Income inequality has become one of the biggest political talking points of our age — and for good reason. The new World Inequality Report 2018, by Berkeley economist Emmanuel Saez along with collaborators Thomas Piketty and Gabriel Zucman, reviews the recent distribution of gains in wealth among various income brackets. Little surprise to most, their research shows that over the past few decades the majority of income gains have gone to the top 1%, not to the middle class.
Saez and his colleagues' findings couldn't have been published at a more appropriate time. As the 2017 legislative session closed, House and Senate lawmakers passed the most sweeping tax reform package since the Reagan years. Mainstream analysts and critics of the proposal say that under the GOP plan, the vast majority of benefits will go to corporations and the wealthiest. The fact is, only the corporate tax breaks are permanent; by 2025, the middle class, by comparison, will be paying vastly more in taxes than they already do today.
Digging deeper into the report's findings, we learn that income inequality has rendered it virtually impossible for those of lesser means to climb the socioeconomic ladder, and why so many people are projected to be left behind.
The Scope of the Study and the Effect of Recent Legislation
Saez and Piketty's research sought to measure the disparity in income between different socioeconomic classes between the years 1913 and 1998.The results are sobering. The team focused its data on income tax return information – dating back a century to when the income tax was first established.
Prior to 1944, due to progressive taxation, the vast majority of households weren't liable to pay federal income tax. This was due in large part to the fact that in previous years, middle-income taxpayers often had enough personal exemptions to make the middle class worker's tax liability all but disappear. This benefited individuals, but primarily benefited families with two or more children, as each child in the household also stood to gain from the personal exemption.
It's worth nothing that under the freshly passed GOP tax plan, the personal exemption is completely eliminated. True, the standard deduction is higher, which will benefit workers with few children. But for households with two or more children, they come out behind even with an increase in the Child Tax Credit from $1,000 to $2,000. When you contrast this with the $4,150 personal exemption per person per household, you can do the math and see that families with multiple children will take a hit on their 2018 taxes.
Saez and Picketty also looked at the sources of income on the income tax returns they examined. They found that for the majority of workers, their income stemmed primarily from the fruits of their labor, or their wages. Conversely, for the highest income workers, their income stemmed primarily from their investment in stocks and other investment vehicles – in other words, not their labor.
Herein lies just one of the reasons for the growing income inequality, according to the authors. Even the healthiest and most productive human beings have only 24 hours in a day to perform labor, time they must also delicately budget out for sleep, eating, etc. The income of low-to-middle age workers is necessarily limited by the fact that they are human and, as such, need to take time out to rest, to eat and to maintain human connections with those they love.
For those whose wealth is derived from investment vehicles, there is no limit to the number of stocks they can buy, sell and trade. Their investments make money for them around the clock, 24 hours a day, 365 days a year. Even while the well-off sleep, their investments continue to make income gains for them.
Now, consider that the top tax rate for investments is only 20 percent for capital gains – meaning the gains made by buying and selling assets of stock and other investment property – whereas those with higher incomes are already taxed at significantly higher rates than most workers. The highest tax bracket for working individuals can be as high as 39 percent if the worker is a doctor, attorney, pilot or other high wage earner.
The way our tax code is structured taxes working people at higher rates than those who can rely on their investments for income. It is almost as if workers are penalized simply for having to work.
A Growing Income Gap in Recent Years
Saez and his team show that since the Tax Reform Act of 1986, income and wealth inequality have advanced more rapidly, deepening the divide between the haves and have-nots. Saez and Pikitty also took a comparative look at how the wages of CEOs have risen versus the rise in regular worker income. The results aren't surprising.
Since the early 1970s, the annual wage of the average CEO has increased 28 times faster than the wage of the average worker. This makes a powerful case for returning to a more progressive taxation system, such as that which existed under President Eisenhower in the post-WWII era. During that time, income of the top earners was taxed at 55 percent, providing critical capital for rebuilding infrastructure and funding various social programs designed to help the less fortunate climb out of poverty.
Today, top earners are taxed, at most, at 39 percent. Not only has the lowering of the tax rate for the wealthiest created a massive deficit. It's also left a legacy of failing schools, crumbling infrastructure and the loss of programs designed to help the less fortunate succeed. Should the U.S. continue to institute less-than-progressive tax policies, the gap between the rich and the poor will keep widening until it reaches a breaking point.
According to a recent UN study, the United States has both the largest gap in income between members of the middle class, and the largest proportionate population of poor people, at approximately 44 million Americans. Due to the current "philosophy" that tax cuts will benefit all Americans, not just the lucky few, the number of Americans living in poverty (not to mention without healthcare) is expected to grow, while the very rich continue to get richer and those in the middle class find it even harder to get by.
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