the lost economic advantage without insisting that everyone fall in love.
Racism is a rational human reaction that has become irrational as we moved from band to tribe to city to nation to globe. It’s very hard to deal with because down below the civilized level it makes sense: if your little forager band is white and you come across a band that’s black it will light up your stranger-danger alert more quickly than if you’ve run into people who look like you. Different = Dangerous to the lizard brain, and we survived as a species by being able to quickly identify danger.
I wonder if rather than seeing racism as a moral failing we should begin looking at it as a mental health issue. Normal human fear that becomes too extreme is called paranoia, and we treat it. Normal human attraction to fat and sugar becomes gluttony and obesity and we treat that. It is perfectly normal for humans to fear snakes, but carried to extremes it’s a phobia and we treat it. Civilization imposes burdens, among which are that we must curb natural human tendencies that are incompatible with said civilization. What if the next time some high school kid paints a swastika on a school building rather than wag our fingers at him and shun him, we brought him to the counseling office, told him it’s not his fault and that he’s suffering from a personality disorder and will need to see a shrink and attend counseling sessions? A substantial number of people (I’m one) are largely indifferent to being thought of as, “bad,” but no one likes being thought of as mentally ill.
But more basically, don’t we need to start with some idea of what inequality means? What degree is okay, what degree is too much? We probably all agree that we don’t want a society where 1% are billionaires and 99% are starving. But we’d probably all agree we don’t want to enforce absolute equality. What are we comfortable with? How much is too much, how little is too little?
Most professionals (MDs or JDs) are between one standard deviation and two standard deviations above normal intelligence (115 and 130). Above two or three standard deviations there’s very little relationship between income and IQ.
It’s a slightly different story with PhDs. Depends on the PhD. But PhDs aren’t that closely associated with higher income.
BTW, I think there’s more of the “lizard brain” involved in racism than you might. Have you ever wondered why our close relations in genus homo aren’t around any more? I think we killed ’em off.
That’s a sucker’s game. Practically a sure path to a stratified society.
Either U. S. corporate taxes should be eliminated altogether or the rates brought into line with those in other OECD countries. Companies aren’t leaving the U. S. for Uzbekistan (8%) or Montenegro (9%). They’re going to Canada (15%) or Ireland (12.5%).
(1) Trade policy. A focus on increasing exports of products/services from people with incomes up to 150K (like manufacturing) while increasing imports (and through competition, lower the price and income derives) of products/services from people with incomes beyond 150K (mostly intellectual property).
(2) Inheritance tax. Get rid of loopholes via foundations.
(3) Stop subsidizing the rich via the tax code. An example is the tax credit for buy Tesla’s. Its amazing how many people defend a tax break for buying $100000 cars.
(4) Reform the use of credentialing and other non-market means for many professions that are used to artificially restrict supply. Examples include actuaries (they “curve” exams to ensure a regulated number of people can pass), and optometry (they have a limited number of schools)
(5) Health care costs reform. Getting health care cost down should boost incomes, and as a percentage of income, I think the middle class / lower class spend more on health care.
An observation, the countries that traditionally have low income inequality and not been forced by communism are Japan, and the Nordic countries. What they have in common is a high degree of homogeneity which makes possible strong social community and cohesion. I think that community and cohesion makes possible politically policies that help with income inequality.
Something to think about when you see how our culture encourages one half of the country to view the other half as an enemy.
All I can see from the bottom here is that the poor need to manage their money. People you mentioned. Athletes, entertainers, even c e o ‘s would have their pay reined in if no one bought what they sell.
I know, won’t happen, but it is still true that if no one bought Bull’s tickets, M J would not be rich.
What interested me more personally, is marriage. My daughter, a minority victim, has a son (5) with another minority victim, pregnant with another minority victim, (daughter in april). They have lived as a family now for 12 years and will not marry. Major reason? Health care. Get married and lose coverage. Yes I know, this is gaming the system, but everybody does it.
I agree with that observation strongly. I’ve made similar remarks myself.
WRT trade policy the I think our problem is less a trade policy problem that it is a monetary policy problem. If people in the countries with which we trade were only able to use the dollars they receive for the goods they sell here to buy products and services made in the United States, the problem would take care of itself.
But they’re able to purchase dollar denominated securities instead and earn interest on them without American-made products and services competing with their own domestic industries.
Besides the U. S. economy is just too large for us to become a lot more export-driven. Together just four countries (U. S., China, Japan, Germany) account for about half of global GDP. China, Japan, and Germany are all heavily export-driven. There just isn’t enough world GDP for us to be export-driven, too.
