Most people know America is unequal. Many of us have heard the statistic that the richest 1% of Americans receives 24% of the nation’s income. This number looks big. It might even look huge. But if it doesn’t utterly shock you, you don’t really understand it.
This graph illustrates inequality by lining up the incomes of the U.S. population along a football field with $100 bills.* The median U.S. family earns a stack of bills approximately 1.7 inches high—that’s $42,327 (this exercise assumes there are 250 bills in a 1 inch stack, which of course depends on whether or not you press it down). As you go up field, the stack gets gradually larger until the 99 yard line, the average income is about $500,000 and the stack of bills is about a foot and a half tall. The top of the graph is the Fortune 400 list. In 2008, their incomes averaged $270 million (likely higher in 2011, but similar data are not available. Their stack of bills is about 900 feet tall or 300 yards—that’s the height of three football fields standing on their sides. Makes that 1.7 inch stack look pretty darn small…doesn’t it? (By the way, these statistics are considerably more extreme when you consider wealth, instead of income)
These statistics do not indicate economic growth. To the contrary. Widening income inequality cuts people off from economic opportunity. Many economists have found inequality on a global scale is correlated with lower rates of economic growth (Pineda and Rodriguez 1999, Alesina and Rodrik 1994, and Perssen and Tabellini 1994). On a smaller scale, a recent paper uses census data in U.S. states to conclude that inequality is positively correlated with bankruptcies, which may be a result of those with less attempting to “catch up” with their neighbors and depleting savings or taking on excess debt in the process. Even Alan Greenspan, infamously libertarian, has said on widening income inequality: “this is not the type of thing which a democratic society—a capitalist democratic society—can really accept without addressing.”
To a large extent, inequality is a relatively natural byproduct of capitalism. On a basic level, inequality should exist purely because society aims to compensate workers proportionally based on productivity. Those who are more productive receive higher compensation and vice versa. Ideally we should all have the same basic economic opportunities, but different economic outcomes based on a person’s contributions.
But it doesn’t really work that way, not even in basic principal. In 1915, a statistician at the University of Wisconsin named Willford I. King wrote: “It is easy to find a man in almost any line of employment who is twice as efficient as another employee, but it is very rare to find one who is ten times as efficient. It is common, however, to see one man possessing not ten times but a thousand times the wealth of his neighbor.”
So what does cause income inequality? The answer is not so straightforward. Many economists point to new technologies, which have created huge opportunities for wealth for a few and meanwhile rendered many traditional jobs obsolete. Global competition, the decline of the union, and free trade have eroded many middle class jobs. Others point to the slowdown in educational gains in America, particularly compared to other nations.
Another compelling argument has to do with tax. The top income tax bracket now is about 30-50 percentage points below what it was under Eisenhower, Nixon and Ford—when the country was a great deal more equal. The top marginal income tax rate is a little below 35%–compared to 70% before Reagan took office and up to 90% in the 1950s! But the marginal tax rate, the rate on the last dollar earned, is not the same as the effective tax rate, which includes taxes on capital gains and pensions, and removes money on government payments, including Social Security. The effective tax rate has been much more stable. But it’s shown some pretty funky trends among those top income tax earners—the ones who make three football fields worth of $100 bills.
According to the IRS the effective federal income tax rate for the Fortune 400 fell from almost 30 percent in 1995 to just below 17 percent in 2007. But the true effective rate is even lower than government statistics because those figures fail to include income generated by tax-avoidance strategies. In many of these strategies, the earner will borrow money against their assets and then never (or indefinitely push off) repay. Other executives—like Phil Knight of Nike, Jeffrey Immelt of GE, and James Gorman of Morgan Stanely—have left future earnings to children without paying estate tax by setting up Grantor Retained Annuity Trusts. And then there are the many complicated accounting strategies involving secrecy jurisdictions. There are massive numbers of avoidance schemes. I won’t bore you with more details.
Tax and government policy do not explain the whole story of rising income inequality in America and probably not even the majority of it. But it does provide an accessible remedy. We aren’t going to slow the pace of technological change nor are we going to stem global competition. We probably won’t end free trade or refortify the unions. But we can close tax loopholes. It won’t be easy. There will be pushback, particularly from the people it hurts most. But America can’t afford to keep striding down this path. And more importantly, 300 million Americans can’t afford it, either.
* Note: In my description I have updated these figures to 2011 statistics, though the original representation is 2004. The chart claims Bill Gates’ largest annual income was $50 billion—an assertion for which I could find no credible source. With factual inputs, the illustration does, however provide a contextualization for a concept that is difficult to visualize.
Disclaimer: Unless specifically stated to be the views of the Task Force, the opinions expressed on this blog are solely the opinions of the individual blogger and are not necessarily those of the Task Force on Financial Integrity & Economic Development.