By: Lawrence Summers
February 16, 2014
The United States may be on course to becoming a "Downton Abbey" economy. There are valid causes for concern about inequality: sharp increases in the share of income going to the top 1 percent of earners, a rising share of income going to profits, stagnant real wages and a rising gap between productivity growth and growth in median family incomes. A generation ago, it could have been asserted that the economy's overall growth rate was the dominant determinant of growth in middle-class incomes and progress in reducing poverty. This is no longer a plausible claim.
Issues associated with an increasingly unequal distribution of economic rewards are likely to be with us long after cyclical conditions have normalized and budget deficits have been addressed.
Those who condemn President Obama's concern about inequality as "tearing down the wealthy" and un-American populism have, to put it politely, limited historical perspective. Consider some past presidential rhetoric:
Franklin Roosevelt said of the financial industry in his first inaugural address: "Practices of the unscrupulous money changers stand indicted in the court of public opinion . . . they know only the rules of a generation of self-seekers. . . . and when there is no vision the people perish." In 1936, Roosevelt asserted that "we had to struggle with the old enemies of peace -- business and financial monopoly, speculation, reckless banking. . . . They are unanimous in their hate for me, and I welcome their hatred."
Harry Truman observed: "The Wall Street reactionaries are not satisfied with being rich. . . . They want a return of the Wall Street economic dictatorship."
John Kennedy, dismayed by a steel price increase, was quoted cursing the steel executives.
Richard Nixon announced in 1973 that he had "ordered the Internal Revenue Service to begin immediately a thoroughgoing audit of the books of companies which raised their prices more than 1.5 percent above the January ceiling."
Bill Clinton complained during his first presidential campaign that "America is evolving a new social order, more unequal, more divided, more impenetrable to those who seek to get ahead. Although America's rich got richer . . . the country did not. . . . the stock market tripled but wages went down."
More such examples abound. It is neither unusual nor un-American to be concerned about income inequality, the concentration of wealth or the influence of financial interests. Demands for action are hardly unreasonable given frustration with stagnant incomes and a growing body of evidence linking inequality to reduced equality of opportunity, reduced demand for goods and services and increased alienation from public institutions.
The challenge is what to do. If total income were independent of efforts at redistribution, there would be a compelling case for reducing incomes at the top and transferring the proceeds to those in the middle and at the bottom. Unfortunately, this is not the case. It is easy to conceive of policies that would have reduced the earning power of a Bill Gates or a Mark Zuckerberg by making it more difficult to start, grow and globalize businesses. But it is much harder to see how such policies would raise the incomes of the remaining 99.9 percent of the population, and such policies would surely hurt them as consumers.
Yes, there has been a dramatic increase in the number of highly compensated people in finance over the past generation. But recent studies show that most of the increase has come as the value of assets has increased and that asset management fees have remained roughly constant as a share of assets. Perhaps some policy could reduce these fees, but the beneficiaries would be a group heavily tilted toward the very wealthy: the owners of financial assets.
It is not enough to identify policies that would reduce inequality. To be effective, they must also raise the incomes of the middle class and the poor. Tax reform would play a major role here. Beyond its adverse effects on economic efficiency, today's tax code allows a far larger share of the income of the rich to escape taxation than the poor or middle class. For example, last year's stock market growth represented an increase in wealth of about $6 trillion, with the lion's share going to the very wealthy. It is unlikely that the government will collect as much as 10 percent of this given the capital gains exemption, the ability to defer unrealized capital gains and the absence of any tax on gains on assets passed on at death.
Meanwhile, the ratio of corporate tax collections to the market value of U.S. corporations is near a record low, thanks to various loopholes. And the estate tax can be substantially avoided by those prepared to plan and seek sophisticated advice. Closing loopholes that only the wealthy can enjoy would enable targeted tax measures such as the earned-income tax credit to raise the incomes of the poor and middle class more than dollar for dollar by incentivizing working and saving.
It is ironic that those who profess the most enthusiasm for market forces are least enthusiastic about curbing tax benefits for the wealthy. Sooner or later, inequality will be addressed. Much better that it be done by letting market forces operate and then working to improve the result than by seeking to thwart their operation.