I am pretty skeptical about fixing income inequality now. The wealthy are now so wealthy that they control the economy, the media and our politics. We just elected a sleazy billionaire who put more billionaires in his cabinet. Wonder whose interests they will represent? They won’t allow any changes that will hurt them or help everyone else, but if we could get them through, the following might help.
Truly universal health care.
50% death tax with no loopholes.
Tax expenditures favoring the wealthy should be reduced/eliminated. For example, charity contributions only deductible up to $10,000. Mortgage limit at $200k.
All income in the finance sector taxed at ordinary income rates.
Eliminate marriage penalties on all taxes and health care. Have not thought this through, but how about a more generous deduction for married couples with children than for those who are single?
Eliminate the exotic waivers that let corporations bring in large numbers of workers that allow them to fire existing employees.
Eliminate legacy admissions at colleges.
Provide tax incentives to married couples who have large differences in their incomes. (Reduce assortative mating.) Alternatively, male and female only law schools and medical schools.
While I favor eliminating the corporate income tax, I don’t think that will do anything about income inequality.
Steve
Dave Schuler: The most frequently encountered prescription for reducing income inequality, increasing the marginal tax rates, purports to address those ultra-rich. No proof is ever presented for the effectiveness of high marginal tax rates in reducing income inequality. It’s merely assumed.
Tax reduction in inequality
Income and taxes of top 1%
The United States is not Norway. We presently have about the highest total rate of taxation since World War II.
How do you plan to extract more money from the taxpayers? Just raising nominal rates doesn’t seem be enough.
The issue is not whether in theory a higher marginal rate would realize more revenue. The issue is whether in practice in the United States it would do so. See here:
I am not arguing that Americans are overtaxed relative to the rest of the world. I am arguing that we’re taxed at about the level that has been deemed politically acceptable.
Dave Schuler: The United States is not Norway.
No. We provided data for several countries, as well as for the top 1% of the U.S. You had claimed that the relationship was “merely assumed”, but there seems to be at least some evidence of a historical relationship between tax rates and income inequality.
Dave Schuler: We presently have about the highest total rate of taxation since World War II.
Revenue-to-GDP was 18% in 2015, less than in 2000, and similar to previous cyclical highs (1952, 1969, 1981, 2007).
Dave Schuler: The issue is not whether in theory a higher marginal rate would realize more revenue.
Thought the question was income inequality, not raising revenue.
Yes, we’re also not France. My goodness, how facetious can you be? Comparisons between countries are only relevant when the countries are similar. We’re pretty different from other countries. Unless you can find another highly diverse country with a median income of $50,000 and 330 million people, all that such comparisons prove is that you can use Google.
Look at your 18% graph again. Yes, during boom times and during war we’ve temporarily had very slightly higher effective federal tax rates. That doesn’t demonstrate that raising marginal effective tax rates will be an effective policy in producing greater income equality and it doesn’t demonstrate that a 20% or higher effective tax rate can be accomplished. You’re hanging an awful lot on that 19.6% in 2000.
Is it your position that a 19.6% effective tax rate will solve our problem with income inequality? If not, what is your point?
Dave Schuler: Is it your position that a 19.6% effective tax rate will solve our problem with income inequality?
Higher marginal tax rates do not generally produce more federal revenue, which have been remarkably stable since WWII, but they may help reduce income inequality.
You can enact marginal tax rates into law. That doesn’t enact higher effective tax rates into law.
Is your view that a higher marginal tax rate in the absence of a higher effective tax rate will reduce income inequality by a mechanism other than by motivating more rich Americans to move to Belize? What’s the mechanism?
Dave Schuler: Is your view that a higher marginal tax rate in the absence of a higher effective tax rate will reduce income inequality by a mechanism other than by motivating more rich Americans to move to Belize?
We’re saying that your claim that the relationship between marginal tax rates and income inequality is “merely assumed” is false. Historical data and the experience of different countries at least suggests such a relationship.
If marginal tax rates were the only variable you might have a point.
Just to clarify my position I think that income inequality is a problem. It’s not consistent with social equality and I want my country to be one with greater social equality.
I don’t think that higher marginal rates alone will accomplish that but they might be part of the solution. I think that other components of the reforms will include making our immigration policy more like that of Canada or Australia and enforcing it more like Canada or Australia does, changing corporate governance regulations, ending subsidies to the financial sector, and capping deductible executive pay including incentive pay.
Even those reforms which I fully acknowledge are politically very difficult probably won’t be enough.