Managing the Beast: How Government Can ReduceWealth Inequality
Jon Forman
Alfred P. Murrah Professor of Law
University of Oklahoma
Remarks for
Panel III, How Law Constructs Wealth Patterns
at the
Wealth Inequality and the Eroding Middle Class Conference
Co-sponsored by the
Center on Poverty, Work and Opportunity
and the
American Constitution Society for Law and Policy
University of North Carolina
Chapel Hill, NC
November 4-5, 2007
Table of Contents
I.How Government Affects the Distribution of Wealth and Income
A.An Overview of Inequality in the United States
1.Income Inequality
2.Wealth Inequality
B.Measuring the Impact of Government on the Distribution of Economic Resources
II.Government Intervention Should Promote Greater Economic Justice
A.Our Tax System Should Promote Economic Justice
1.Combine the Income and Payroll Taxes
2.Tax Wealth
B.Our Welfare System Should Also Promote Economic Justice
III.Conclusion
1
Managing the Beast: How the Government Can Reduce Wealth Inequality[*]
Jonathan Barry Forman[†]
Thank you for this opportunity to share my thoughts on how government can reduce wealth inequality. In my remarks today, I willtalk about how government policies influence the distribution of income and wealth, and I will offer some suggestions about how our tax and welfare systems can be redesigned to promote economic justice.
I.How GovernmentAffects the Distribution of Wealth and Income
In a complex society like ours, the distribution of economic rewards is determined by a combination of market forces and government policies. Markets arise automatically from the economic interactions among people and institutions. Here and there, government policies intervene to influence the operations of those markets and to shape the outcomes that result from market transactions.
Needless to say, policymakers can’t do much about market forces. Adam Smith’s laws of supply and demand are every bit as immutable as Newton’s laws of thermodynamics. But policymakers can change how governments influence market operations and outcomes.
In that regard, governments influence market outcomes through a combination of regulation, spending, and taxation. Government regulation defines and limits the range of markets and so influences the shape of the initial distribution of income and wealth. Government taxes and spending also have a significant impact on the distribution of income and wealth.Most clearly, taxes and transfers are the primary tools for redistribution.[‡]
A.An Overview of Inequality in the United States
As earlier panels have explained, there is substantial inequality in the distribution of earnings, income, consumption, and wealth in the United States today. The distribution of consumption is the least unequal, while the distribution of wealth is the most unequal (see Figure 1).[§] Earnings and income fall in between.
1.Income Inequality
Pertinent here, household income inequality has increased dramatically over the past few decades. For example, in 2005, the average household in the richest 20 percent of households had almost 15 times as much income as the average household in the poorest 20 percent, up from just 10 times as much in 1975 (see Figure 2).[**]Similarly, the average household in the richest 5 percent of households now has more than 26 times as much income as the average household in the poorest 20 percent, up from just 15 times as much in 1975.[††]
2.Wealth Inequality
Wealth is even more unequally distributed. In 2004, for example, the top 1 percent of American households had 34percent of total household wealth, and the top 20 percent had 85 percent of household wealth (see Figure 3).[‡‡]Meanwhile, the bottom 80 percent of households held just 15 percent of total household wealth, and the bottom 40 percent held much less than one percent of the nation’s wealth.[§§] Worse still, wealth inequality is perpetuated through countless generations as a substantial portion of wealth is passed on through inheritance.
B.Measuring the Impact of Government on the Distribution of Economic Resources
It is probably impossible to measure the full impact of government on the distribution of economic resources. In particular, it is difficult to estimate the impact of government regulation on the distribution of income and wealth. We simply do not start from some theoretical Hobbesian state of nature, only to have government add a regulatory framework to it. Rather, governments define and limit the realms of market competition. These activities both enhance the ability of markets to create wealth and influence the ultimate distribution of that wealth.
