Monday, September 04, 2006

Income Inequality & Labor Incentives

True or False: There is greater income inequality now, under Republican policies implemented under the Bush administration, than we experienced in those halcyon days of the Clinton administration.

If you answered True, you are probably listening to modern pundits, who would like you to believe that growing inequality is a product of Republican policies. However, the data suggests otherwise. An op/ed piece in the online version of the Wall Street Journal, posted last Saturday (9/2/06), provides some analysis of new figures coming out on the tax and income distribution in the United States through 2004. The story can be found here:

Significantly, the share of income of the top 1% of earners is down to 19.0 percent, down slightly from 20.8% in 2000, the last year of the Clinton administration. Those top earners paid more taxes in 2004, but the total percentage of taxes was about the same: 36.9% vs. 37.4 % in 2000. Apparently, lower capital gain and dividend rates were helping this group, while those in the next tier – the top 5 to 10 % of earners, most of whom are earning wage income – paid a slightly higher percent of taxes. The bottom 50% -- earning less than $44,389 – paid 3.3% of taxes in 2004, below the 3.9% they paid in 2000.

Despite tax cuts, the system is still highly progressive. And the system is still raking in record tax receipts. FY 2005 brought in $2.153 trillion, and through ten months of FY 2006 (through July – August figures won’t be released until the end of this week) we have collected nearly $1.97 trillion. If August and September match last year’s receipts of roughly $400 billion, the total for FY 2006 will be nearly $2.4 trillion. (Unfortunately, we are still spending more – though the gap is narrowing.)

Focusing on individual income tax collection, collections through July are over $866 billion, up some 14% from the $758 billion in the prior fiscal period. Corporate income taxes through July are at $261 billion, up some 27% from the prior fiscal period. (See for all the above data.) These figures indicate solid earnings and profits, which are reliable indicators of prosperity. You don’t fudge the numbers up (a la Enron) when you have to pay your government partner on the outcome.

Despite the success of the current system in collecting more and more taxes, some still wring their hands over income inequality. And you would be right in suggesting it has nevertheless grown over the past fifteen years or so. During the beginning of the Clinton Administration, those top 1% of earners had only about 13 percent of total income. What is happening may have more to do with technology changes than tax policy. The problem is coming up with a solution that is not worse than the condition. Raising taxes on high-income (and productive) people kills innovation. Growing government programs to redistribute wealth also creates inequality – as witnessed from the fact that some states with low populations, like Alaska, reap huge per capita benefits from discretionary government spending.

We must understand that technology has given huge benefits to all people in terms of the goods and services they can enjoy. However, in terms of reaping profits from those innovations, the results are not so uniformly generous. Some are well placed and can benefit from the change; others do not. That is hard to change, and it is part of a dynamic economy.

Over time, markets have a way of providing new winners and losers. Witness the spectacle of the current struggles of Ford Motor Company. Once the leader in manufacturing, the founding family’s fortunes have waned in comparison to those in other leading industries, where new wealth has been created.

However, there is one aspect of this problem that is within the control of individuals. They can work to ensure that they, and their children after them, get an education and develop malleable skill sets that can adapt to changing market demands. It is not hard to see how the lesser skilled workers, and those who don’t pursue educational opportunities to provide an edge in the market place, will be left behind when the marketplace ratchets up demands for new skills and rewards them appropriately.

Differential rewards are needed to justify the new investment in human capital. That means inequality - and perhaps more of it, to the extent that more and more investment is required in knowledge and experience to exploit the opportunities presented. Policies to incentivize those investments make much more sense than policies based on creating disincentives for production through higher tax rates.



Anonymous said...

The government is spending more as a result of international policy, NOT domestic policy via review of the congressional budget office, CBO, and general accounting office, GAO. As you know, these organizations are non-partisan, or have not yet proven otherwise unlike the Federal Reserve board. The domestic size of the government has remained about the size it was when Bush took office.

Earnings and profits are conservative definitions of posterity. Democrats use standards of living, unemployment, and more importantly under-employment as the standard of living. We have changed the unemployment rate so much, that it is hardly meaningful. Under employment continues to be on the rise.

Do you honestly believe taxes kill innovation? How can this be? Even if my total marginal tax rate is 60%, I am still making 40%, which is way more than zero! If anything, increasing the tax rate causes people to work harder to earn their money. Yes, this does assume people need money to pay bills and buy things which seems to be under normal circumstances. While these people are working hard, their fair share of dollars is going to those who need it.

I'm not sure if technology has helped all people. Talk to the GM workers who were laid off last year or those at the Ford plants. In fact I spoke with some at the Ford Ranger plant in Minnesota, and let me say they are not pleased.

It seems families will have a harder time getting an adequate education in America. The republicans continue to push for the reduction of subsidies to colleges, thereby increasing tuition for those who cannot afford to pay. Republicans also do not believe in the benefits of affirmative action plans. This is normally because they believe in the free market, which helps the affluent; rather than those who are actually in need.

Are you admitting to increasing the amount of inequality in the U.S.? If Bush said this, he would simply not get elected! The government has a job to provide stability for its citizens. Part of which is done by providing money for colleges. Look at where most of the innovation is coming from for a minute. The two large regions of IT innovation are Silicon Valley and Boston. These places are surrounded by colleges, which are funded by; you guessed it, the government. Let’s not pursue inequality. Instead, let us present opportunities for as many citizens as possible so we, society, can work together to make our world better. The way to fund this so it actually takes place is through a progressive tax system. Let's get started!

Anonymous said...

Here is something to think about since we are close to election time, the moment of truth.

If every eligable voter in the U.S. actually went to the polls to vote, would a democrat or a republican win the election? This would be true democracy wouldn't it, since all voices in the U.S. would be heard with equal wait at a certain point in time?

Ed Morse said...

Shawn, I've been away from the blog for a few days. With only limited time to respond, let me mention a few things.

On spending, I think you have ignored some major initiatives, not the least of which is prescription drug coverage. This is significantly increasing the size of the government in a domestic matter by anyone's measures.

On taxes and innovation, I know of no empirical study that would suggest that higher taxes induce more work. In fact, let me suggest this to you if you are willing to try: tell your employer to cut your wages and see if that makes you want to work any harder. I suppose in the short run if you have incurred debt you need to service, you may go out and get another job to meet those obligations. But in the long run, I would guess you would adjust by doing less, taking more breaks, or otherwise adjusting your own lifestyle as you compare the value of leisure to the after-tax value of your hard-earned cash. If you don't believe this, then I suggest you keep it quiet lest your boss discovers your altruism and exploits it. After all, that is what capitalists do, right?

Thanks for writing.

Anonymous said...

Hi Ed,

I didn't ignore the senior drug bill, just did not think it was large enough to matter. The prescription drug bill cost $730 billion, where Bush's two tax cuts cost $3.3 trillion,which is almost five times as much money.

Also, your recommendation to me makes little sense on tax incentives. If my employer cuts my pay I have the following options. One, find another job which pays more. Two, work more hours to retain my former income level. Three, lower my life style. Your suggestion, which is to work less, will result in me losing my job, thus not a realistic option.

Thomas Sowell, an intellectual conservative, said it well. People believe in a vision, and subsequently, go out into the world to prove it correct. They don't independently take in information, and then determine correct action. Rather, we take in information with our biased vision lens, which of course, prove our vision true.

Thanks for reading,


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