recent decades powerful forces have increased economic inequality.
Technological innovations have displaced blue-collar workers. Outsourcing to
low wage countries has impoverished employees who lack proprietary skills.
Downsizing, one reason corporate earnings have grown faster than revenues in
recent years, has bolstered profits at the expense of the middle class.
Since 1980, General Electric cut its domestic work force 40% while tripling
revenue. General Electric is a representative example. In the last two decades of
the millennium the 500 largest U.S. corporations saw assets and profits triple
while cutting 5 million jobs. Only one of ten workers laid off by downsizing
subsequently found a job paying more than 80% of his previous salary. We have
compounded matters by adopting our least progressive tax code since the 1930s
and by cutting government programs designed to benefit the middle class.
Due to the confluence of these economic and political forces, the top
quintile of Americans has grown richer while the bottom four quintiles have
become poorer. Between 1977 and 1989 the top 1% saw their incomes double. In
contrast to enormous gains made at the top of the economic ladder, workers in
private industry suffered a decline in average real weekly earnings.
Despite the huge increase in wealth at the upper end of the economic
spectrum since the mid-1970s, the real after-tax income of our bottom 60 percent
has declined, their real wealth has declined more sharply, and our poverty rate
has risen. It took less than two decades to double from levels of the early 1970s.
We gave back gains made in the Truman-Johnson days, and despite modest
improvement in the latter half of the 1990s, one-fifth of our children are buried
below the poverty level. The U.S. has a higher poverty rate than other
industrialized countries, and our ratio of income of the richest quintile to the
poorest quintile is far above the average of the other industrialized countries.
“Over 50 million people living in the United States in the mid-1990s had an
income the same as the world average and lower than a large proportion of the
population of states such as Sri Lanka, Morocco and Egypt.” (Ponting, The
Twentieth Century, p. 155.) This is partly responsible for our crime rate, with the
highest level of incarceration of any industrialized state.
In such circumstances it would be prudent, as well as decent, to adopt
policies to narrow the gap between the rich and the rest. A highly progressive
tax code tends to enlarge the middle class while slowing the increase in affluence
of the wealthy. When our top marginal tax rate was 91%, outrageous to free
market sensibilities, our middle class grew and prospered, as did the country as a
whole, even the rich. As our highest tax rates have been reduced, primarily on
the grounds that a lower tax rate would provide incentive to be more productive,
not only has our productivity lagged, but the disparity between our rich and the
rest has grown.
This pattern occurred before. In the 1920s, government repeatedly reduced
the progressivity of our tax code, also in the name of free enterprise. In four steps
it cut the top tax bracket from 77% to 25%. Then, as now, the rich grew richer
while the bottom four quintiles grew poorer. Despite the roaring stock market of
the 1920s and the increased affluence of our wealthy bankers at the expense of
the middle class, that era did little to establish a sound economy or a healthy society.
The history of the 1920s holds lessons that may be relevant if we wish to
avoid a repetition. When natural economic forces threaten the middle class,
widening the gap between the rich and the rest to dangerous levels, it may be
appropriate to adopt a more progressive tax policy to protect middle America.
Such a policy might counter the tendency, caused in part by natural economic
forces, for income disparity to increase.
Of course, this is sacrilege. Anyone who can read lips knows taxes are bad
and more taxes are worse. Wrong! There is more than just the failure of the
Kennedy and Reagan tax cuts. Historically, the necessary perversity of taxation
is not at all evident.
Holland, the most prosperous country in the seventeenth and early
eighteenth centuries, had the highest taxes. “Observers all agree that no other
state, in the seventeenth or eighteenth century, laboured under such a weight of
taxation.” (Braudel, The Perspective of the World, p. 200.) At the end of the
eighteenth century, when England was becoming the dominant world economic
power, its average tax rate was double that of France.
Even in the U.S., the Kennedy tax cuts marked a major decline in long-term
economic growth and productivity. The 1978 capital gains tax rate cut saw a
transition from strong economic growth to a recession. The 1981 capital gains
rate cut also marked an economic slowdown. Inversely, the 1976 and 1986 Tax
Reform Acts, which increased taxes at the top, saw the economy accelerate. Are
we missing something?
That is not the only point. If we are not going to eliminate taxes altogether,
any change in tax policy changes relative after-tax incomes. The more
progressive the tax policy, the more it equalizes incomes. The more regressive
the system (sales taxes, for which the median rate has doubled in the past 25
years; social security taxes, which have increased even more sharply), the more it
increases income differences. A truly progressive tax system could mitigate the
effects of natural economic forces and increase the dispersion of wealth.
But what about the conventional wisdom that lowering the top tax rates
encourages our most productive people to work harder because they keep more
of what they earn? What about the argument that increasing the tax bite on our
wealthiest citizens decreases the capital they have to save and invest, causing a
reduction in investment, lower productivity, slower economic growth, and a
lower standard of living for all? What about the claim that greater economic
disparity benefits everyone by generating an incentive to work harder?
The conventional wisdom sounds nice, but just the opposite may be true.