For example, government grants of patents not only encourage the creation of tradable property rights in new technologies, but also concentrate the resulting wealth in the hands of the patent owners. And the same goes for copyrights and trademarks. For example, Elvis Presley earned $49 million last year, even though he has been dead for 40 years.
Regulations also grant monopolies to utilities, broadcasters, and liquor stores, and it would be difficult to estimate the impact of those rules on the distribution of income and wealth.
On the other hand, we can get a very good idea about how much influence government tax and spending programs have on the distribution of income and wealth. According to the Census Bureau, the current mix of government tax and transfer policies reduces household income inequality by about 20 percent (see Table 1 and Figure 4).[***]
Table 1. Share of Aggregate Household Income by Quintiles and Gini Index, 2005
Market income / Disposable incomeQuintiles
Lowest / 1.50 / 4.42
Second / 7.26 / 9.86
Middle / 14.00 / 15.33
Fourth / 23.41 / 23.11
Highest / 53.83 / 47.28
Gini Index / 0.493 / 0.418
II.Government Intervention Should Promote Greater Economic Justice
Is a 20 percent reduction in economic inequality enough? If not, is more redistribution called for? I believe so.
To be sure, it seems unlikely that a convincing moral argument can be made for any particular distribution of economic resources. Still, given how unequal the present distribution of wealth and income is, I think it is clear which direction we should go. More government intervention is needed to achieve greater economic justice.
In particular, I believe we should focus our efforts on increasing the economic rewards for low-income workers. Increasing the economic rewards for low-income workers will increase their participation in the workforce, their productivity, their incomes, and, ultimately, their wealth.
In the regulatory arena, for example, we recently helped low-income workers by raising the minimum wage. I hope thatwe will eventually index the minimum wage for future inflation—so that we never again see a year, let alone an entire decade, without an increase in the minimum wage.[†††]
As several of my fellow panelists have other suggestions about how government regulation can be used to reduce economic inequality, I will spend the rest of my time talking about how we can redesign the tax and transfer systemsto promote greater economic justice.
A.Our Tax System Should Promote Economic Justice
First, let us consider taxes. Over the years, the federal government has increased its reliance on individual income taxes and payroll taxes, and it has decreased its reliance on corporate income taxes, estate and gift taxes, and other sources of revenue.[‡‡‡]
In effect, there are now two taxes on earned income, and hardly any taxes on wealth and investment income.Workers pay income taxes on their earned income at tax rates of up to 35 percent,[§§§] and they pay Social Security taxesof up to 15.3 percent.[****]Thecumulative tax rates on earned income can be extraordinarily high, and those high tax rates discourage work and result in greater inequality.
Meanwhile, taxes on wealth and investments have fallen dramatically. The maximum tax rate on dividends and capital gains is now just 15 percent, and the estate tax is scheduled to disappear. In short, Warren Buffett—one of the richest men in the world—faces a lower tax rate than his secretary.
1.Combine the Income and Payroll Taxes
If it were up to me, I would combine the individual income tax and the Social Security payroll tax into a single, comprehensive income tax system with a broad base and low tax rates on earned income. In particular, I would repeal many of the special tax breaks for investment income.For example, repealing the tax break for capital gains and dividendscould raise about $130 billion a year,[††††] and that revenue could be used to lower tax rates on earned income.
2.Tax Wealth
I would also keep the current estate tax or,alternatively, replace it with an annual wealth tax. A number of European countries already have annual wealth taxes.[‡‡‡‡] High exemptions are provided to exclude taxpayers with few economic resources, and tax rates are also graduated.
