Nov. 5 (Bloomberg) -- Why did inequality never become the defining issue of the 2012 campaign? It appears that voters, intuitively, don’t see it as the problem some politicians would have us believe.
Even economists disagree over how bad inequality is, the correct way to measure it, why it’s increasing and what to do about it. And most Americans, no matter how humble their circumstances, don’t resent the wealthy so much as strive to get rich, too. One point on which economists do seem to agree is that income inequality by itself isn’t harmful -- except when it’s so great that the scales of opportunity tilt. On that score, the U.S. has reason to worry.
Median household income is lower than it was a decade ago. At the same time, the gap between rich and poor has widened. Economists recently reported that the top 1 percent receive about a fifth of the national income -- up from less than a 10th in 1970 -- and control about a third of the country’s wealth.
The data, however, overstate inequality by not counting government transfers such as food stamps, unemployment insurance and Social Security. When these things are included, every income group shows modest gains from 1997 to 2007. When health benefits are also calculated, income disparity really drops off, with the bottom 20 percent registering income growth of about 26 percent. The top 5 percent show a 63 percent increase.
Overlooking such benefits helps build the myth that inequality is always bad. Yet some imbalance is good. Imagine a tax system that would redistribute income so that everyone came out roughly equal. Entrepreneurs wouldn’t be motivated to innovate because they wouldn’t be able to reap the rewards. Fewer risks would be taken, and economic growth would stall.
It would be convenient to blame the super-rich for stagnant middle-class incomes. It would also be wrong. Technology and globalization have done more than anything to toss workers out of jobs and damp wage growth. Just because a 28-year-old tech entrepreneur has billions doesn’t mean others have less. There are fewer good-paying jobs because today’s growth industries are creating enormous wealth, but not enormous numbers of jobs. The payroll of a company like Facebook Inc. looks anemic next to the industrial behemoths of yesteryear.
None of this is to say inequality ought to be ignored. Left alone, it could erode opportunity, which ultimately would weaken the economy. What matters is that the poor and middle classes have pathways to advance. This is difficult under a system of taxation, education and politics that favors the well-to-do.
What do we mean? Well, a tech entrepreneur, for instance, can borrow against shares in his company without paying the capital gains taxes that would be due if he sold stock. With the right legal advice, his heirs don’t need to pay taxes either.
And the children of that entrepreneur are likely to do better in school than their less-privileged counterparts thanks to tutors and well-financed school districts. Indeed, recent studies show that, since the late 1980s, the gap in test scores between low-income and affluent children has widened by about a third. College attendance is also declining because tuition is rising faster than wages, and student loans are getting harder to come by. Yet a college degree is the surest path to upward mobility.
Here’s another discomfiting data point: Generational mobility -- how often poor children move into the upper or middle classes -- is now lower in the U.S. than in some European countries. The Pew Economic Mobility Project recently found that a child born in the bottom 20 percent has only a 17 percent chance of making it to the upper-middle class. Forty-two percent of boys born into the bottom 20 percent stay there.
Where does this leave us? If income inequality by itself isn’t bad, and if it’s not a zero-sum game, it’s debatable whether the tax system should be used to close the rich-poor chasm. Redistributing income might choke off growth. But with the opportunity gap growing, the tax code certainly shouldn’t encourage more inequality, as it now does. In that spirit, here are three tax and education reforms that might help rebalance the opportunity scales:
The estate tax is a good starting point. For 2012, estates get a $5.1 million federal exemption; amounts above that are taxed at 35 percent. That overly generous treatment swings too far in the other direction in 2013, when the exemption plummets to $1 million and assets above that are taxed at 55 percent. We prefer the in-between rates -- a $3.5 million exemption and a 45 percent tax on the remainder -- that existed until 2009.
As we’ve written, it also makes sense to limit the countless deductions, exemptions and credits that benefit mostly well-to-do taxpayers and cost the U.S. more than $1 trillion a year in revenue. Economic research shows the two biggest tax expenditures -- the mortgage interest deduction and the employer-provided health-care exclusion -- may even hurt low-wage earners by driving up home prices and health-care costs.
Restricting these breaks would help make the tax code more progressive without redistributing income by raising rates. It would also free money for deficit reduction. President Barack Obama, his Republican challenger Mitt Romney and bipartisan deficit reduction panels, including the Simpson-Bowles commission, have all embraced a form of this solution.
Another idea catching on with lawmakers in both parties is education savings accounts, which work like 401(k) retirement plans. The federal government would seed an account with $1,000 for every U.S.-born child, and parents could add as much as $1,000 a year tax-free. Lower-income parents would get an annual government contribution or matching amount. The money could be used only for education expenses, including tutors. The cost -- about $4 billion a year -- would be worth it if more low-income students graduated from high school ready for college.
Government’s proper role isn’t to guarantee everyone a comfy suburban bungalow. Government can and should address inequality, but with the goal of making sure the economic pie grows enough that everyone’s living standards improve, even if the top 1 percent get a bigger share.
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Today’s highlights: the editors on improving federal economic disaster aid; William D. Cohan on how the next administration should deal with Wall Street; Albert R. Hunt on how Bill Clinton is the big winner of this election; Pankaj Mishra on Indonesia’s new economic model for Asia; Cass R. Sunstein on why regulatory reform will continue; Steven Greenhut on California’s post-election future; Carl Pope on what’s behind Mitt Romney’s anti-environmentalism.
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