Restoring the middle class will require more than taxing “The Rich”

A couple great pieces on income inequality, both inspired by a recently released study from the CBO that finds, between 1979 and 2007, income grew by:

  • 275 percent for the top 1 percent of households,
  • 65 percent for the next 19 percent,
  • Just under 40 percent for the next 60 percent, and
  • 18 percent for the bottom 20 percent.

The old arguments you’ll hear from we conservative types are some version of (a) a rising tide lifts all boats – the poorest 5% in America are still wealthier than 68% of the rest of the world; and (b) the disparity is largely a function of globalization – we’re all competing with cheap labor throughout the world so our skills either have to be better or of the type that must be provided locally (e.g., the trades).

Perhaps that’s all fine and good.  But Daniel Foster wonders if those numbers still aren’t “inefficiently top heavy”

The years 1979–2007 indeed corresponded both to a period in which the U.S. economy as a whole grew at a brisk pace (an unmitigated good), and a period in which the size of the financial sector ballooned as a share of the economy (a, well, mitigated good, at best). I don’t know enough — I’m not smart enough — to weigh-in confidently on whether the financial sector was/is too big. On the one hand, a big, creative financial sector should efficiently allocate capital to the best entrepreneurs, and remove barriers to capitalization for entrepreneurs who otherwise may not have been able to bring their products to market. On the other hand, a large and leveraged financial sector (infamously) shackles the health of the overall economy to its own health, greatly amplifying the effects of banking crises. It might also siphon talent away from more socially and economically useful pursuits.1

In any event these are complex issues that conservative wonks should care about. Just as conservative wonks should care about massively disproportionate income gains. It’s (tautologically) true that putting money in the hands of job-creators create jobs. But is a 275-percent gain in income for the top one percent of households required to create that 40 percent gain in income for the middle classes? Is all that accumulated cash likely to be reinvested, or tucked away? Are there free-market-based policies that help channel gains to middle class investors and would-be entrepreneurs, e.g. to those who are most likely to put the marginal dollar to good economic use? Like I said, I’m too dumb to know the answers. But I know we should care about them.

Ross Douthat in What Tax Dollars Can’t Buy also acknowledges this growing gap between rich & poor presents but laments the inadequacy of “re-invigorated liberalism’s” same-ol’, same-ol’ response:  tax “The Rich.”

if all you care about is reducing measured income inequality, then the Occupy Wall Streeters and their Democratic admirers have it right. Tax millionaires sufficiently and you’ll end up with a more equal society. The tallest poppies will be trimmed, and some of their income will find its way to someone’s else pocket.

But true social mobility and broadly shared prosperity are not so easily achieved. Remember that those tax dollars, once collected, would not be disbursed with perfect effectiveness to the most deserving members of the American middle class. Instead, they would be used to buy a little more time for our failing public institutions — postponing a reckoning with unsustainable pension commitments, delaying necessary reforms in our entitlement system and propping up an educational sector whose results don’t match the costs.

More spending in these areas won’t necessarily buy us more mobility.

Both Douthat and Foster then beautifully make the following point:  feeding more tax dollars to the federal government will prop up certain constituencies but do little to restore the middle class.

Foster cites the very same CBO study to prove that transfer payments have grown dramatically less redistributive.  You may have heard me joke about this before: my kids will face punishing tax rates so that Warren Buffett can have free Viagra and Lipitor.  And yet the AARP will tell us, with a straight face, that their members are only getting “what they paid in” to the system.

That’s right, according to that same CBO study, the share of government transfer payments going to the poorest 20 percent of Americans has declined from 50 percent to 35 percent. And the share of those payments going to the wealthiest 80 percent has risen from 50 to 65 percent. In other words, the entitlement state is ever less about keeping the poor out of destitution, and ever more about subsidizing the health care and retirement benefits of the likes of Warren Buffett. Liberals are likely to use the CBO report to buttress the case for taxing “the rich” more. But they ought to think instead about subsidizing them less.

Douthat echoes that point, adds two other groups to the list of culprits, and chides republicans for their unimaginative response:

The story of the last three decades, in other words, is not the story of a benevolent government starved of funds by selfish rich people and fanatical Republicans. It’s a story of a public sector that has consistently done less with more, and a liberalism that has often defended the interests of narrow constituencies — public-employee unions, affluent seniors, the education bureaucracy — rather than the broader middle class.

The alternative to this liberalism should not, however, be the kind of reverse class warfare currently being championed by the not-Romney candidates in the Republican field, whose flat-tax fantasies would ask working Americans to bear more of the burden for public institutions that have been failing them for years.

Rather, it should be a kind of small-government egalitarianism, which would seek to reform the government before we pour more money into it, along lines that encourage upward mobility and benefit the middle class. This would mean seeking a carefully means-tested welfare state, a less special interest-friendly tax code, and a public sector that worked for taxpayers and parents rather than the other way around.

Several times in my lifetime we (republicans, or conservatives if you prefer) have negotiated “grand bargains” in which we raise taxes for the promise of reduced spending which never materializes.  This history of negotiating in bad faith from the other side makes us reluctant to go along with another such grand bargain, especially when their leader spends so much time publicly impugning our motives.

Better to hold out for a deal that raises taxes in exchange for actually addressing the underlying (demographic, institutional) problems.

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