Even a modest annual wealth tax couldraise a lot of revenue. For example, New York University EconomistEdward Wolff has estimated that a modest annual wealth tax in the United Stateswould raise around $50 billion a year.[§§§§]
B.Our Welfare System Should Also Promote Economic Justice
We should also redesign our welfare system. Right now, 85 separate federal programs provide income-tested welfare benefits to low-income families.[*****] To keep costs down, virtually every one of these programs phases benefits out as family income increases. Unfortunately, these phase-outs often combine with income and payroll taxes to subject beneficiaries to confiscatory tax rates (see Figure 5).[†††††]
I believe that we should replace most of the current welfare system with a system of refundable tax credits. The general idea is to “cash out” as many welfare programs as possible—from food stamps to housing subsidies. And we should use that money to pay for a system of earned-income tax credits, refundable personal tax credits, child care tax credits, and health care tax credits.
First, to encourage work, we should have a $2,000-per-worker earned-income tax credit, computed as 20 percent of the first $10,000 of earned income.Along the same lines, Congressman Charles Rangel, Chairman of the House Ways and Means Committee, recently proposed doubling the earned income tax credit for workers without children.
A $2,000 per worker earned income tax credit would act as an earnings subsidy, and most economists believe that earnings subsidies increase work effort.Moreover, earnings subsidies,like the earned income credit, can alsoincrease employment opportunities for low-wage workers. By increasing the compensation paid to low-wage workers at no cost to employers, earnings subsidiesactually increase the demand for low-skilled workers.
Second, we should replace personal exemptions, standard deductions, child tax credits, and much of the current welfare system with universal $2,000-per-person refundable tax credits. Under such a system, a working, single parent with two children would receive three personal tax credits for a total of $6,000, and she would also receive a $2,000 earned income credit, and her salary. Altogether that should put her well over the poverty level.[‡‡‡‡‡]
Third, we should expand the current child care tax credit and make it refundable. Child care costs are a challenge for low-income parents who are trying to work. We should use the tax system to reimburse low-income parents for 50 percent or, perhaps, even 80 percent of their child-care costs.
Finally, we need universal health care. We should cap the current exclusion for employer-provided health insurance and gradually replace it with a refundable tax credit. Like deductions, exclusions are the most valuable to high-income taxpayers. On the other hand, refundable tax credits are equally valuable to all taxpayers. Consequently, replacing the current exclusion with a refundable tax credit would shift the health care subsidy toward those low-income families that have the greatest need for government assistance.
III.Conclusion
All in all, I believe that the government can, and should, intervene in the free market to reduce economic inequality.We simply do not have to settle for a society where the top 5 percent of households have dozens of times as much income as the bottom 20 percent and hundreds of times as much wealth.
In the words of James K. Galbraith,
The economy is a managed beast. It was managed in such a way that this was the result. It could have been done differently.[§§§§§]
Let us work together to find different and better ways to manage our economy and to promoteeconomic justice.
Thank you.
1
[*] This article is based on Jonathan Barry Forman’s remarks on November 5, 2007, on Panel III, “How Law Constructs Wealth Patterns” at the Conference on Wealth Inequality and the Eroding Middle Class co-sponsored by the Center on Poverty, Work and Opportunityand the American Constitution Society for Law and Policy held at the University of North Carolina. The article draws fromJonathan Barry Forman, Making America Work(Washington, DC: Urban Institute Press, 2006). Copyright 2006 by the Urban Institute Press. Portions are reprinted by permission of the Urban Institute Press, 2100 M Street N.W., Washington, D.C.20037. This article is only sparingly footnoted, and interested readers should look in that book for the detailed citations of authority.
[†] Alfred P. Murrah Professor of Law, University of Oklahoma; B.A. 1973, Northwestern University; M.A. (Psychology) 1975, University of Iowa; J.D. 1978, University of Michigan; M.A. (Economics) 1983, George Washington University; Vice Chair of the Board of Trustees of the Oklahoma Public Employees Retirement System.
[‡]In addition, taxes and spending change the distributions of income and wealth by favoring some sectors of the economy over others and by influencing the behavior of economic actors in the marketplace.
[§] Forman, Making America Work, supra note 1, Figure 2.4. Note that consumer units are similar to households.
