The Rich and the Rest

By Robert J. Samuelson
Wednesday, April 18, 2007

In a democracy, there is something unsettling about great extremes of wealth and poverty. One question today is whether rich Americans are claiming too much of the economic pie. Look at the latest astonishing estimates from economists Emmanuel Saez of the University of California at Berkeley and Thomas Piketty of the Paris School of Economics. They find that the richest 10 percent of the population received 44 percent of the pretax income in 2005. This was the highest since the 1920s and 1930s (average: 44 percent) and much higher than from 1945 to 1980 (average: 32 percent).

But the biggest gains occurred among the richest 1 percent. Their share of pretax income has gradually climbed from 8 percent in 1980 to 17 percent in 2005. Indeed, many others in the top 10 percent seem mainly upper middle class. For example, those in the richest 90th to 95th percentiles had incomes of about $110,000.

We don't know exactly who is in the top sliver. Economists Steven Kaplan and Joshua Rauh of the University of Chicago estimate that there were about 18,000 lawyers, 15,000 corporate executives, 33,000 investment bankers (including hedge fund managers, venture capitalists and private-equity investors) and 2,000 athletes who made roughly $500,000 or more in 2004. Although there are others from these groups in the top 1 percent (average income: $371,000), they clearly would make up only a small fraction of the total. With more than 140 million U.S. workers, the top 1 percent exceeds 1.4 million (and the top 10 percent equals 14 million).

As for what's caused greater inequality, we're also in the dark. The Reagan and Bush tax cuts are weak explanations, because gains have occurred in pretax incomes. Globalization, by increasing company sizes, may have boosted executive salaries and payouts. The economy also has become more competitive -- with more pressures on firms from foreign rivals, new technologies and the stock market. Pay practices de-emphasized "fairness" and focused on what the market would bear. Opportunities for huge gains -- from company start-ups, from dealmaking -- mushroomed.

Whatever its source, the present income distribution hardly seems optimal. The rich often appear caught up in a race to out-consume each other and to differentiate themselves from the middle class. The Financial Times, a paper for the economic elite, regularly publishes a glossy magazine supplement called "How to Spend It" that celebrates exotic vacations (spas in New Zealand) and purchases ($267,000 for a rare motorcycle). Even so, the lifestyle gap with much of the middle class has shrunk.

"So I can't afford a [villa] on Bermuda, but I can get in on a time-share for the weekend," advertising professor James B. Twitchell of the University of Florida writes in the Wilson Quarterly.

That said, the inequality debate is misleading. Up to a point, inequality is inevitable and desirable. The prospect of doing well encourages people to work hard, develop new skills and take risks. It anchors America's entrepreneurial spirit and economic success. Most of today's rich have earned -- not inherited -- their status. Among the top 1 percent, report Saez and Piketty, more than four-fifths of income comes from salaries and self-employment. In 1916, the top 1 percent relied far more heavily on income from dividends, interest and rent.

The question of whether the rich pay their "fair" share of taxes has triggered one of those debates in which both sides are half right. It's true, as liberals say, that the Bush administration pampered the rich. Tax cuts on capital gains (stock profits) and dividends weren't needed as incentives. Ending the estate tax would be similarly unwise. But it's also true, as conservatives say, that liberals popularize the fantasy that taxing the rich more will solve most budget problems.

It won't. The richest 10 percent already pay half of all federal taxes, including the 25 percent paid by the top 1 percent. Just how much these taxes could be raised without dulling economic incentives and stimulating massive tax avoidance is unclear. But increasing the taxes on the top 1 percent by 25 percent wouldn't cover even today's budget deficit, let alone pay for new programs (universal health insurance, more school aid) or baby boomers' retirement costs.

It would be healthier if the trend toward greater economic inequality reversed itself spontaneously. The poor aren't poor because the rich are richer. Their poverty reflects low skills, poor work habits or bad luck. But if the middle class thinks the rich are grabbing most of the gains from economic growth, they will feel resentful. The result could be a self-defeating debate over income redistribution, not growth. To paraphrase economist John Maynard Keynes: The rich are tolerable only so long as their gains can be held to bear some relation to roughly what they have contributed to society.

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