How Not to Fight Economic Inequality

Published on
by

How Not to Fight Economic Inequality

'Without a serious effort to enact tax and transfer policies that can check economic inequality, America will continue down the path to a new Gilded Age of extreme inequality.' (Photo: Reuters/Lane Hickenbottom)

Hillary Clinton has now locked in the Democratic nomination for President, and it is time to look ahead to the general election. It remains to be seen whether Bernie Sanders and his supporters can force progressive economic policies to the forefront.  But the early signs are disappointing. So far, the Trump-Clinton race seems likely to be light on policy substance and heavy on negative personal attacks.

The obvious loser in a no-issues campaign would be American democracy, with voters casting ballots based on gut feeling rather than informed opinion. But the less-obvious winners would be the rich.  Without a serious effort to enact tax and transfer policies that can check economic inequality, America will continue down the path to a new Gilded Age of extreme inequality.  

"The obvious loser in a no-issues campaign would be American democracy, with voters casting ballots based on gut feeling rather than informed opinion. But the less-obvious winners would be the rich."

Consider taxation. Hillary Clinton has offered only incremental proposals to combat inequality, including a small college tax credit. Donald Trump's tax plan seems only semi-serious, a warmed-over menu of familiar tax cuts for the rich and the middle class, predicted to produce massive deficits.   

A casual observer might infer that not much is at stake in the tax arena.  After all, President Obama managed to claw back some of the Bush-era tax cuts for the rich.  And most people have heard that the federal income tax is progressive.

But “progressivity” is a waffle word, because it means only that the rich pay a higher fraction (even if only a small fraction more) than the poor.  So a tax or transfer system may be “progressive” and still do little to redistribute income.

The federal tax system is progressive in this technical sense, but the reality is that there isn’t much redistribution going on.  In 2016, according to the Urban-Brookings Tax Center, Americans earning $1 million a year will grab 13% of total income and pay just 19% of total taxes.  Half-millionaires (those with incomes between $500,000 and $1 million) earn 5% of total income and pay 8% of total taxes.  

Without reform, then, the federal tax system can only modestly curb the inequality that has fueled mass mobilization and anger from Occupy to the Bernie Sanders campaign. 

To be sure, taxes are only one side of the fiscal coin.  Transfer programs (like Social Security) target proportionally greater benefits to the poor than the rich.  Maybe a holistic picture would reveal that government policy is progressive in a more robust sense.

If only. 

The fact is that, over the last thirty years, federal taxes and transfers have not meaningfully altered market trends that distribute economic rewards to the rich. The CBO’s most recent comprehensive study finds that the labor and capital markets, acting alone, boosted the incomes of the top 1% by 174% between 1979 and 2011.  Taxes and transfers actually added to the gains at the top, because taxes fell over this period.  The result is that the top 1% gained a whopping 200% after taking taxes into account.

To be fair, the tax-and-transfer system did improve market outcomes somewhat for the bottom 80%.  This group fared dismally in the marketplace, with growth of just 16% over thirty years.  Taxes and transfers boosted them to growth of 30-40%.  

So, in terms of progressivity, the current tax-and-transfer system is, well, better than nothing.  But that's faint praise.  Absent major reform, fiscal measures will not do much to address the growing gap between rich and poor.  In fact, without policy change, inequality will only get worse, because static rules tend to favor the rich.  

Social Security provides a surprising example.  Liberals treat it, with reason, as one of the signal achievements of the twentieth century.  But, without policy change, the program is destined to grow less and less redistributive in the twenty-first.

On the tax side, as income inequality grows, the Social Security payroll tax grows more regressive, because the tax cap excludes a larger fraction of (high) earnings from tax.  In 1983, about 10% of total earnings were non-taxable, but today about 17% are

On the transfer side of Social Security, growing inequality in lifespans is undercutting the redistributive effect of retirement benefits. As an American at, say, age 40 looks ahead to retirement, a rich man can expect to live to about age 87, while a poor one can expect to live only to 73 – a whopping 14-year gap.  Social Security now pays benefits beginning at age 66 and continues until death.  Without reform, the system will skew more and more to the benefit of the well-off, who will collect decades of unneeded benefits.

These gloomy outcomes are not written in stone.  We could – and should debate the merits of lifting or eliminating the payroll tax cap and raising the retirement age.  Progressives worry, with reason, that an across-the-board increase could harm low-earners, whose stressful jobs and poor health lead to earlier retirement.  But careful policy design could enhance early retirement benefits for low-earners while delaying benefits for high-earners able to work.  For instance, I have proposed replacing the current one-size-fits-all penalty on early retirement with a sliding scale that would favor low-earners.  

But neither candidate, so far, has tackled taxes or Social Security with any energy.  Trump’s campaign site has literally nothing to say about Social Security.  Hillary Clinton’s site promises to “defend Social Security against Republican attacks" and cautiously proposes that high-income Americans pay taxes on “some” of their income in order to protect the status quo. 

Static law and rising inequality make a toxic brew.  A no-issues campaign will leave unchallenged the legal structures that protect wealth and fuel inequality.

Anne Alstott

Anne Alstott is a Yale Law Professor and the author, most recently, of "A New Deal for Old Age."

Share This Article