Capitalism is the best economic system that has ever existed. Although a bold statement, Capitalism efficiently allocates goods and services. When Adam Smith wrote of the market’s “invisible hand” in Wealth of Nations in 1776, he argued that humans’ natural tendency toward self-interest results in prosperity. He believed that by giving everyone freedom to produce and exchange goods as they pleased (free trade) and opening the markets up to domestic and foreign competition, people’s natural self-interest would promote greater prosperity than with regulations (Investopedia). But, there are shortcomings to Capitalism, the most significant of which is it does not guarantee an equitable distribution of wealth, especially when society allows for inheritances.
Taxes, in combination with social programs, have been the main mechanisms to ensure that income inequality does not become extreme. In specific, during the Great Depression of the 1930’s the US government created safety net programs to respond to the suffering and the political power that the poor had due to their sheer numbers. Safety net programs and the taxes that provide their funding, basically transfer income from the rich to the poor. As the major safety net programs in the US are Social Security and Medicare, these programs primary transfer income from the younger generations to the oldest generation. I contend that spreading around at least some of the US’s vast wealth has brought us economic and government stability.
The 1980s’ Tax Cuts and the growing income Divide
Since the 1930’s with the introduction of major safety net programs income equality had been falling until the 1980s. The major policy change in the 1980s were the Reagan tax cuts. These tax cuts were implemented in 1981 and 1986 and slashed the top marginal tax bracket (PoliticalEye). Beginning in the 1980’s income inequality ballooned in the US. There is a clear correlation between the 1980 tax cuts and the increase in income inequality in the US. But correlation is not causation and it is likely that other economic factors have contributed to the trend. However, it is hard to ignore the fact that, as the figure below shows, since the 1980s income inequality has increased significantly returning to pre-World War levels. The top 1 percent of the population has nearly 20 percent of the income. Even more dramatic is that .01 of the population has approximately 8 percent of the income. The timing of the increases in income inequality is so tightly tied to the tax cuts that is impossible to ignore their contribution to this very concerning outcome.
The even more dramatic wealth divide
The gap between rich and poor is even more dramatic when one examines wealth rather than income. Wealth is the value of ones assets (house, stocks, bonds, etc.). The concentration of wealth that has occurred since the 1980s has been even more dramatic than the concentration of income. The chart below show that in the 1962 the top 1 percent and bottom 90 percent each held about 35 percent of the nation’s wealth, Although income inequality widened in the 1960s, the divide really began widening since the 1980’s. By 2016, the top 1 percent increased their share to 39 percent of the wealth bottom 90 percent saw their share drop to 20 percent.
Share of the Wealth Held by the Top 1 Percent versus the Bottom 90 Percent
The table below shows amount of wealth held by the top .01 percent in terms of dollars. The top .01 percent is comprised of 16,070 families that have 11.2 percent of the nation’s wealth. This is an extraordinary concentration of wealth among a very small share of the population.
Taxes Paid By Income Share
Not surprisingly, when one examines who pays the lion share of income taxes, it is the wealthy. After all, they have all the money. In Tax Year 2011 half of all filers had about 11.5 percent of the income and paid less than 3 percent of all income taxes. In contrast, the top 1 percent have almost 20 percent of the income and pay 35 percent of all the income taxes collected.
Tax Burden by Percentage Share of Adjusted Gross Income, 2011
How does the tax system lessen inequality?
Taxes are a main mechanism by which income can be transferred from the rich to the poor. When the income tax rates were slashed, the amount of money transferred from the rich to the poor was reduced. Even with relatively low tax rates these income transfers lessen the degree of inequality as shown in the graphic below. At 2017 rates, income taxes lessen inequality by about 3 to 4 percent.
Income Shares Before and After Income Taxes, 2017
Billionaire Boo Hoos
The growing wealth divide has reached unacceptable levels. Conservatives have sung the song that high marginal tax rates kill the economy so long that people accept this as true, despite the lack of evidence. I think the time is right to make income inequality and the tax system central issues for the 2020 campaign. There are many ways to approach improving the tax system including raising the top marginal rate. imposing a wealth tax, or levying luxury taxes. In the coming months we will hear how the Democrats are trying to soak the rich. To that I say they are dripping in wealth, a little squeeze will do us all a lot of good.