The Price of Inequality

Joe Stiglitz on the price of inequality. He makes the argument that a lot of what those at the top do is really rent seeking, rather than anything productive. If you could reduce that behavior, you would reduce inequality without hurting growth.

He also makes the (unsubstantiated, but I believe true) statement:

Inequality leads to lower growth and less efficiency. Lack of opportunity means that its most valuable asset – its people – is not being fully used. Many at the bottom, or even in the middle, are not living up to their potential, because the rich, needing few public services and worried that a strong government might redistribute income, use their political influence to cut taxes and curtail government spending. This leads to underinvestment in infrastructure, education, and technology, impeding the engines of growth.

I also believe that lower middle class purchasing power is an important link between higher levels of inequality and lower GDP growth.

Finally, Stiglitz makes the argument that increasing inequality undermines American values:

America’s inequality is undermining its values and identity. With inequality reaching such extremes, it is not surprising that its effects are manifest in every public decision, from the conduct of monetary policy to budgetary allocations. America has become a country not “with justice for all,” but rather with favoritism for the rich and justice for those who can afford it – so evident in the foreclosure crisis, in which the big banks believed that they were too big not only to fail, but also to be held accountable.

Inequality needs to be controlled. The best way to do that is with high marginal tax rates on very high levels of income. Here’s a quick example. Let’s assume we have the following marginal tax rates (including all tax rates with the caveat that I don’t know how much income this would raise):

  • 0% on the first $15k,
  • 10% on income from $15k to $40k,
  • 15% on income $40k to $75k,
  • 20% on income from $75k to $100k,
  • 25% on income from $100k to $200k,
  • 30% on income from $200k to $400k
  • 35% on income from $400k to $750k
  • 40% on income from $750k to $1 mil
  • 45% on income from $1 mil to $3 mil
  • 50% on income from $3 mil to $5 mil
  • 60% on income from $5 mil to $10 mil
  • 70% on income from $10 mil to $20 mil
  • 80% on income over $20 mil

Now a top marginal tax rate of 80% seems really high, so let’s see how much money you get to keep at different pre-tax income levels.

If you are a typical worker, making $40,000, you pay $2,500 in tax for an average rate of 6.3%. If we’re arguing that this includes all types of income taxes (state, federal, and payroll), it basically means you are only paying a payroll tax.

If you are a couple making $75,000, a little above average for family income, you pay $7,750 in tax for an average rate of 10.3%.

If you are in the top 5%, making $200,000 a year, you pay $37,750 in tax, for a rate of 18.9%. So far, these rates don’t seem to be too bad. But what about for those at the very top?

If you are pulling down $1 million, and facing a marginal tax rate of 40%, you are paying $320,000 in taxes and taking home $680,000, for an average tax rate of 32%. That’s high, but I doubt it’s high enough to discourage our entrepreneurs, finance professionals, or others who are in this tax bracket.

If you are a CEO pulling down $10 million in annual income (and I would include all types of income), you are paying just over half (52.2%) in taxes. You’re still taking home almost $5 million, but maybe this is enough to get you to work a little less on lobbying regulators, breaking unions, or setting up a monopoly.

And what about that $1 billion hedge fund manager? Well, he’s screwed. He’s paying almost $800 million in taxes and only (only!) gets to keep around $200 million. Maybe he still tries to make $1 billion, maybe he doesn’t. I can’t see how society is worse off is he doesn’t. But if he does, the government is almost $800 million richer. That’s money that can be spent on roads, education, and national defense.



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