Reducing inequality: what to do about the top 1%

by lane on April 17, 2009

In my view, raising and indexing the minimum wage, enhancing the Earned Income Tax Credit, and expanding and improving public services ought to be our top priorities for boosting the incomes and living standards of Americans in the lower half of the income distribution. What about the other component of rising inequality: soaring incomes of those in the top 1%?

It’s tempting to want to intervene directly in markets to reverse this trend. One way to do so is to legislate some sort of pay cap—a maximum wage, if you will. I don’t think this is the right way to go. If the value-added by particular individuals—a CEO, financial innovator, top athlete, movie star, or what have you—is sufficient to merit pay above the cap, firms will figure out ways to get around it, for instance by providing non-monetary perks or deferring pay.

Stricter regulation of the financial sector is another possibility. This is a good idea, though mainly to prevent a repeat of the current economic downturn. If doing so has the indirect effect of reducing enormous payouts to financial players, so much the better.

The simplest and best strategy is to let markets largely determine high-end earnings and incomes and use the tax system to redistribute (more here and here). We should increase the top income tax rate and/or add one or more new rates for those with very high incomes.

This would help to reduce income inequality. And it follows logically from the rationale for progressive taxation: the higher your income, the larger the share of it you can afford to pay in taxes. Since high-end pretax incomes have risen sharply in recent decades, those at the top can afford to pay a greater share of those incomes in taxes than they did in the past. So far they haven’t had to do so, as the following data on the top 0.01% of households (about 10,000 households) indicate. This group’s average inflation-adjusted pretax income soared from $7 million in 1979 to $35 million in 2005, but the share of that income they paid in taxes didn’t increase.

What’s the proper effective tax rate on top incomes? It’s the rate that is consistent with fairness norms and produces the most tax revenue without (significantly) reducing work, investment, and innovation. I don’t know what that rate is. Maybe it’s 40%. Perhaps it’s 50% or 60%. It could conceivably be even higher. Figuring this out requires policy adjustment and monitoring.

{ 42 comments }

1

Doctor Science 04.17.09 at 7:13 pm

If the value-added by particular individuals—a CEO, financial innovator, top athlete, movie star, or what have you—is sufficient to merit pay above the cap

Your statement is full of assumptions that have been undermined by experience.

CEOs and financial industry people don’t get high incomes because they *merit* them, because they have added value in some way. They have not been controlled by “the market”. The financial industry and much of the upper reaches of American corporate culture is a very successful kleptocracy. The first step is asking how do we break it up, if pitchforks seem too messy.

2

Henri Vieuxtemps 04.17.09 at 7:40 pm

Right. Also, if something firms (and individuals) will figure out ways to get around is not worth doing, then absolutely nothing is worth doing; collecting taxes for example (whatever the rate), or regulating the financial sector.

3

StevenAttewell 04.17.09 at 7:52 pm

I would agree with DoctorScience; taxing the rich and redistributing their wealth is a good thing, but the salaries of the top 1% are increasingly not being driven by the market. This is especially true among corporate executives, whose salaries are set by boards of directors made up of other corporate executives who have a vested interest in keeping average corporate executive salaries high.

After all, value-added doesn’t particularly explained why the difference between CEO and line worker salaries has increased fifteen-fold in the last 28 years. CEOs haven’t become 15 times more productive than they were in the 1980s, or 15 times more qualified.

This survey (http://baselinescenario.com/2009/04/05/two-things-that-have-nothing-to-do-with-each-other/) notes that there doesn’t seem to be any relationship between compensation and return. So if there is a market, it’s in market failure.

4

Righteous Bubba 04.17.09 at 7:54 pm

The first step is asking how do we break it up, if pitchforks seem too messy.

Steal the money back via taxes. Really, if some idiot firm wants to spend 10 million on candidate A and 5 million goes to the government, why complain if they move on to candidate B for 20 million when you can, uh, paint a buncha schools in Iraq for the 10 million you collect? (50% number used for ease of calculation: I’m all for a higher rate.)

