Rhetoric isn't equal to reality

By Clive Crook

The Democrats have decided to make inequality a central issue in next year's elections. I'd question whether that's good politics. Even in hard times, American voters aren't easily persuaded by appeals to class interests.

Yet even setting electoral tactics aside, focusing on inequality seems unlikely to lead to better policy, especially considering how current U.S. policies stack up against those of other advanced economies.

That's because inequality isn't one issue, but a writhing bundle of issues. Unpack it and you see there's no easy remedy. It demands more thought and humility than most politicians can muster.

For the American left, the question comes down to the incomes and taxes of the "1 percent." Even if, like me, you think that a rapidly widening gap between rich and poor calls for a response, and that progressive taxes are ethically correct, this obsession with the peak of the income pyramid is too simpleminded.

Growth in the highest incomes has been stunning, to be sure. A recent study by the Congressional Budget Office found that the incomes of the top 1 percent of households almost quadrupled between 1979 and 2007, and their share of total income more than doubled, to 17 percent. Inequality has increased almost everywhere, but the surge in the highest incomes is especially startling in America.

Why is this happening? Nobody quite knows.

Global markets and new technology have increased the earning power of star athletes and entertainers. The pay of top executives has soared, too. That might be because the most successful companies have grown bigger and harder to run. Globalization increases the returns on innovation, and the United States is the world's leading innovator.

If top incomes were surging only for reasons like that, few would complain: Americans believe in pay for performance. Unfortunately, though, huge rewards for disastrous incompetence have also become common, pointing to failures of corporate governance. The finance industry has expanded mightily, not to the country's obvious benefit, and partly thanks to hidden subsidy.

The point is that some instances of very high pay are fair and efficient, and some aren't. Do we raise taxes on all high incomes regardless?

If that's all you do, you leave the underlying failures (of corporate governance, regulation, and so on) unaddressed. Also, heavier taxes have practical limits. There's collateral damage to incentives. The rich can afford to be clever about tax shelters, so higher rates raise less revenue than you think. Push tax rates too high, and the superrich can simply leave.

Perhaps you think the United States taxes the rich so lightly that these issues don't apply. Think again. By international standards, the overall U.S. tax burden is low - mainly because there's no national sales tax - but contrary to popular opinion, the top marginal rates of income tax (including state income taxes) are not far out of line.

If anything, rich Americans contribute a greater share of taxes than their peers in other industrialized nations. The top 1 percent of U.S. taxpayers paid 40 percent of federal income taxes in 2007, compared with 24 percent in Britain.

A new report by the Organization for Economic Cooperation and Development shows that in the middle of the last decade - after the Bush tax cuts - U.S. income taxes were about as strongly redistributive as those in Canada, Denmark, Finland, the Netherlands, and Sweden. Between 1979 and 2007, the CBO found, "the federal individual income tax became slightly more progressive."

The awkward truth is that the U.S. income tax system is anomalous not because it taxes the rich lightly, but because it taxes everybody else lightly.

I grant that because the rich in America have done so well, they can afford to pay more taxes. Yet with notable exceptions, it's wrong to say that the U.S. tax system has been rigged in favor of the rich. Overall, despite the Bush tax cuts, the opposite is closer to the truth.

The OECD's international comparisons tell us some other interesting things. For instance, at the bottom of the income distribution, unlike at the top, U.S. policy is an outlier. In most industrial countries, social benefits such as unemployment insurance and other cash supports are easier to get and more generous than in America - and typically two or three times more powerful in reducing inequality.

This difference is at least as striking as divergent rates of growth in top incomes. Why does it command so much less attention? One reason is that American liberals find high incomes more upsetting than poverty. It's an instance of how distorting the preoccupation with inequality can be.

An enlightened liberal agenda should include higher taxes on the rich - and higher taxes on the middle class as well. Those revenue streams are needed not to punish the 1 percent, but to pay for low-wage subsidies, other supports for the working poor, and a more effective safety net. K-12 education, vocational training, and other avenues of opportunity for the less well-off should be priorities. So should addressing rent-seeking, broken corporate governance, and hidden subsidies to industries that don't add value. These things would narrow the gap between rich and poor.

Focus too narrowly on inequality, though, and you might forget the rest. And then you will have forgotten why inequality matters.