June 20 (Bloomberg) -- There are two main schools of thought on income inequality: The fatalists, who contend that rising inequality is the ineluctable result of a changing economy, and the redistributionists, who blame a skewed tax system and lethargic government. Perhaps it’s time to consider a third.
The fatalist case rests on technology: As we replace human toil with networked computers and tireless robots, those who own the technology or learn to master it benefit, and those whose jobs are displaced by technology suffer. The ease with which we outsource jobs, ship goods and videoconference to China helps people who own companies but hurts those whose jobs are shipped out. The winner-take-all economy is a boon to people who can market themselves or their product globally and a bust for those who can’t.
Of course, this creates a less equal world, the fatalists say. A private equity manager can goose profits at one company by outsourcing the call center and at another by automating production. The new economy is perfectly organized to make this manager richer. Meanwhile, the 52-year-old machinist who was fired isn’t trained in the latest technology, can’t compete with the low wages of a Malaysian 19-year-old and is stuck on the outskirts of Reno, Nevada, with an upside-down mortgage. Everything in the new economy is working to make him poorer. Inequality is simply the space between those two lives.
Precisely as this analysis would predict, income inequality has skyrocketed since 1979. Median income for high-school educated men has fallen by 31 percent. Meanwhile, the top 1 percent has seen its pay rocket up 130 percent. And that’s before taxes even enter the picture.
Fatalists conclude that government hasn’t caused inequality -- taxes and social services haven’t changed all that much -- so government action raising taxes or increasing infrastructure spending, for example, won’t fix it either. The only possible remedy is more education and training for workers, which will take decades. Shame, isn’t it?
The redistributionists agree with much of this analysis. But they think the fatalists understate both how much the government has contributed to inequality by cutting taxes on the rich and not investing in the poor, and how much good it could still do. In a new paper for the Economic Policy Institute, Andrew Fieldhouse makes the most optimistic version of this case.
The effective tax rates for the very rich -- that is, the tax rates they actually pay -- have fallen precipitously since the 1970s. “The effective tax rate for the top hundredth of a percentile (i.e., tax filers in the 99.99-percent-and-above range by income) has fallen by more than half, from 71.4 percent in 1960 to 34.7 percent in 2004.” So as the rich have gotten richer, the share of income they pay in taxes has declined.
The twist in Fieldhouse’s argument is his identification of a secondary effect by which tax cuts have goosed incomes at the top while holding them down at the bottom. He cites research suggesting that the high tax rates paid by the rich in the mid-20th century gave them little reason to spend time and energy trying to get even richer. If a big raise would be accompanied by a big tax bill, why bother fighting for a raise?
Thus, declining tax rates unleashed the desire of the wealthy to seek a bigger piece of the pie. As it turned out, they had quite a lot of power to get themselves a better deal. They had political power in Washington and state capitals, of course, but also power in the workplace. Since 1979, chief executive officer pay has gone from 29 times what the average worker is paid to 228 times what the average worker is paid. Much of that increase is zero-sum: Income that once might have gone to workers is now diverted to the C-suite, because executives have more bargaining power. And with private-sector unions wasting away, that power increases every day.
Consequently, Fieldhouse concludes that higher taxes on the rich may do more to curb inequality than many realize. First, higher taxes would reduce inequality directly through redistribution. Second, they would lessen it indirectly by discouraging the rich from making great efforts to become even richer. If Fieldhouse is right, then the fatalists are wrong: Pretax inequality can be mitigated by tax policy.
There’s something to this, but ultimately I think Fieldhouse gives the tax code too much credit. Changes he attributed to the tax code are really rooted in political culture. Taxes on the wealthy didn’t lower themselves, after all. Wealthy Americans fought to bring them down. And now that they’ve grown used to those low taxes and high incomes, they will fight to keep them.
Toward the end of the 2012 presidential campaign, Mitt Romney’s candidacy was powered in part by a plutocratic revolt against Democratic plans to let the top marginal rate revert to 39.6 percent. The wealthy wouldn’t meet a truly sharp increase in the top income tax rate with a shrug and a renewed disinterest in their wages. If anything, it would increase their class solidarity and political mobilization.
Yet the fatalist and redistributionist camps also give the government too little credit -- and too little blame -- for inequality. Both cleanly divide the issue in half: On one side is the way the economy distributes income, on the other the way the government redistributes it. But this misses the space between: the way the government itself changes the economy.
This drives Dean Baker crazy. “Federal government spending averages roughly 20 percent of GDP,” the dyspeptic Washington economist writes in “The End of Loser Liberalism: Making Markets Progressive.” And that’s just the beginning. “Adding in state and local government spending gets us a bit over 30 percent. This means that all levels of government spending account for less than one-third of the economy. If this is the exclusive realm for political debate, and we ignore the way in which the government structures the larger economy, then we have given up two-thirds of the game,” he writes.
It’s a shame that Baker frames his book as advice for progressives because his argument should also appeal to conservatives. Who the government taxes and how it spends that money, Baker argues, doesn’t begin to describe the myriad ways in which the government shapes the economy. The Federal Reserve’s decision to prioritize low inflation over full employment, for example, is a government intervention of staggering importance, even if it’s rarely presented that way. The same goes for the Treasury Department’s management of the dollar. The duration of patents matters enormously, as do the licensing requirements for high-wage jobs, the regulation of corporate boards and even rules on how much cash banks must keep on hand.
Baker basically agrees with the fatalists who believe the economy has changed in ways that have exacerbated inequality, and he even agrees that changes to the tax code won’t suffice to remedy it. Where he parts with both fatalists and redistributionists is in his belief that government policies have hastened those divisive economic changes, and that a different set of government interventions has the potential to counteract them, creating a more equal economy.
Baker’s insight is bracing, though his book doesn’t follow through on it as comprehensively as I’d like. Still, it suggests the right starting point for a smarter debate over what has caused inequality and what can be done about it. Washington argues a great deal over taxes and spending, and far less over the way government sets the rules for the economy and for those who benefit most from it.
“This is sort of like playing football without knowing that the way to score points is to get the ball into the other team’s end zone,” Baker writes. “It’s hard to win when you don’t know how the game is played.”
(Ezra Klein is a Bloomberg View columnist.)
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