5

MarkUp 04.17.09 at 8:37 pm

”taxing the rich and redistributing their wealth is a good thing,”

Maybe necessary, but not good really; good would be having systems of governance that precluded the rise of the problem. For example look at Dana holdings – where the office is and where the boss’s live. Somehow their deal doesn’t inspire much hope for performing their job.

6

StevenAttewell 04.17.09 at 8:58 pm

MarkUp:
Well, as someone who believes that a “rough equality of means” is good for a republic, I think it is a good thing to redistribute towards equality – even if we’re talking about the 40-50x line worker salaries of the CEOs of yore instead of the 600x line worker salaries of CEOs today.

7

Barbar 04.17.09 at 9:00 pm

the salaries of the top 1% are increasingly not being driven by the market

There are literally over a million households in the top 1%. Some evidence about a few hundred CEOs does not address what is driving the success of the top 1%.

8

MarkUp 04.17.09 at 9:07 pm

Steve, why do you think I’d allow 40-50x under my system of governance; or that if it were to get excessive the other levels of governance – tax codes say – would not kick in. Single layers won’t work. As we’ve seen simply imposing a higher tax rate or counting perks just raises the pay. My system would involve the interested parties beyond the board.

9

Jeff R. 04.17.09 at 9:19 pm

First, I’m increasingly of the opinion that this is addressing the wrong problem; that the presence of inequalities is inevitable and what should be focused on is maximizing upward mobilities within and between the income quintiles. If the position on the chart were more strongly determined by age than by social background, similar data would stop being so much of a problem for justice.

Which probably means a larger estate tax, but more fundamentally a restructure estate tax in which most of the current loopholes are closed while allowing economically-productive family owned businesses to escape it. (The last being a preference of mine independent of the general equalization interest.)

Which brings me to the individual topic of this post, which is to say that closing the popular tax loopholes is at least as important as raising the nominal tax rates at the top 1%. Doing away with the excecption for municipal bond interest in the AMT calculation, getting rid of the possibility to game differences in income and capital gains taxes by choosing different compensation plans, putting a cap on exemptable morgage interest. Because the top 1% are, almost by definition, going to have the best accountants around…

10

Kevin 04.17.09 at 10:38 pm

“good would be having systems of governance that precluded the rise of the problem. “

What exactly is the problem? Certainly, poverty is a problem. But the existence of a wealthy people is not a problem. This comment thread is pervaded by the idea that their is a finite, limited pie that is being carved up. As any economist will tell you, that is simply not the case. In other words, wealth does not cause poverty. Work on solving poverty, not punishing those who create wealth.

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StevenAttewell 04.17.09 at 10:47 pm

MarkUp: I don’t. I was just saying what my own position was.

Jeff: upward mobility is kind of hard when you’ve got existing inequalities; people pass on their advantages to their kids, better prepared and financed kids have an easier time getting into elite institutions, have better social networks, and so forth.

That’s why I think you need to redistribute the wealth here – because otherwise those kids from poor families aren’t going to have the tutors, summer schools, Kaplan prep courses for standardized tests, aren’t going to be able to know the right people to talk to for letters of recommendation or references, and too many rich kids are going to have unlimited resources, as they all gun for limited slots in colleges and limited numbers of jobs.

12

Alderson Warm-Fork 04.17.09 at 10:52 pm

I agree totally with doctor science: the wealth of most of the wealthiest people is a result of power, not any contribution they make. Chris Dillow discusses it more fully than I could here: http://stumblingandmumbling.typepad.com/stumbling_and_mumbling/2009/02/bonuses-power-and-inequality.html

The same applies to those people who earn huge amounts of money as profits, dividends, rents, interests – i.e. through what they already own. Ownership is a form of power (the power to dictate the uses of resources) and they can use it to bring them money.

This is why the proposal to tax the rich more heavily seems too limited to me. The aim is precisely to take away their wealth without taking away their power – which means they will be able to use that power to fight back, through tax evasion, tax avoidance, political lobbying, campaign funds, control of the media, etc.

