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Unbalanced Ecomomy

The Problem

There is an increasing disparity between the rich and poor in the United States (See Int'l Herald Tribune, MSN Money).  “Data from the United States Department of Commerce and Internal Revenue Service indicate that income inequality has been increasing since the 1970s, whereas it had been declining during the mid 20th century."  We risk becoming like a Latin American country or returning to the robber baron years at the end of the 19th century. The wealthy and companies have an interest in restoring balance, since our service/knowledge based economy depends on a high quality workforce.  People are the engine of our economy.


The US was created uniquely as a meritocracy, in contrast with the aristocracies of Europe.  We’ve never had a totally free market (that would be the mafia).  The government sets the rules for the market, and provides the infrastructure and education of its workers.  There is a balance between workers and capital (money).  Both need to be encouraged for an optimum market.  The balance has been cyclical throughout US history, from workers (Homestead Act), to capital (robber barons, trusts), to workers (New Deal), to capital (post-Reagan cuts of taxes & services).


Causes of Problems


The basic problem is that salaries for the middle class have not kept up with the cost of living recently.  This has two components, not enough salary increase and too much expense (cost of living) increase.  While in the past only the husband had to work, nowadays the wife often must work as well to make ends meet.


Not enough salary increases.  Companies have a never-ending incentive to increase profits for investors, which means keeping salaries down for workers.  This is an unavoidable aspect of a free market, which, even with its flaws, is the best system there is.  Even companies that want to do good by their workers are limited by offshore competition.  Blue collar manufacturing jobs are disappearing or being off-shored.  The service economy tends to have either high end or low end jobs.


Too much expense increase.  Even though some things are cheaper, such as goods made in China, certain categories have seen huge increases: housing, health care and a college education (Center for American Progress).  The high cost of college is also a barrier for poor and middle class kids to get the training needed for high end service jobs.  In addition, the proportion of taxes paid by the middle class relative to the rich has increased (Perfectly Legal).


The system is out of balance.  Reagan had many good policies, such as cuts to the high 70% tax bracket, cutting of wasteful government spending, and a defense buildup to end the Cold War.  However, those policies have been extended too far, with unfairly generous cuts to taxes for the rich and excessive defense spending which is running up a deficit that threatens the economy.


The Founders of this country worried about the accumulation of wealth giving the rich undue access and influence in the government [cite].  Money concentrated in companies has allowed companies to lobby for a host of subsidies and loopholes which has reversed the good effects of Reagan’s tax simplification act of 1986.  Companies also lobby government and run ad campaigns to preserve their profits, such as in health care by defeating reforms that would improve access and bring down costs (and their profits).  Thus, health care costs have skyrocketed.


Excessive local regulation has driven up the cost of housing.  Government assistance for college has dropped just when we need it most to compete.


What is not the problem


NAFTA, free trade and globalization are not the problem.  The opposite of free trade and NAFTA is tariffs on imports.  While the US in its early years, and other developing countries, used these successfully to protect infant industries, it only works for a few industries, and not an entire industrialized economy.  For example, a tariff on steel protects steel worker jobs, but drives up the cost of steel for carmakers, costing auto industry jobs and also making cars more expensive for every other worker.  The net is a negative effect on middle class workers.


Structural Solutions


The squeeze can be reversed by reducing the main expenses the middle class has, while at the same time providing accessible training to gain the skills for better paying service jobs.  Balance needs to be restored to the federal budget, to spend money on programs to invest in our people, rather than enhancing profits of companies.  Rather than subsidies, it is preferable to address the structural causes of high costs for housing, health care and college, reducing their cost for everyone.  Also, balance needs to be restored in tax rates.


Taxes have shifted from rich to middle class

Restoring balance to taxes

College Costs

Health Care Costs

Housing Costs


Capital gains are taxed at 15%, and are 2/3 of the income of the 400 richest people. Billionaire Warren Buffett pointed out that he was taxed at 17.7 % on his $46 million income, while his receptionist was taxed at 30 %.



Some hedge fund managers are effectively paid in stock so the only taxes they pay are capital gains (Economic Policy Institute).


Details of Hybrid Solution

Taxes have shifted from rich to middle class

Historical and International context of taxes.

The top federal income tax rate started at 6% when the 16th amendment was ratified to permit income taxes. By 1918, to finance WWI, the top rate was 77%. It reduced to 24% by 1929. In 1932 it was increased to 63% during the Great Depression, and increased to 94% in 1945 to finance WWII. It stayed near 90% until 1964 when it was lowered to 70%, then 50% in 1982, 28% in 1988, raised to 39% by 2000 and lowered to 35% in 2003 (Wikipedia).

The overall tax burden in the US is lower than all OECD countries (Organisation for Economic Co-operation and Development - the industrialized countries), except Japan, Korea and Mexico (Forbes). (Because many countries use value-added and other taxes not used in the US, a comparison of just income taxes is not meaningful)

Increasing disparity between rich and poor.

