The Reagan tax cuts didn't create most of the new income inequality, and Democrats can't reverse the trend by soaking the rich.
Democrats are celebrating, with good reason. They've raised taxes on the rich without creating a major capital gains loophole. The affluent will now bear their share of the pain of deficit reduction. And Democrats stand for something again: tax fairness.
But before we all raise our populist six packs in a toast, a few sobering words are in order. In the headiness of the tax-the-rich surge, certain oversimplified concepts were bandied about, while some harsh realities were glossed over. Unless these misconceptions are cleared up, they could produce a nasty post-progressivity hangover for the Democrats. Better to purge the following three ideas from the party's word processors immediately:
1. The tax code is regressive. Standard Democratic rhetoric now disparages the "regressive tax code" of the Reagan era. In fact the federal tax code -- even under Reagan, and even including the Social Security payroll tax -- was still "progressive," meaning that richer people paid a higher percentage of their income than poorer people. The debate is about the degree of progressivity. Under Reagan the rich paid more, but not as much more. The system got less progressive. Now it will be a bit more progressive. It still won't be as progressive as it was, say, in 1977, and we can expect Democrats to call for a return to those halcyon days. That's fine. But they should drop the "regressive" charge. As the party of activist government, and hence of the taxes that pay for it, Democrats of all people should be wary of encouraging anti-tax sentiment by painting the system as less fair than it is.
2. The Reagan tax cuts are what made the rich richer. The rich did get richer in the '80s, while everybody else lagged behind. But why did it happen? Kevin Phillips, whose recent book gave Democrats their current catechism, writes that the Reagan tax shifts "go a long way to explain ... the rising inequality of income." That's a weaselly locution, and others don't even bother with the weaseling. (The income of the richest went up "largely because of tax changes in the '80s," reported Richard Threlkeld of CBS News.) In fact, the tax changes in the '80s were a minor factor. After taxes, the income of the richest 10 percent of families went up $16,000 between 1980 and 1988. But according to the much-cited (and hardly anti-Democrat) Congressional Budget Office, only about $1,200 of that gain came from tax changes.
The rich are getting richer primarily because of deep, long-term trends in the economy that are increasing their incomes before taxes come into play. The most obvious of these trends is the growing disparity in pay between skilled and unskilled labor. In 1973 college graduates made only 15 percent more than mere high school graduates; by 1982 the differential was 49 percent. In a system of international free trade, Robert Reich has pointed out, unskilled labor will tend to be performed where it can be done the cheapest, which is usually overseas. That means fewer and poorer-paying jobs for unskilled Americans. But American brainworkers are still competitive and well-paid.
Worse, as skills become more important, the gaps in performance between people with the same formal training become more important. The difference between an average bolt-tightener and a superlative bolt-tightener isn't much as long as the bolts don't fall off. Both workers will tend to be paid about the same. But train them as computer programmers, and the picture changes. The difference between an average and a terrific programmer is enormous. Employers will reward the terrific programmers with large sums of money. The result is rising income inequality. Reagan has little to do with it. Which brings us to the most dangerous fallacy:
3. Democrats can reverse the rise in income inequality. If Reagan's tax cuts were only a small part of the reason the rich got richer, then undoing Reagan's tax cuts won't do much to make incomes more equal. In fact, there's virtually no chance the Democrats can make the tax system progressive enough to reverse the income inequality trend.
Suppose populist Democrats wanted to tax the richest one percent of Americans enough so that their share of the nation's income, after federal taxes, would be equal to what it was back in 1977. In 1977 their after-tax share was 7.3 percent. By 1990 it was about 12.6 percent. To cut it back down to 7.3 percent, the effective federal tax rate on the rich (that is, the percent of their income they actually pay in taxes) would have to be more than doubled, from roughly 27.5 percent today to more than 55 percent. In the current budget deal, after all the huffing and puffing, Democrats have succeeded in raising the rate to about 29 percent. Nice try.
In fact, among America's major industrial competitors, only Sweden taxes the rich at rates in the range that would be required to bring American inequality back to its 1977 level. And the Swedes are in the middle of a tax revolt that will produce a dramatic cut in their top tax rate. If Sweden can't do it, nobody can.
The growing income gap between affluent Americans and average Americans is deeply unsettling, but today's Phillips-head Democrats won't be able to do much to close it. Democratic strategists tend to brush off this unpleasant fact. After all, FDR didn't really soak the rich either, they say. He still got a lot of votes by running against them. Likewise, Democrats can win elections by slapping new taxes on the wealthy, even if those taxes don't reverse the underlying income trends.
That's one way to look at it. Another way is to say FDR was elected to end the Depression, and he eventually ended the Depression. Democrats elected to stop rising income inequality won't be able to similarly deliver on their promises. What happens when Joe Lunchbucket wakes up, after a decade or so of populist Democratic progressivity, and realizes that the rich are still getting richer? Better to admit now that this week's tax hikes are designed to spread the pain of a particular budget crisis rather than to undo the inequality boom of the '80s. Greater income inequality is simply something the Democrats, and the country, are going to have to learn to live with.
The writer is a senior editor of The New Republic.