Our Inequality of Outcomes

Wednesday, August 27, 2008; Page D01

Hey, good news on the income front: The Census Bureau reported yesterday that median earnings for full-time male workers rose by $1,653 last year, to $45,113, after adjusting for inflation.

Another year like that, and maybe the typical male worker will finally catch up to where he was in 1973.

Truth is, despite the squishy nature of income data, things haven't been so great for the middle and working class for some time. Every now and again you get a good year like last year, when wages and household incomes increased. That's usually at the tail end of an economic expansion.

But over the past 35 years, the typical American household has managed to eke out only a 15 percent increase in its pretax income. During that same period, the productivity of the American worker -- the value of the goods and services produced per hour worked -- has increased by 90 percent.

So where did all that money go?

To some degree, it went to the stock and bond holders who invested capital in the new equipment and technology that made those workers more productive. You'd expect that from a well-functioning capitalist economy.

What you wouldn't expect is that the rest of the income gains would go disproportionately to the households at the top of the income scale. According to data compiled by the Congressional Budget Office, in recent decades the top 10 percent of households have taken an ever-increasing share of the national income, at the expense of everybody else.

It would be neat if we could blame this upward redistribution on the economic policies of Ronald Reagan or George W. Bush, but for the fact that the trend lines also take in the Carter and Clinton administrations. Moreover, while more pronounced in the United States, there has been a similar trend elsewhere, including in countries with more egalitarian business environments such as Sweden and France.

Up to now, Republicans have tried to ignore the inconvenient truth about increasing inequality. Their first line of defense is to argue that in an economy with as much income mobility as ours, what matters is equality of opportunity, not equality of outcomes -- and then mumble something about more money for community colleges and No Child Left Behind. When that doesn't quite do it, they trot out their all-purpose solution -- the tax cut -- which does little to address the underlying disease but at least offers the salve of letting everyone keep a little more of what they earn. For the past eight years, that was pretty much the Bush administration's strategy. Now it seems to have been Xeroxed into the playbook of John McCain.

Democrats, on the other hand, have seized on middle-class anxiety as their ticket back into power. Early on, their favored solution, pushed hard by organized labor, was to try to tame the market by limiting trade and strengthening the bargaining clout of workers, but that never gained much traction with white-collar voters who didn't trust unions and weren't particularly threatened by trade. So centrist Democrats decided that rather than tamper with the workings of the market and risk sacrificing economic efficiency and competitiveness, it would be better to deal with inequality after the fact by using the tax code as an instrument of income redistribution.

The latest version of that strategy is given voice in Barack Obama's tax plan, which would not only keep most of the Bush tax cuts for working-, middle and upper-middle-class families, but add a few more of his own. At the same time, Democrats vow to restore the inheritance tax on large estates and raise taxes on those with incomes above $250,000. According to the latest analysis prepared by the nonpartisan Tax Policy Center, Obama's plan would raise after-tax incomes from present levels for the 80 percent of households at the bottom of the income scale -- anywhere from 5.4 percent, on average, for households with incomes below $20,000, to 1 percent for households with incomes below $120,000. By contrast, after-tax income would decline by 2 percent, on average, for households with incomes above $240,000, 8 percent for those above $620,000 and 10.2 percent for those above $2.8 million.

Two things to note about the Obama tax plan:

First, there is little evidence that the proposed tax increases on high-income households would seriously harm the economy. The effective average tax rates at the top would be about the same as they were in the mid-'90s, which if memory serves were boom years for investment and entrepreneurship, boom years for the U.S. economy, and boom years for federal revenue.

Second, even with the Obama tax plan, the distribution of after-tax income would still be roughly where it was only four years ago.

The reality is that the market's tilt toward unequal outcomes is now so strong that you can't just rely on a progressive tax code to counteract its effects. To do that, it may be necessary to forgo some of those additional tax cuts for the middle and professional classes to pay for increased spending on early childhood education, state colleges and universities, and expanded public health programs. It may be necessary to "tinker" with the markets just a bit by indexing the minimum wage to overall income growth, using the antitrust laws to bust up oligopolies like those on Wall Street and making it possible once again for workers to unionize without fear of losing their jobs. It may even be necessary to slow the pace of further globalization.

There's a good debate to be had on all of these ideas -- every one involves economic risks and trade-offs. But there is no debating that markets are doing a lousy job of distributing the benefits of economic growth and that another decade of stagnant wages and runaway inequality is unacceptable.

Steven Pearlstein will host a Web discussion today at noon athttp://washingtonpost.com. He can be reached atpearlsteins@washpost.com.

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