Reducing income inequality is the superficial shadow of the real need, reducing power inequality, and that has to mean expropriation. But looking at it this way also means we need to look at the body that’s taking away that power – because if it’s just as hierarchical as business, it won’t be any better. So ideally it should be public and democratic organisations – like communal assemblies or workers’ councils – that bypass the state.

13

Jeff R. 04.17.09 at 11:10 pm

Steven: If the goal is to redistribute wealth, then focusing on income (both as a diagnostic and as a policy target) is wrongheaded and quite possibly counterproducting since some instances how high income are the result of the upward mobility betweeen wealth strata that we want.

I also think that you’re overestimating the degree to which the elite’s ability to pass advantage to their kids depends on their discretionary income: I don’t think you could crush it even with Stalinist-level taxation (and, in fact, one is fairly certain that the russian elites had no problem getting their children into the ideal positions…)

I’m not sure what the solution here is, exactly. But I don thing that mobility a better place to attack the problem than attempting to make sure everybody’s income is above average.

14

Jonny Newton 04.17.09 at 11:14 pm

Stricter regulation of the financial sector is another possibility. This is a good idea, though mainly to prevent a repeat of the current economic downturn.

This is contentious in itself. The credit bubble would have eventually burst anyhow and we would have had a downturn. The question is would the bubble have burst earlier or grown less under different regulation? It is conceivable that fewer complex financial instruments would make it easier to read a bank’s balance sheet (and possibly lessen the effect of bank failures on other banks) without significantly affecting the real economy.

15

Jonny Newton 04.17.09 at 11:21 pm

Also, many of the arguments about why we should care about inequality apply less the smaller the percentage of people being looked at. If the top 1% are unlikely to live near you or come into contact with you in any meaningful way, why care?

16

David Kane 04.18.09 at 2:00 am

Here is a simple method for reigning in pay, at least at publicly traded companies.

The SEC should pass a regulation requiring that all publicly traded companies allow their shareholders to vote on the following (binding) resolution each year.

“The total compensation of both the CEO and the CFO shall not exceed $1 million in the coming fiscal year.”

Those who dislike government meddling in business have little to complain of here since the government isn’t telling any business how to set salaries. The government is just requiring that business owners be allowed to vote on a specific option.

What would happen of such a regulation were in place? Senior executives would complain long and loudly. Many large shareholders — especially pension funds — would gladly vote for lower compensation. Many mutual funds would feel pressured to do so. My guess is that the resolution would pass at many companies.

There would then be significant (downward) pressure on executive salaries across the board. If you’re the CEO/CFO of a big company, there are very few employees who you think should be paid more than you are. Of course, this won’t allow you to pay people (much) less than they could get elsewhere, but the number of people for whose services the “market” is willing to pay more than $1 million per year is small. The very best baseball players, rock stars, entrepreneurs and Wall Street traders would still make millions, but only because any attempt to lower their pay would cause them to go elsewhere with their talents.

Some would say that this plan won’t work since the companies whose shareholders agree to pay more than $1 million per year (whether they be public or private companies) will snap up all the “best” executive talent. Maybe. But, our ability to measure executive talent is so limited that it would be hard for any company to easily identify a CEO candidate who is significantly better than many other candidates for the job.

There is a sense in which such a scheme, if implemented, would amount to implicit collusion among the employers of senior executives. Perhaps. But collusion in the service of class warfare is no vice.

Won’t solve the whole “problem” of the top 1%, but would help a fair amount.

17

Doctor Science 04.18.09 at 2:40 am

Kevin:
punishing those who create wealth

Do you realize how detached from reality that sounds?

For wealthy people to have an upper limit on their income is not *punishment* in any meaningful way, it does not *hurt* — or at least, it hurts no-one sane. I myself am a follower of the late, great Alice Trillin, who developed the principle of “Enoughness” — there is a upper limit to how much money (=power) a person should have, and saying “enough” is not a punishment.

