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Re-Creating the American Dream- with LESS Government!

By June 9, 2008No Comments
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An article of faith of the populist left is that there are too many rich people, who have too much income in the United States. They rant about this being a bad thing, aside from being grossly unfair, because it is the result of specific actions taken when fiscal conservatives have controlled the government. They believe that the principal cause of this appalling “inequityâ€� is Ronald Reagan’s Tax Reform Act of 1986, and of course George W. Bush’s further transgression with his major tax cuts of 2001 and 2003. And of course the liberal “tax and spend; punish the rich; redistribute the wealthâ€� crowd paints the CEOs who receive “unconscionableâ€� multiples of the wages of their hourly workers as the prominent villains in this rich versus poor epic saga.

This political story line is useful for those who believe fermenting class hatred is the way to win the political wars. For anyone willing to examine data (aka facts), the real story is both dramatically different and more constructive, as well as instructive. A recently published research project Top Incomes Over the 20th Century (Edited by A. B. Atkinson and T. Piketty), uses income tax data to develop top income shares for 10 countries over long time frames. The data in the accompanying table (below) is extracted from the extensive tables contained in this book.

Income Before Tax (in Percent Shares)
Top 1% Highest Increase
Year Since 1970
U.S. 14.7% 1913 +6.9
Canada 13.6% 1921 +4.6
U.K. 12.7% 1918 +5.6
Germany 11.1% 1938 -0.2
Ireland 10.3% NA +4.4
France 7.7% 1905 -0.6

What is the real story? The rich are indeed getting richer in the UK, Canada, Australia, New Zealand and Ireland, as well as the United States. Using the Top 1% of income earners (which is where the most variation occurs), the share of income for this small minority follows a “Uâ€� shaped curve through time. Their percentage of total income was high before 1929; declined during the depression and WWII; and then began to recover in the past quarter century. But is this recent recovery bad? The Top 1% of incomes began to raise first in the United States, beginning in the late 1970s; then in the early ’80s it spread to UK, Canada, Australia; by the late ’80s it reached New Zealand. The trend has been nearly steadily upward; through the presidencies of Republicans and Democrats (Jimmy Carter and Bill Clinton) alike in the U.S. and a mix of Labor and Conservative (right and left) governments in the other counties.

Across the board, the component of income that has risen the fastest is the infamous wage income (which includes stock options)- not dividends or capital gains. In fact the steady rise of top income shares for 30 years has resulted in this “richest 1%� gaining almost as high of a share as they had attained earlier in the last century.

However, in four of the 10 countries in the study the share of income of the top 1% has declined over time. These declines result from lower income from dividends and interest, not wages. For these countries wage income has been nearly flat for the whole period. Total income shares peaked in 1970 for Netherlands and Switzerland (8.6 and 11.0% respectively) and they have declined ever since. In France and Germany, the share of the top 1% has been flat- Germany at a high level (11%) and France at a low level (7.7%). If the critics of United States income distribution believe the top incomes must be reduced to attain some lower, fairer “more democratically optimal level,� it appears this could best be accomplished by pursuing the economic policies of, say, France.

But is France our role model? If France’s economic policies do indeed promote “fairnessâ€� and equality, why are the headlines dominated by riots in France’s poor neighborhoods? France is indeed “fairerâ€� if what you mean by fair is that everyone shares the misery, everyone is unhappy, and everyone complains about a lack of opportunity. Because taxes are so high in France, the economy is stagnant, there is no job growth, opportunity for class mobility is nonexistent, and workers can never save enough of their own money to invest in stocks, real estate or start their own business (all of which results in capital gains- the fastest way to attain wealth). Is that what we’d like to see happen in the USA?

What is the more likely explanation for a growing share of income, and especially wage income, accruing to top income earners in countries like the United States? How about “market forces� being more important than government actions? Using a method other than taxes, one graph in the study depicts the “Globally Rich� (defined as those with 20 times the world mean income) as a percent of the world population. Not surprisingly this percentage declined the six decades prior to 1970, reaching a nadir of about 10%, and it has trended up ever since- reaching nearly 15% in the last year shown 1995.

The real mistake of the political left is to focus on government as the arbitrator of top income shares. Global competition, not government policy or pliant Boards of Directors, determine how talent is compensated. As global trade has thrived, competition has escalated, technology has accelerated decision-making, and global free markets have placed a premium on creativity, education and leadership talent. Then too, as the media has globalized and expanded, there is enormous demand for exceptional athletic prowess, coaching success, a lyrical voice or an exquisite look- meaning the global free market awards outsized compensation to entertainers and big producers of all sorts- actors, singers, athletes, coaches, artists (and of course executives, entrepreneurs, business owners, technology gurus). High demand in the free market and scalability of global media have created disproportionate rewards for the exceptional few.