Higher tax rates may increase the incentive to work harder because we would
have to work harder just to maintain our after-tax income. Lester Thurow’s The
Zero Sum Economy maintains that people will work harder in the political sphere
to preserve what they already have than to gain something new. Perhaps this is
also true in the economic sphere.
Independently, increasing the after-tax income of those likely to spend,
rather than save, increases the demand for goods. This demand generates
investment opportunities, which in turn stimulate savings. The fact that
investment opportunities providing a good return on investment are more
important than the amount of capital that is theoretically available to invest may
explain the positive correlation between a more progressive tax structure and
faster economic growth.
Finally, contrary to the “incentive” argument of economic radicals of the
right (including Stakhanov, Stalin’s supply-side economist), history suggests
excessive wealth disparity is bad for economies. Even now our trading partners
have smaller disparities in wealth and income but their growth exceeds ours.
This is not intended to oppose tax simplification, though much of the
complexity of our tax code has come from rich and powerful interests
“purchasing” their own tax breaks. The bad will generated by, as well as the
costs of, tax collection are separate issues. Still, there are ways of simplifying the
tax code that provide a progressive system.
Consider a national sales tax coupled with a steeply graduated rebate,
refunding much to middle and lower income families, but little or none to upper
income families. Point-of-sale tax collection could be less painful and also reduce
tax avoidance. It would dovetail with advice provided three centuries ago by
Colbert, the finance minister of Louis XIV. Likening collecting taxes to plucking
a goose, he described its aim as getting the most feathers for the least hissing.
In addition, if we aim to use tax policy to increase savings, point-of-sale
collection would be effective. Because sales taxes do not tax funds that are saved
and invested, this mode of taxation would encourage investment. Paying the
sales tax refunds as lump sums would further encourage savings and investment.
Independently, it is reasonable to increase inheritance taxes on the
wealthiest. The argument that fairness requires that individuals be allowed to
keep all they earn from their hard work and talent is already questionable.
Earnings capacity depends on the educational, financial and cultural
infrastructure of society. Without that infrastructure, the talent and hard work
might not be worth so much. Contrast Michael Jordan’s earnings to Bill
Russell’s, Leon Russell’s to Wolfgang Amadeus Mozart’s, Bill Gates’ to
Alexander Graham Bell’s.
The argument that we are solely entitled to the fruits of our labor and
talent is even more tenuous if we include the hard work and talent required to be
born into extreme wealth. Furthermore, a large inheritance has the same
drawbacks as welfare. It has been argued, often with more validity than candor,
that welfare is debilitating to its recipients. But isn’t it just as debilitating to
receive a large entitlement check from a trust department as a small entitlement
check from the government?
Even in the case of raw talent, which we may regard as our own, to be used
for personal gain, is it through some virtue of ours that we have obtained such
talent? Gandhi suggested we regard our talent as a trusteeship to be used for the
benefit of others as well as ourselves.
It is understandable that the wealthy should wish to retain their wealth
and pass it on to their children. But it is also understandable that society should
exercise its right to limit the amount of wealth to be retained or passed on.
Taxation does not violate the right to private property; to the contrary. If
government did not have the ability to collect revenue, it could not fund police
forces and court systems. If it could not fund police forces and court systems, no
one could enjoy a right to private property — for anyone could seize the
property and its “owner” would have no recourse.
If government is to collect revenue, it is reasonable and moral that
legislators consider the impact of different forms of revenue collection on society
as a whole. It is natural that the rich would oppose anything that threatens to
disproportionately reduce their wealth, that they would argue that a steeply
graduated income tax or inheritance tax is unfair, or even that any inheritance
tax is unfair because it is taxing money that has already been subject to income
tax. But such arguments are hardly convincing. They apply equally to the much
larger category of sales tax. But sales tax is regressive; so it generates no
complaints about double taxation.
An alternative approach, following the tack of Reagan’s economic advisors,
might claim that a less progressive or more regressive tax code stimulates
investment and economic growth and is better for all of society. The problem
with this claim is that there is so much evidence against it — from the
correlation of a more progressive tax code with faster economic growth to a
millennium of evidence that excessive economic inequality is a menace to the
security and standard of living of all.
Note, too, that the notion of inheritance runs counter to the spirit of free
market capitalism. That spirit insists on a level playing field where the spoils go
to the most productive. Such a system, according to classical economic theory,
maximizes the incentive to be productive and so leads to the most efficient
economy. But such a system is incompatible with inheritance, which tilts the
playing field by rewarding the descendants of the rich, even if they are not
productive. (Isn’t it interesting that we espouse the laissez faire orthodoxy of flat
playing fields, which serves the rich at the expense of the rest, and that where we
deviate from pure orthodoxy, it is also to serve the rich at the expense of the
rest?)
In light of this evidence, why would anyone wish to preclude an effectively
progressive tax code? Devotees of laissez faire may be unaware of the historical
precedents. Even more important may be their depth of faith in the principle of
government non-interference. This faith, no matter how pure and well
intentioned, has been a source of misdirected policies.
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