The Price of Inequality: How Today's Divided Society Endangers Our Future (14 page)

Lending and housing discrimination has thus contributed to lowering standards of living of African Americans and their wealth, compounding the effects of the labor market discrimination discussed earlier.

R
OLE OF
G
OVERNMENT
IN
R
EDISTRIBUTION

We have examined how market forces, shaped by politics and societal changes, have played a role in bringing about the level of inequality in
before-tax incomes and transfers
.

The irony is that just as markets started delivering more unequal outcomes, tax policy asked less of the top. The top marginal tax rate was lowered from 70 percent under Carter to 28 percent under Reagan; it went up to 39.6 percent under Clinton and down finally to 35 percent under George W. Bush.
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This reduction was supposed to lead to more work and savings, but it didn’t.
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In fact, Reagan had promised that the incentive effects of his tax cuts would be so powerful that tax revenues would
increase
. And yet, the only thing that increased was the deficit. George W. Bush’s tax cuts weren’t any more successful: savings did not increase; instead the household savings rate fell to a record low (essentially zero).

The most egregious aspect of recent tax policy was the lowering of tax rates on capital gains. This happened first under Clinton and again under Bush, making the long-term capital gains tax rate only 15 percent. In this way we have given the very rich, who receive a large fraction of their income in capital gains, close to a free ride. It doesn’t make sense that investors, let alone speculators, should be taxed at a lower rate than someone who works hard for his living, yet that’s what our tax system does. And capital gains are not taxed until they are realized (that is, until the asset is sold), so there is an enormous benefit from this deferral of taxes, especially when interest rates are high.
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Furthermore, if the assets are passed on at death, the capital gains made during the individual’s lifetime escape taxation. Indeed, the tax lawyers for rich people like Ronald Lauder, who inherited his fortune from his mother, Estée Lauder, even figured out how to “have your cake and eat it too,” that is, in effect, sell your stock and not pay the tax.
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Their plan, and other similar tax-avoidance schemes, involves complicated transactions including short selling (selling borrowed stock) and derivatives. Though this particular loophole was eventually closed, tax lawyers for the rich are always seeking to outsmart the IRS.

The inequality in dividends is greater than that in wages and salaries, and the inequality in capital gains is greater than that in any other form of income, so giving a tax break to capital gains is, in effect, giving a tax break to the very rich. The bottom 90 percent of the population gets less than 10 percent of all capital gains.
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Under 7 percent of households earning less than $100,000 receive any capital gains income, and for these households capital gains and dividend income combined make up an average of 1.4 percent of their total income.
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Salaries and wages accounted for only 8.8 percent of the income of the top 400, capital gains for 57 percent, and interest and dividends for 16 percent—so 73 percent of their income was subject to low rates. Indeed, the top 400 taxpayers garner close to 5 percent of the country’s entire dividends.
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They posted an average of $153.7 million in gains each (a total of $61.5 billion in gains) in 2008, $228.6 million each (for a total of $91.4 billion) in 2007. Lowering the tax on capital gains from the ordinary rate of 35 percent to 15 percent thus gave each of these 400, on average, a gift of $30 million in 2008 and $45 million in 2007, and it lowered overall tax revenues by $12 billion in 2008 and $18 billion in 2007.
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The net effect is that the superrich actually pay on average a lower tax rate than those less well-off; and the lower tax rate means that their riches increase faster. The average tax rate in 2007 on the top 400 households was only 16.6 percent, considerably lower than the 20.4 percent for taxpayers in general. (It increased slightly in 2008, the last year for which data are available, to 18.1 percent.) While the average tax rate has decreased little since 1979—going from 22.2 percent to 20.4 percent, that of the top 1 percent has fallen by almost a quarter, from 37 percent to 29.5 percent.
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Most countries have adopted estate taxes, not just to raise revenue from those who are more able to afford it but also to prevent the creation of inherited dynasties. The ability of one generation to pass on its wealth to another more easily tilts the playing field of life chances. If the wealthy escape taxation (as they increasingly do) and if estate taxes are lowered (as they were under President Bush—actually abolished in 2010, though only for one year), then the role of inherited wealth will become more important.
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Under these circumstances, and with more and more of the wealth concentrated in the upper 1 percent (or the upper 0.1 percent), America has the potential of becoming increasingly a land of an inherited oligarchy.