Additionally, the idea that the very wealthy are that way because they “create wealth” is nonsense. If you look at the list of the wealthiest people in America (or the world), it’s heavily tilted toward people who were born to their fortunes. Even those who are much, much wealthier than their parents — like Bill Gates and Warren Buffett — did not come from even the middle class. Gates and Buffett, at least, know that they did not “earn” their money by personal virtue, and neither plans to leave a great fortune to his children.

18

foxmarks 04.18.09 at 3:47 am

Doctor Science, you cannot decide anyone else’s pain. If it tell you jabbing a fork in your face does not hurt anyone sane, which one of us more distant from “reality”?

Punishment need not be painful to be meaningful. I propose the measure of punishment is the effect on behaviour. If there are diminishing returns to work, sane people will work less. These clownish proposals are, indeed, meaningful punishment. For what, though? The “good of society”?

You assert that wealth creation by individuals is nonsense. Well, then, who made it? Your (false) conception of inheritance only masks the flaw in your thinking. If the wealth was not created by the children, it was created by the parent, grandparent or other ancestor. This ludicrous proposal to limit wealth-building and legacy-passing will lead to less wealth for all.

I say “enough” of such envious claptrap.

19

Righteous Bubba 04.18.09 at 3:54 am

This ludicrous proposal to limit wealth-building and legacy-passing will lead to less wealth for all.

Attention.

20

Omega Centauri 04.18.09 at 4:05 am

I have to (OK only halfway) agree with Kevin. We have to be careful that we don’t slip into punishing success. I happen to agree however that only a minority of the wealthiest actually created anything like the amount of wealth the recieve, but who’s to decide? Yes modestly higher marginal tax rates, and fewer loopholes, certainly will help. But we can only expect a rather modest improvement to the Gini coefficient, by the employment of such methods. But, if the goal, is improved funding for public programs, as opposed to knocking down the wealthiest, that shouldn’t be a problem.

21

StevenAttewell 04.18.09 at 5:14 am

Jeff R:

You make a good point – I’m down for a wealth tax too.

22

StevenAttewell 04.18.09 at 5:34 am

Foxmarks:

The idea that higher marginal tax rates reduce work just isn’t true. High-earning people are usually self-motivated enough that if taxes go up, they work more to keep earning at the previous rate.

Historically speaking, top marginal rates have been much, much higher than they are today. Top income brackets were at 80-90% from the 1940s and 1963, and in the 70% range from 1963-1981. (http://www.truthandpolitics.org/top-rates.php) Rich people didn’t stop working, and the economy didn’t shut down – economic growth averaged 6% in the 1940s, 4.1% in the 1950s, 4.4% in the 1960s, and 3.3% in the 1970s. This compares quite favorably from the 1980s to today, when we’ve tended to average 2-3% growth per year.

23

StevenAttewell 04.18.09 at 5:35 am

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minneapolitan 04.18.09 at 5:46 am

Individuals create wealth, but they do not necessarily enjoy the use of the wealth they have created. In fact, it is almost universally true in our civillization that most of the people who create most of the wealth enjoy a proportionally smaller amount of that wealth than the amount they create. David C. Novak, the CEO of YUM! Brands, does not wake up at 4 a.m. to go into a Taco Bell location, clean the grease trap, slice the tomatoes, replace the toilet paper in the restroom, etc. Someone else does that work, the work that is essential to creating wealth, and Novak profits from his ability to coerce them into doing it for less than an equivalent share of the wealth they create. His children will likewise do no work to create that wealth, yet they’ll be educated at the best schools and be given similarly exploitative positions in the management of large corporations, despite already posessing more than enough wealth, due to the accident of their birth, to live for the rest of their lives without creating any more wealth.