The income of the 1% richest taxpayers doubled from 1977 to 1999. The top 10% went up 88.6%. The bottom 90% stagnated, slipping slightly (all inflation adjusted) (Perfectly Legal).

Capital gains (income of rich) taxed less than wages.

The capital gains tax (capital gains are 2/3 of the income of the 400 richest people) fell from 28% in 1987 to 20% in 1998 to 15% in 2003. Some hedge fund managers are paid based on stock performance so the only taxes they pay are capital gains - their salaries are capital gains. The 2003 dividend tax reduction primarily affects the wealthy, since the middle class usually own stock in 401K plans that aren't taxed (Perfectly Legal).

Many commentators argue that low capital gains rates are needed to spur investments, although they seem short on proof. For example, The Heritage Foundation points to capital gains tax collections doubling after the cuts as proof that it spurs investment. However, this just shows that people sold, it doesn't show what they did with the money. This is un-investing to presumably re-invest. No proof is offered that this helps the economy.

Others, however, say this is wrong. The Congressional Budget Office says "But in general, the more a business tax cut is focused on income from new capital as opposed to income from old capital, the more effective it will probably be in stimulating new investment." In other words, capital gains tax cuts only spur investments if applied to sales of capital purchased after the cuts go into effect. The CBO goes on to say "In general, little immediate fiscal stimulus would be provided by cutting capital gains tax rates or expanding capital loss provisions." (See also Joel Friedman).

Many states, such as California, tax wage income and capital gains at the same rate - and we haven't exactly seen venture capitalists fleeing California.

It makes common sense that raising capital gains rates would not strangle investments. People need to put their money somewhere, and are unlikely to move to another country to avoid a higher rate. Corporate investments may be another matter, as corporations can re-incorporate elsewhere.

Increasing tax share on middle class wages.

As described above, although salary income tax rates are higher for the rich, capital gains rates, which make up much of the income of the rich, are only 15%. In addition, social security taxes, which only apply to the first $87,000 of wages in 2003, increased 82% faster than incomes (most social security revenue is diverted to the general budget, so this is another income tax). Thus, social security taxes are a larger percentage of the income of the middle class than the rich. Those objecting to the poorest paying little or no income tax need to remember that they pay sales tax, and through rent, pay property tax, with the amounts paid being a higher portion of their income. Looking at all income (not just reported income), in 2001 all taxes (not just income taxes) were 18% of income for the poorest fifth of Americans, and 19% for the richest fifth (Perfectly Legal, page 308). [although this number isn't broken down in perfectly legal, the poorest fifth pay a higher percentage on sales taxes and social security. The highest fifth pay less on the portion of their income due to capital gains. Presumably, capital gains rates don't account for all of the reduction to 19% from the 35% (plus state) income tax rate, and there are a lot of deductions or tax avoidance. If any reader knows the answer, we'd appreciate an email]

The rich should be taxed more.

A 70% income tax was excessive, but can't the rich pay 22% rather than 19%? Capitalism disproportionately rewards those with capital - it takes money to make money. The playing field should be leveled more, or at least the incline reduced. Money can pay lawyers to take advantage of complex regulations, lobbyists for special breaks, and create corporations with limited liability and bankruptcy protection. Complex regulations are a barrier to those with little capital trying to run a small business. Those with less money pay higher checking account fees, or go without and pay high check cashing fees, and pay high fees to send money home if they are an immigrant. Low cost housing isn't explicitly prohibited, but extensive zoning and approval processes drive up the costs of new homes (and the home values of the haves) at the expense of the have-nots. Those who benefit most from this type of system should pay to support it - it's not the poor that would be hurt if those regulatory benefits were lost.

Doublespeak sold tax relief for the rich.

The AMT, without inflation indexing, was a brilliant Trojan Horse. It was pitched to make the rich pay their fair share, but over time shifts the tax burden to the middle class (interestingly, the AMT affects the liberal states of California and New York more, since the home mortgage deduction is capped at $1million and the high state taxes aren't deductible). The few taxes on wealth (estate, capital gains and dividends) have been reduced by selling them as benefiting the middle class and family farms, when they really benefit the rich. (A one year extension of AMT relief was enacted for 2008).

Wealth v. wages.

Taxes have shifted from wealth to wages. The rich make money on investments, not on wages. To spur the economy, we cut the capital gains tax - which makes stock prices go up. But is the economy boosted more than by cutting wage taxes, which would certainly be spent?

Restoring balance to taxes

Capital Gains taxes. The rate should be increased.

Income tax. The rate is high enough. Loopholes and subsidies need to be ended.

Corporate taxes. Increase corporate tax rate? The amount of the US tax burden born by corporations had dropped over the years. Can we increase this without driving corporations to other countries?

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