The rich and superrich often use corporations to protect themselves and shelter their income, and they have worked hard to ensure that the corporate income tax rate is low and the tax code is riddled with loopholes. Some corporations make such extensive use of these provisions that they don’t pay any taxes.
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Even though the United States supposedly has a higher corporate tax rate than much of the world, reaching 35 percent according to statute, the real average tax that firms pay is on par with that of many other countries, and corporate tax revenues as a share of GDP are smaller than they are, on average, in other advanced industrial countries. Loopholes and special provisions have eviscerated the tax to such a degree that it has gone from providing 30 percent of federal revenues in the mid-1950s to less than 9 percent today.
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If an American firm invests abroad through a foreign subsidiary, its profits are not taxed by the United States until the money is brought home. While a great deal for the firm (if it invests in a low-tax jurisdiction like Ireland), it has the perverse effect of encouraging reinvestment abroad—creating jobs outside the United States but not in it. But then the corporations duped President Bush into giving them a tax holiday—money they brought back during the holiday, supposedly for investment, would be taxed at only 5.25 percent; they would bring the money back and reinvest it in America. When Bush put in place a one-year holiday at that rate, they did bring their money back; Microsoft alone brought back more than $32 billion.
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But the evidence shows that little additional investment was generated. All that happened is that they managed to avoid paying most of the taxes that they should have paid.
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At the state level, things are even worse. Many states don’t even make a pretense at progressivity, that is, having a tax system that makes the 1 percent, who can afford it, pay a larger fraction of their income than the poor have to pay. Instead, the sales tax offers a major source of revenue, and because the poor spend a larger fraction of their income, such taxes are often regressive.
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While tax policies can either let the rich get richer or restrain the growth of inequality, expenditure programs can play an especially important role in preventing the poor from becoming poorer. Social Security has almost eliminated poverty among the elderly. Recent research has shown how large these effects can be: the earned-income tax credit, which supplements the income of poor working families, by itself lowers the poverty rate by 2 percentage points. Housing subsidies, food stamps, and school lunch programs all have big effects in lowering poverty.
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A program like the provision of health insurance for poor kids can bring benefits to millions and help ensure that these children have a lower risk of being handicapped for life by an illness or other health problem; this stands in marked contrast to some of the corporate subsidies or tax loopholes that cost much more and the benefits of which go to far fewer people. The United States spent far more on its big bank bailout, which helped the banks to maintain their generous bonuses, than it spent to help those who were unemployed as a result of the recession that the big banks brought about. We created for the banks (and other corporations, like AIG) a much stronger safety net than we created for poor Americans.

What is striking about the United States is that while the level of inequality generated by the market—a market shaped and distorted by politics and rent seeking—is higher than in other advanced industrial countries, it does less to temper this inequality through tax and expenditure programs.
And as the market-generated inequality has increased, our government has done less and less.
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Government and opportunity

Among the more disturbing findings recited in chapter 1 is that the United States has become a society in which there is less equality of opportunity, less than it was in the past, and less than in other countries, including those of old Europe. Market forces described earlier in this chapter play a role: as the returns to education have increased, those with a good education have fared well, those (and especially men) with a high school education or less have done miserably. This is even more true today, in our deep economic downturn. While the unemployment rate among those with a college degree or higher was only 4.2 percent, those with less than a high school diploma faced an unemployment rate three times higher, at 12.9 per cent. The picture for recent high school dropouts and even graduates not enrolled in college is far more dismal: jobless rates of 42.7 percent and 33.4 percent, respectively.
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But access to good education depends increasingly on the income, wealth, and education of one’s parents, as we saw in chapter 1, and for good reason: a college education is becoming more and more expensive, especially as states cut back on support, and access to the best colleges depends on going to the best high schools, grade schools, and kindergartens. The poor can’t afford high-quality private primary and secondary schools, and they can’t afford to live in the rich suburbs that provide high-quality public education. Many of the poor have traditionally lived in close proximity to the rich—partly because they provided services to them. This phenomenon in turn led to public schools with students from diverse social and economic backgrounds. As a recent study by Kendra Bischoff and Sean Reardon of Stanford University shows, that is changing: fewer poor are living in proximity to the rich, and fewer rich are living in proximity to the poor.
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U.S. neighborhoods are even segregated between homeowners and renters. This pattern cannot be explained by race or the presence of children in the household, because it occurs within racial groups and among households with children. The segregation in American metropolitan areas into homeowner communities and renter communities can produce communities with starkly different civic environments. Community quality depends on residents’ efforts to prevent crime and improve local governance, and the payoff to an individual making that effort is greater for homeowners than for renters, and generally greater for those who live in communities where many other residents make similar efforts to render local government more responsive to community members. Thus there are economic forces that lead from differences in household wealth (and homeownership) to differences in the civic quality of the community in which a household lives.
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U.S. policy to increase low-income ownership rates reflects the understanding that homeownership rates affect neighborhood quality and that growing up in a violent, crime-ridden neighborhood impairs health, personal development, and school outcomes. But homeownership—a major way in the United States that households access better neighborhoods and also accumulate wealth—is not sustainable for households with no wealth to start with and little income.

We also noted in chapter 1 that even among college graduates, those who are fortunate enough to have wealthier and better-educated parents have better prospects. This may be partly because of networking—making connections—which may become especially important when jobs are scarce, as now. But it is also partly because of the increasing role of internships. In a labor market such as the one we have had since 2008, there are many job seekers for every job, and having experience counts. Firms are exploiting this imbalance by providing unpaid or low paid internships, which adds an important element to a resume. But not only are the rich in a better position to get the internship; they are in a better position to
afford
unpaid work for a year or two.
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While government has been doing less to countervail these market forces that lead to greater inequality of opportunity, on the basis of differential access to “human capital” and jobs, it has also, as we have noted, been doing less to level the playing field in financial capital, as a result of less progressive taxation and especially lower inheritance taxes. In short, we have created an economic and social system, and a politics, in which, going forward, current inequalities are not only likely to be perpetuated but to be exacerbated: we can anticipate in the future more inequality both in human capital and in financial capital.

T
HE
B
IG
P
ICTURE

Earlier in this chapter and in chapter 2 we saw how the rules of the game have helped create the riches of those at the top and have contributed to the miseries of those at the bottom. Government today plays a double role in our current inequality: it is partly responsible for the inequality in
before-tax distribution of income
, and it has taken a diminished role in “correcting” this inequality through progressive tax and expenditure policies
.