Does 39.6 percent, which is today’s top marginal tax rate, sound like the optimal top marginal tax rate to you? No? How about 80 percent? Not that either? Well, if you’re concerned about reducing income inequality in the United States, then you better get used to the idea of having substantially higher top marginal tax rates than we have now.
At least that’s what economist Thomas Piketty of the Paris School of Economics would like you to believe.
Income distribution is so skewed in the United States, according to Piketty, because the U.S. has such low tax rates. A much higher tax on upper income — say 80 percent — coupled with a significant tax on wealth — say 10 percent — would go a long way toward making America’s income distribution more equitable than it is now.
Piketty presented his ideas during his April 15 talk (a fitting day to talk about taxes, as it’s the day when some 154 million Americans file their tax returns and pay around $1.4 trillion in federal income taxes) at an event held at Washington’s Economic Policy Institute and co-sponsored by the Washington Center for Equitable Growth. Piketty has just published a book “Capital in the Twenty-First Century,” in which he measures income inequality in some three dozen countries. Because he was in Washington, his talk largely focused on the gap in the United States and what to do about it.
How bad is income inequality in the United States? Pretty bad. Piketty shows that the top one percent of American households accounted for more than 22 percent of the country’s income in 2012. That same one percent also received 95 percent of the income gains from 2009 to 2012, according to Heather Boushey, executive director of the Washington Center for Equitable Growth, who moderated the panel discussion.
The problem isn’t limited to the United States. A few months ago, the anti-poverty group Oxfam used Piketty’s data to estimate that the wealthiest one percent of people in the world controlled more of the world’s wealth than the bottom 3.5 billion people combined.
This leads to three main questions. What’s causing this divergence in income across so many countries? Why is income inequality bad? What should policymakers do about it?
First, capital is the chief culprit, according to Piketty. It’s not because capital (or capitalism) is bad, per se. Capital investment is essential for economic growth. And no one would argue that the destruction of capital during the 20th century’s two world wars was good for the global economy, even though income inequality narrowed because of it.
The real problem, Piketty and others argue, is that capitalists — meaning the chief executive officers and other leaders of American industry — are paid too much.
These people — the so-called “supermanagers” — earn an outsized share of national income. For example, estimates from Piketty’s book and related research with Emmanuel Saez of the University of California at Berkeley show that up to 70 percent of the income in the top 0.1 percent goes to these supermanagers.
Unfortunately, as Nobel laureate Robert Solow remarked, “these supermanagers are not all that super.” In setting their compensation, committees at these firms tend to fall under the sway of the “Lake Wobegon” effect, where everyone believes they’re above average, he said.
“These compensation committees seem incapable of linking pay to performance,” added Josh Bivens, research and policy director at the Economic Policy Institute.
It may seem obvious to some that one percent of the population shouldn’t receive more than 20 percent of the nation’s income (it should be noted that they also pay about 24 percent of federal taxes, according to the Congressional Budget Office). But, doing something about it isn’t so easy. After all, if income inequality is bad, then the logical conclusion is that everyone should have the same income, i.e., a socialistic economy. That’s not an argument anyone’s making.
That said, there are pernicious effects caused by the gap between the richest and the poorest members of an economy that justify doing something to reduce the gap. To Piketty, the gap poisons “the working of democratic institutions – extreme inequality leads to corruption of the democratic process.”
Betsey Stevenson, who is a member of President Obama’s Council of Economic Advisors, had a different view. She said that society’s overall well being will rise as income inequality becomes less extreme. Society gains more by increasing the income of those at the bottom of the economic ladder than it loses by taking away income from those at the top of the economic ladder, Stevenson said, using standard theories of diminishing marginal utility to highlight the point.
She also noted that the International Monetary Fund has published new research showing that “policies that reduce inequality have a more benign impact on growth than once thought.”
So, accepting that extreme income inequality is bad, we need to figure out what to do about it.
That’s where taxes come in. Piketty believes that the optimal top tax rate is about 80 percent. (That’s pretty close to the top rate of 94 percent that President Franklin D. Roosevelt imposed to help finance World War II. The top rate had fallen to 28 percent under President George H.W. Bush.) But, he says that an 80 percent tax rate is unrealistic.
Piketty has another pretty radical, at least for the United States, way to shrink the share of wealth at the top — introduce a global tax on all capital. This means taxes on not just stocks and bonds, but also land, homes, machines, patents — you name it; if it’s wealth or if it generates what tax authorities call “unearned income,” then it should be taxed. One other thing. All countries have to adopt the tax to keep capital from fleeing to tax havens.
Wealth and financial taxes exist in many forms around the world. The idea of a financial transactions tax has a stellar pedigree, as Nobel laureate James Tobin of Yale University proposed the idea in 1972. France has a tax on wealth and on financial transactions, while the finance ministers in 11 of the 28 European Union countries are working on introducing a financial transactions tax. In the United States, Sen. Tom Harkin (D-Iowa) and Rep. Peter DeFazio (D-Ore.) introduced The Wall Street Trading and Speculators Tax proposal, which would collect 3 cents on every $100 in stock transactions.
But, as Nobel laureate Robert Solow said, using tax policy to narrow the income gap is hard.
“This is a country that’s no damn good at income redistribution,” Solow lamented.
And, with taxes off the table, policy makers will have to turn to other areas to increase income at the lower end of the population — providing pre-school education, making college more affordable, strengthening wage growth — to reduce income inequality.