This is not about income inequality. Income inequality poses no threat to our democracy, to us or to the economy. This is about extreme income inequality. Extreme income inequality is the threat. Extreme income inequality adversely affects the fabric of our lives, as the authors of the 2010 book, The Spirit Level, point out. Higher levels of drug abuse, incarceration, teenage pregnancies, obesity, cancer and heart disease, just to name a few, all correlate with higher levels of income inequality. If we are to create a well-functioning society where representation cannot be bought, we must find a way to reverse the trend toward excessive income inequality within this nation.
Part of the solution will be to bring about full and meaningful employment. To do this we must overcome the notion rich people create jobs. We must recognize business owners react to market conditions and that companies don't hire when they have an abundance of profits; they hire when they have an abundance of customers (Liu / Hanauer). We must recognize the true job creator is the buying power of a financially strong middle class. Our task, therefore, is to find a way to rebuild and sustain a strong middle class.
A pundit wrote recently that class warfare is alive and well in this country, and the tax code is the weapon of choice. A few rich and powerful individuals are obsessed with the amount of money they pay in taxes, and they make their presence known in Congress and elsewhere. Where money is no object, a lot of pressure can be brought to bear. We end up with, as they say, 'the best government money can buy'. For those who think we deserve better, the question becomes, "What can be done to turn this around?"
Accounting for about 70% of the annual Gross Domestic Product (GDP), consumer spending drives the U.S. economy. To turn things around, consumers need more discretionary income. Given the top wage earners' high propensity to save, more discretionary income for median income earners means higher levels of consumer spending.
There are many tools available to put more money into the hands of those who would spend it. The federal government could simply send a check to everyone, the so called "helicopter money", it could guarantee a job for anyone willing and able to work, as Roosevelt did in the 1930s or it could adjust the federal income tax code to make it more progressive, thereby lowering the tax rate on median income earners. An adjustment to the federal income tax code will be the alternative favored here.
U.S. Tax Code
Enacted in 1915, the U.S. federal income tax code was designed to tax income according to one's ability to pay. It's progressive, meaning the tax rate increases as the taxable amount increases. This tax strategy is used in almost every industrialized country. Few argue that the highest income earners should not pay a higher rate. The question becomes, "How much higher?" That is what will be examined here.
We, as a nation, have been all over the board in terms of federal income tax policy for these last one hundred years. In the World War II era, income tax rates for high income earners topped out at 90 plus percent. When Ronald Reagan was in office in the 1980s, the top rate had dropped to 28%. Currently, the top rate is about 40%. "What is the optimum rate of taxation?" The optimum rate, argued here, is a moving target and should be set to one's level of saving. Those with a higher propensity to save will pay a higher rate. The idea is not to discourage the building of a nest egg but to limit excessive saving.
For most, excessive saving does not seem possible. One never knows what calamity might arise. In terms of those who cannot possibly spend a significant portion of their income, and particularly in terms of the economic health of the nation, more in savings, however, is harmful. Economies, ultimately, are a result of money changing hands. When money ceases to change hands on a broad scale, growth is compromised. This is what happens when excessive savings is allowed to persist. Growth is compromised when money is pulled out of an economy in the form of saving. Our economy is bleeding in perpetuity with current high rates of saving. We need to better understand specifically where the highest rates occur and how best to deal with it.
An economy is like a pressure cooker. Allow too much steam to escape, and it becomes less effective. Excess saving is currently allowing pressure to escape from the U.S. economy at an unhealthy rate. A parity of saving strategy will help to limit the storage of economy crushing wealth. Let's take a look at how a strategy of this sort would work.
To start, we must identify income levels with high rates of saving. This can be done by dividing household income into deciles (ten equal parts) by number of households. Since there are approximately 120 million households in the U.S. each decile would be made up of approximately 12 million households. For each decile the average rate of saving would then be determined based upon the previous year's financial data. The average rate of saving for deciles five and six (the middlemost groups) are then compared to rates of saving for higher income groups. Where the saving rate for the middlemost groups differ from the saving rate of the higher income groups, adjustments to the tax rate would be necessary.
For example, if it is found the saving rate of decile 5 is at 10% of income and the saving rate of the highest decile is 25%, the strategy would be to lower the tax rate for lower income groups and raise the tax rate for higher income groups proportionate to their rates of saving. By lowering the tax rate on middle income groups, these groups will have both a higher marginal propensity to save and more discretionary income to spend. At the same time, by raising the tax rate on higher income groups, a lower propensity to save will result. The intent, ultimately, is to achieve a type of saving parity (saving equality) among the median and higher income groups where the levels of saving are similar among various (but not all) income groups. When saving parity has been achieved, excessive saving will have been squeezed out of the economy resulting in more money in circulation, more demand for products and services and eventually more growth.
We have it within ourselves to create a more just society, but thoughtful action is required. As Frederick Douglass once said, "Power concedes nothing without a demand." To put an end to extreme income inequality we must demand a sufficiently progressive tax code be put in place and end the assault on the middle class. A parity of saving strategy can help to take us there.
We must recognize an economy is a force of nature, and while we can influence it, we cannot change the way it works. Keeping taxes artificially low for so called “job creators” is contrary to the way economies work. For this economy to perform at a high level, consumption of goods and services must take place at that same high level. Putting more money into the hands of the middle class consumer, the true job creator, will allow for this higher level of economic activity.
Creating a financially strong middle class is the recipe. Squeezing out excessive saving is the secret sauce.