Solving Inequality Problem Won't Take Class Warfare

By Steven Pearlstein
Wednesday, March 15, 2006

Ask most economists what to do about rising income inequality, and they'll say it's better to redistribute income after it is earned than try to tamper with the markets now generating such unequal outcomes.

The reason is simple: The factors responsible for the inequality -- the new technology, increased trade and immigration, deregulation, deunionization, the relentless focus on "shareholder value" -- are also the ones that have produced big gains in productivity and job growth and restored the United States as the world's most competitive economy.

The classic redistribution scheme would be to raise taxes on the top 10 percent of income earners, roughly those with household incomes above $125,000, who have captured the lion's share of the benefits of economic growth. The money could then be directed to the poor and middle class, whose incomes have been flat, in the form of tax cuts and increased government benefits and services.

This involves more than simply canceling the Bush tax cuts. After all, parts of the Bush tax cuts, like the new 10 percent bracket, actually make the system more progressive. And while Democrats love to demagogue on the reduced 15 percent rate for capital gains and dividends, they've never really made a credible case for why capital income should be taxed twice.

Rather, the situation calls for more fundamental tax reform -- one that shifts the tax burden onto the rich without unduly distorting economic decisions or imposing the high marginal rates that only invite tax avoidance. The idea would be to close loopholes in both the corporate and individual income taxes that benefit the rich more than everyone else. Throw in, for good measure, the restoration of a reasonable inheritance tax that couldn't be bypassed through insurance scams or offshore trusts.

Indeed, you can construct a tax regime that, without increasing the top marginal rate beyond 35 percent for either individuals or corporations, would not only balance the federal budget but also provide extra revenue to repair and extend the social safety net and revitalize public services.

This last point is crucial. Up to now, Americans have put up with more income inequality than Europeans, Canadians or Japanese. But their tolerance is wearing thin as they see Wall Street sharpies and corporate executives getting fabulously rich by undercutting the economic security of the working poor and middle class. Not only are job security, private pensions and employer-provided health care coverage being cut back, but there is also a noticeable erosion in the public services that serve as a backstop -- schools and colleges, transportation, health, recreation, job training, and food stamps. Many citizens feel they are now walking an economic tightrope, without a net, and it is this -- more than mansion-envy -- that animates their anxiety.

As a rough approximation, the top 10 percent of income earners now take in an extra $750 billion a year because of their increased share of national income. I think it hardly "class warfare" to suggest taking back a chunk of that good fortune, investing it in public goods that can help take the sting out of rising income inequality.

That said, I doubt that merely redistributing income is going to be enough to offset, let alone reverse, the dramatic increase in income inequality over the past 30 years. The forces that are pushing the economy toward inequality are not abating. In fact, they are just picking up steam, moving their way up the economic ladder from the poor and working class to college-educated engineers or legal researchers, who now find themselves competing with workers in India and the Philippines. And with the continuing trend toward globalization, corporate consolidation and "winner-take-all" competition, the gap between ordinary workers and superstars continues to widen exponentially.

Free-market types will huff and puff that any attempt to tinker with the market machinery will turn the United States into France. This is nonsense. There is nothing in theory or experience to suggest that modest steps to soften the rules of competition, or rebalance the power relationship between labor and capital, will "kill the goose." Nor is it unreasonable for a society to decide that it is willing to sacrifice a half a point of GDP growth to achieve greater social harmony.

What "modest steps" do I have in mind?

One would certainly be giving workers more bargaining leverage by restoring the right of workers to form a union -- a right that's been effectively repealed through the indifference of the National Labor Relations Board.

Or requiring shareholders to approve executive compensation packages.

Increasing the minimum wage, and indexing it to inflation, would help push up wages at the bottom of the income ladder.

Would American capitalism be brought to its knees if all companies had to pay half the cost of catastrophic health insurance for their workers? Or if companies were required to fully fund their pension promises each year before using free cash to pay dividends, buy back shares or fund executive bonuses?

Sixty years ago, American political and industrial leaders came up with a "social compact" designed to generate enough economic equality to discourage dangerous new ideas like communism and socialism. It worked remarkably well. But now that communism and socialism are in retreat, the compact is crumbling. Shouldn't there be something to replace it? And wouldn't these steps be a reasonable place to start?

Steven Pearlstein will host a Web discussion today at 11 a.m. at He can be reached

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