What always strikes me as odd in these discussions of the basic material conditions of the society we live in, is that the people who complain most bitterly about “punishing the people who create wealth” are themselves the people who do the creating, which is to say, not the people who actually get to enjoy the wealth created. On the contrary, the wealthiest members of society, people such as Warren Buffett or Bill Gates, don’t complain about being punished at all, and in fact strongly support the system that is allegedly so inimical to their own interests.

I wonder why that should be, if they are in fact being punished so cruelly?

25

gordon 04.18.09 at 5:52 am

The idea that increased taxes on very large incomes will somehow damage wealth creation is such an old one. It has been trotted out at the appropriate occasions all my lifetime, and probably has been around for longer than that.

The argument is not without holes.

In one form, the argument involves an assumption about talent. If you assume that talent is very scarce, you might conclude that very large rewards are justified. For this form to work, you need to prove first that the talent in question is directly related to wealth creation, and second that the talent is in fact rare. As far as the talent/wealth creation link is concerned, surely since we have just lived through (are living through) a dramatic expose of how untold billions of dollars are effectively used for gambling by the very wealthy, the link is questionable at best. Either the very wealthy don’t have much wealth creating talent or if they have it is easily swamped by their talent for games of chance.

And as for scarcity of talent, I’m unconvinced. I recently watched the video of a dumpy 47-year-old lady from Britain get on the stage in “Britain’s Got Talent” and astonish a sceptical audience with the quality of her singing. I think that example can be multiplied through a range of talents, not just singing. There are probably millions of people out there who would be just as good at running a bank as the ones we have now – and many of them probably better. Certainly many would be more honest.

Another form of the “wealth creation” argument revolves around effort. We are told that large rewards are needed to provoke effort. In response to this it has often been pointed out that historically the multiple of CEO remuneration to mean or median employees’ salaries was much lower than it now is. Were the forebears in office of today’s managers therefore lazy?

Finally, we need to remember what “wealth creation” means. It means investment. And Govt. investment is no less investment than private investment. Again, the current debacle in financial markets shows us that large aggregations of private wealth are no guarantee of large private investments – unless you count truckloads of valueless paper as an “investment”. I’d rather have a bridge to nowhere. At least some people got paid for building it.

26

Henri Vieuxtemps 04.18.09 at 9:20 am

Right, some good points there. To an avaricious power-hungry sociopath it may indeed feel that being downsized from billionaire to millionaire is like being jabbed a fork in the face. Mental health services must be provided, free of charge.

27

Tom Fuller 04.18.09 at 3:00 pm

Just to slightly change the subject, if I were happily in the category being discussed, I am pretty sure my accountant/financial adviser would be very… tired. And I think everyone that I paid good money to to help me and others like me would be tense and irritable. It’s hard to do financial planning when you don’t know what you’ve got to play with.

As the bottom line of all this is, what level of payment must I make to insure that you don’t eat me, it is a protection racket and we can learn lessons from them. And your predecessors in Sicily know that predictability is really important. If a government were to commit itself to taxing the super-rich at a certain level (probably a band with firm margins), the super rich and those that serve their financial needs would be able to plan successfully. These financial plans would be more successful than those in areas where taxes were changed too frequently, and the super rich would gravitate to those areas–much like they did to London when Blair and Brown committed to low taxation of the rich and used statements similar to Deng’s ‘to get rich is glorious.’

This is a relative game, after all. If you threaten to eat the rich, they will move. They will shop for a tax-lite country. I should think the yield management software used by airlines could be adapted to estimate the most effective tax regime…

28

ScentOfViolets 04.18.09 at 4:43 pm

Ah, good Capitalists all – even the liberals. The question really comes down to this: the labor markets are broken.

How do you fix them? And how did they come to be broken in the first place?

29

Barry 04.18.09 at 5:44 pm

“If you threaten to eat the rich, they will move. ” There are a lot of countries where the rich would be taxed less; it’s amazing that they haven’t all fled by now.

30

Tom West 04.19.09 at 3:07 am

The area where the US really outshines the rest of the world is in entrepreneurship. These are the guys that might think twice about investing their life savings (and the savings of their friends and family) in a business that is 90% likely to go bust if they realize that they are unlikely to see much of the payoff in the unlikely event that they manage to strike it rich. One might see it as privatizing losses and socializing profit.

