Measuring Inequality

Jonathan Chait is a senior editor of the New Republic and a widely published political columnist. His first book, The Big Con, is a highly readable denunciation of the Bush administration’s economic programs. Reading it, in fact, puts one in a rather good mood, for with the president’s current approval rating lower than that of any president tracked, and with local Republican candidates anxiously distancing themselves from the administration, it feels like a chronicle of lamentable events from some recent past—depressing to dwell on, perhaps, but very much over.

One can excoriate George W. Bush for incompetence, but never for inconsistency. Just as his foreign policy was almost wholly subordinate to the goal of subduing Iraq, his economic policies seem to have had only two objectives—cutting taxes as much as possible, and putting business interests in control of the federal regulatory apparatus.

While Chait offers some brisk pages on the lobbyists’ takeover of official Washington, his main focus is on taxes, and especially on the singlemindedness with which the administration “sharply cut the proportion of taxes paid by those at the top and therefore raised the proportion paid by those elsewhere.” All of this is consistent “with Republican thought over the last few decades, which has agitated fiercely against the most progressive taxes and left alone the most regressive.”

Chait’s polemic would have been written when the Bush administration was still in full swagger mode after the crushing win over John Kerry. But how times have changed. With most indicators pointing toward a Democratic victory in November, both Barack Obama and Hillary Clinton have identified inequality and health care as core domestic priorities. And consistent with Chait’s polemic, both have focused on the Bush tax code as the key to success in both areas: as a source of revenue for health care and as a weapon for narrowing the spreading gap between upper- and lower-income Americans.

But when the election is over, Democrats will have to move beyond polemics. The rather surprising truth is that, whatever Bush’s intentions may have been, the federal tax structure has become considerably less regressive since 2000, and has had little to do with increasing inequality.

There is a vast difference between headline tax rates and what people actually pay. In 1980, when the top tax rate was 70 percent, the top 1 percent of earners actually paid a total effective tax rate of 34.6 percent, only a tad higher than the 31.2 percent they paid in 2005.

The Congressional Budget Office (CBO) tracks effective tax rates by income group, combining income taxes, payroll taxes, federal excise (sales) taxes, and corporate taxes. (Corporate taxes are paid at the company level but really come out of the pockets of owners. The CBO allocates them based on dividends, capital gains, and other corporate income streams reflected in individual tax returns.) Cross-walking the CBO effective-tax data with data on long-term changes in income shares among the top 10 percent of earners reveals the shifting relation between tax shares and income shares among the wealthy.

The Bush administration lowered taxes for all income groups, but as the table on page 26 shows, the rate reductions were skewed toward the lower earners. By 2005, the last year for which the analysis was completed, the ratio between the effective tax rates on the top 1 percent and on the lowest quintile of earners is the most progressive in the CBO series.

But wait. Sure, the rich got smaller percentage tax breaks, but they were getting so much richer, didn’t they still benefit disproportionately? Not really. In 1980, when marginal rates were very high, the total tax share of the top 10 percent of earners was 1.21 times larger than their income share; in 2005, when marginal rates were very low, their tax share was a virtually identical 1.20 times their income share. (Their share of personal income taxes grew from 48 percent to 73 percent.) The top 1 percent of earners did slightly better. From 1980 through 2005, the growth in their share of all taxes (94 percent) was somewhat lower than the growth in their share of income (112 percent). During 2000–2005, however, the tax share of the top 1 percent of earners nudged up by 8 percent, while their income share stayed flat.

The power of the homeostatic forces that seem to rule the tax code is astonishing. Enormous political energy has been devoted to both increasing and decreasing the top tax rates over the past twenty-five years, with remarkably little effect. The 31.2 percent effective rate paid by the top 1 percent of earners in 2005 was virtually identical to the 31.5 percent average effective rate since 1980.

Projections by organizations like Citizens for Tax Justice show that the Bush tax cuts are heavily weighted with benefits for the very wealthy, like the full repeal of the estate tax that will kick in just before the tax cuts are supposedly due to expire in 2010. Cutting those off is a no-brainer for any new Democratic administration.

But that will still leave really hard problems like inequality. The headline numbers are driven by extraordinary income gains in a very small group of people—rock stars, reliable left-handed starting pitchers, big-company CEOs, hedge-fund managers. Income shares of the run-of-the-mill wealthy, or people in the 90-to-99 percent income brackets, have changed hardly at all since 1980, from 24 percent to 26 percent.

A tax reform targeted at the top hundredth of 1 percent of earners might be morally satisfying, but wouldn’t produce very much. The numbers are not that large, and the very rich can easily shift their earnings around the globe if they want to. There are much more fertile, and readily exploitable, revenue opportunities, like auditing business partnerships and tax shelters.

The truly important and much harder inequality challenges are phenomena like the flattening of returns to a four-year college degree. As the gap between returns on high-school and college education narrows, the returns to graduate degrees are accelerating. There is also evidence that native-born young people, possibly for the first time in American history, are not keeping up technically.

It’s almost impossible to exaggerate the mistakes and incompetence of the Bush administration. Any new administration is going to inherit a host of daunting problems, from Iraq to the current debacle in housing and financial markets, even as critical priorities, like major health-care reform, will require across-the-board increases in taxes. Polemics are fun, and Chait’s are as good as any. Democrats have been in the wilderness long enough to earn their moments of fun. But, if all goes well, the time to move beyond polemics will loom like a freight train.