[**] Author’s computations from U.S. Census Bureau, Historical Income Tables – Households, table H-2 (2007).
[††] Along the same lines, while the Gini index of income inequality was 0.470 in 2006, it was 0.428 in 1990, 0.403 in 1980, and just 0.394 in 1970. U.S. Census Bureau, Income, Poverty, and Health Insurance Coverage in the United States: 2006 (Current Population Reports, Consumer Income Report No. P60-233, 2007), table A-3. The Gini index is a mathematical measure of income inequality that can range from 0.0, indicating perfect equality (where everyone has the same income), to 1.0, indicating perfect inequality (where one person has all the income and the rest have none).
[‡‡]Edward N. Wolff, Recent Trends in Household Wealth in the United States: Rising Debt and Middle-Class Squeeze (Levy Economics Institute Working Paper No. 502, 2007), table 2.
[§§]Id. The Gini index for wealth inequality in 2004 was an astonishingly high 0.829.
[***]U.S. Census Bureau, The Effects of Taxes and Transfers on Income and Poverty in the United State: 2005 (Current Population Reports, Consumer Income Report No. P60-232, 2007), table 3. Before government taxes and transfers, the richest 20 percent American households received 53.83 percent of household income, while the poorest 20 percent received just 1.50 percent, and the Gini index was a sizeable 0.493. Taxes and transfers increased the relative share of income held by the bottom three quintiles at the expense of the share of income held by the top quintile, and the Gini index fell to 0.418. Figure 4 provides a graphic interpretation of this data.
[†††] U.S. Department of Labor, Employment Standards Administration, Wage and Hour Division, History of Federal Minimum Wage Rates Under the Fair Labor Standards Act, 1938-2007 (2007),
[‡‡‡] See, e.g., Forman, Making America Work, supra note 1, table 4.1 & figure 4.1.
[§§§] I.R.C. § 1.
[****] Overall, the payroll tax is regressive, with workers paying roughly 15.3 percent of their first $97,500 of earned income and 2.9 percent on earnings in excess of $97,500 (in 2007). Social Security Online, Contribution and Benefit Base (2006),
[††††] Joint Committee on Taxation, Estimates of Federal Tax Expenditures for Fiscal Years 2007-2011 (JCS-3-07, 2007), table 1.
[‡‡‡‡] See, e.g., Edward N. Wolff, Top Heavy: The Increasing Inequality of Wealth in America and What Can Be Done About It (1999). Alternatively, we could tax gifts and inheritances as income under the income tax, or adopt an accessions tax. See, e.g., Forman, Making America Work, supra note 1, at 148-149.
[§§§§] Wolff, Top Heavy: The Increasing Inequality of Wealth in America and What Can Be Done About I, supra note 15, at 41. Professor Wolff based his estimate on the Swiss wealth tax system, with marginal tax rates of from 0.05 percent to 0.30 percent and an exclusion of about $50,000.
[*****]U.S. House of Representatives, Committee on Ways and Means, 2004 Green Book: Background Material and Data on Programs within the Jurisdiction of the Committee on Ways and Means (2004), K-10—K-12.
[†††††]Adam Carasso & C. Eugene Steuerle, The True Tax Rates Confronting Families with Children, Tax Notes, October 10, 2005, at 253. At some points between $10,000 and $25,000 of income, the cumulative tax rate on a single parent can even exceed 100 percent.Daniel N. Shaviro, The Minimum Wage, the Earned Income Tax Credit, and Optimal Subsidy Policy, 64(2) University of Chicago Law Review 405 (1997).
[‡‡‡‡‡]In 2007, for example, the federal poverty level for a family of three is $17,170. U.S. Department of Health and Human Services, Office of the Secretary, Annual Update of the HHS Poverty Guidelines, 72 Federal Register 3,147 (2007).
[§§§§§] James K. Galbraith, Created Unequal: The Crisis in American Pay 266 (1998), 167.