31

Tom West 04.19.09 at 3:16 am

the labor markets are broken.

Given your previous postings, I come up with two possible meaning of ‘broken’.

(1) The workers do not receive enough of the surplus they create.

(2) The other is that some workers are in positions that do not create much (or any) surplus, although their work might ‘appear’ valuable. Examples of the latter might be providing quality child-care, for which nobody is willing to pay what some might feel it is worth, or workers in industries where demand for their product has collapsed.

Are you arguing (1) or (2)? Or have I misconstrued the meaning of ‘broken’ altogether?

32

Alderson Warm-Fork 04.19.09 at 12:37 pm

“If you threaten to eat the rich, they will move. They will shop for a tax-lite country.”
That’s called class struggle. And if one side is already fighting, and the other sitting around in confusion…

33

james 04.20.09 at 11:28 pm

There is a joke a Russian colleague likes to tell:

A poor German farmer lives down the road from a rich farmer. A passing stranger stops by talk. He asks the poor German farmer what he thinks about the rich farmer. The poor German farmer swears “by God, I will work, my wife will work, and my children will work, day and night, until we are as rich as he is!”.

A poor Russian farmer lives down the road from a rich farmer. A passing stranger stops by talk. He asks the poor Russian farmer what he thinks about the rich farmer. The poor Russian farmer swears “by God, I will work, my wife will work, and my children will work, day and night, until he is as poor as we are!”.

Personally, not so much a fan of Plan B.

34

Barry 04.21.09 at 6:13 pm

James, if you think that is at all applicable to the US, then you’re a bit detached from reality. Although it *is* a standard line.

35

Barry 04.21.09 at 6:19 pm

Tom West 04.19.09 at 3:07 am

“The area where the US really outshines the rest of the world is in entrepreneurship.”

I *hear* this a lot.

“These are the guys that might think twice about investing their life savings (and the savings of their friends and family) in a business that is 90% likely to go bust if they realize that they are unlikely to see much of the payoff in the unlikely event that they manage to strike it rich. “

Considering that we’re discussing rates for which we have historical data, and that the historical data suggests *better* performance than now, I think that few will ‘think twice’.

“One might see it as privatizing losses and socializing profit.”

As opposed to the current system?

36

watson aname 04.21.09 at 6:22 pm

As opposed to the current system?

Of course. After all, privatizing profit and socializing loss is what made this country what it is today, no?

37

james 04.22.09 at 2:48 pm

Barry – This whole thread presupposes that all wealth ultimately belongs to the State. With such a crowd, it is simply prudent to suggest a goal of equally rich rather than the implied movement towards equally poor. The actual reality in the US is that wealth belongs to the individual. The State’s power to exercise takings, is granted by the citizens, in an effort to achieve goals not possible individually.

38

Barry 04.22.09 at 3:04 pm

“This whole thread presupposes that all wealth ultimately belongs to the State. “

You might want to look up the word ‘strawman’.

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james 04.22.09 at 9:51 pm

Barry – Yes, I have come right out and stated that one of the justifications for this kind of wealth redistribution is the belief that all wealth ultimately belongs to the State.

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Watson Aname 04.22.09 at 10:26 pm

james — you might want to look up the word ‘strawman’ again, it didn’t stick the first time.

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Doctor Science 04.23.09 at 12:17 am

james’ strawman is also a false dichotomy, of a sort that is both (a) IME very common among libertarians, and (b) relevant to the “neoliberal” discussion in the other thread.

What you’ll not about james’ dichotomy is it opposes wealth as held by individuals to wealth as held by The State — but there is no mention of the principle holders of wealth in our society, families and/or corporations. Painting the big opposition as between individuals and The State is a way of distracting attention from where the money is really going.

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Doctor Science 04.23.09 at 12:23 am

what you’ll *note*, not not.

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