Some will argue that the real solution to inequality is to raise marginal tax rates for the top bracket and redistribute more of this unfair “ill-gotten income� for humanitarian purposes. Economist Arthur Laffer has eloquently explained the error of that scheme previously. Say for example, you are a talented native of France, Switzerland or The Netherlands- where taxes are steeply progressive. Those high taxes often drive top earners, producers, creators, and business owners to relocate to low-tax domiciles such as Monaco, Lichtenstein or The Caymans- thereby encouraging the top earners and producers to choose to pay nothing in income taxes to their high-tax country of origin. High taxes therefore chase away the highest earners and thereby result in lower revenues for high-tax governments.

If tax rates in the United States become more progressive some portion of big earners,
producers, business owners and entrepreneurs will choose to either leave altogether or shelter their incomes offshore. Of those who choose to stay, they will (as always) choose to defer income, move income from wages to capital, and hire the smartest lawyers, accountants and lobbyists to pursue more esoteric but legal means of paying lower taxes. Higher tax rates will, without a doubt, cause less taxable income to be declared and slow the growth of reported income in the top brackets.

On a moral basis, most people- including many of the rich- would prefer for incomes to be more equitably distributed. And there is hope for this. Fifty years ago Simion Kuznets theorized that as the industrial revolution matured, more jobs would require more skill and would therefore become more highly paid- thereby drawing more income to the great numbers of workers in the upper middle class. This pattern held for much of the 20th century, until competitive dynamics changed. Still, the proportion of white-collar, highly compensated jobs has continued to grow as technology and complexity have affected the job market. In the world today, lack of education and skill are an increasingly severe handicap- in most cases THE severe handicap.

The real challenge then is to provide citizens with an abundance of skills and opportunities that result in high productivity and high pay. The most important thing that government can do to improve the economy is to get out of the way- shrink the size, scope, power and control of government over its people. But government does have at least a small role to play in this mission: Improve the quality of the education system (on the state level). Subsidize skill development. Foster investment that provides each worker with more capital. Keep inflation and the cost of capital low. Lower income tax rates so that its citizens can save the money necessary to invest in stocks, real estate and business start-ups. Lower capital gains tax rates so that those willing to take the risks, also receive the rewards. Foster and encourage risk, entrepreneurship and ownership (the surest ways to attain wealth).

The answer is not to take money away from the rich, or tax the rich to death (and even after death with high rates of “death taxes�). It is to create more opportunity and mobility for the poor and middle class. It is to make the “American Dream� realistic and available for all Americans. The answer is motivation- empower the poor and middle classes with the education, tools, capital and mobility (opportunity) to succeed. Give them the hope (and role models as proof) that the American Dream is alive and well- that anyone can move up from poor to middle class, from middle class to upper class, from upper class to wealthy, and you will see an economic tsunami like never before in history.

Stealing from the rich to hand entitlements they didn’t earn to the poor is not the answer. No government will be successful over a sustained period of time in attempting to warp market outcomes with progressive taxation of highly skilled, highly productive income producers; or by attempting to cap the compensation of high-achievers; or by shaming decision-makers into accepting outcomes contrary to free market results. These liberal “tax and spend; punish the rich; redistribute the wealthâ€� policies can only result in less total income; lower tax revenues; less motivation by the brightest and most productive members of society; less innovation and creation; retarded economic growth; and a far poorer populace.

The answer isn’t bigger government; more government spending; more bureaucrats; more entitlements; more taxes; more control by government over the lives of its citizens; more Big Brother to rule our lives. All that does is create more misery. And more citizens that are best described as hopeless, helpless, aimless and clueless. Studies prove that those who depend on welfare and government entitlements feel a loss of control, freedom, satisfaction, and self worth. Every American wants the same things- freedom, control, mobility (the opportunity to move up from where we started), the ability to earn our own way, and the freedom to make our own decisions with our own money. The only way to achieve all those worthy goals is through smaller government, dramatically reduced government spending, lower entitlements, fewer bureaucrats (and reduced regulation), more economic freedom, free and unfettered markets, and a dramatically reduced tax burden so all Americans get to earn and keep more of their own money.

Mr. Root is a successful small businessman, entrepreneur, author, business speaker and commentator. He is currently the Vice Presidential nominee for the Libertarian Party on the Presidential ticket of Barr/Root.