Economists have been warning U.S. policymakers
for many years that the incomes of rich
Americans have been rising much faster than the
incomes of everyone else. The trend has been
apparent since the early 1970s. Yet data from the
Federal Reserve's latest triennial Survey of Consumer Finances
throws the problem into particularly sharp relief: Between
1995 and 2004, the wealthiest 10 percent of American families
saw their annual incomes rise about 40 percent, on average,
from $216,000 to $302,000. In the same period, families in
the middle 60 percent of the distribution scale saw their
incomes rise just 20 percent, from an average of $39,000 in
1995 to an average of $46,000 in 2004.
This has been especially disconcerting news because that
10-year period -- including the years before and after the
recession of 2000 and 2001 -- has been marked by some of
the most impressive productivity gains since the 1960s.
Productivity growth was supposed to be the key to wage
growth. It flagged in the 1970s, 1980s, and early 1990s, and
economists long assumed that when it picked up again, wage
growth would soon follow for average workers. That hasn't
happened. So now there is a 6-to-1
income disparity between families in
the top 10 percent and families in the
middle 60 percent of the distribution
scale.
But while economists have been
puzzling over this income inequality
paradox, they have largely ignored an
even more striking gap in capital
ownership: The average net worth of
the top 10 percent of American families
is almost 30 times greater than the
average net worth of families in the
middle 50 percent of the spectrum --
and these disparities in net worth
have been growing even faster than
the disparities in income.
Since 1995, the top group has seen
its average net worth grow 76 percent,
from $1.8 million to $3.1 million,
while those in the middle have seen
their net worth grow about 36 percent,
from $76,000 to $107,000. And that's
before taxes. The after-tax numbers are
even more dramatic, thanks to Bush
administration policies that have sliced
tax rates on high-income people, particularly
on the income they derive
from investments.
Progressives should make closing
this growing capital gap a fundamental
part of a new agenda for democratic
capitalism. Such an agenda
should aim to do something loftier
than just repeal Bush's tax cuts. It
should also boost incentives for average
Americans to increase their savings
and investments, and thus participate
more fully in the upside of
U.S. economic growth.
The main reason the capital gap has
been widening -- aside from the effects
of the recent tax cuts -- is that higherincome
people have higher savings rates
and a much higher likelihood of owning
high-return investments, such as
stocks and other forms of equity capital.
For example, while just over half of the
middle class has a retirement account,
almost 90 percent of the top group
does.
Outside of retirement accounts,
capital ownership is even more exclusively
the province of the well-to-do.
Among the top group, about twothirds
report owning stocks or mutual
funds directly (not in a retirement
account). Among the middle class, it
is less than 15 percent.
The irony here is that while wealthy
people already save and invest at much
higher rates than everyone else, the tax
system piles on by giving them far more
encouragement to save and invest than
it gives middle- and working-class
people.
Three examples illustrate this
misallocation of incentives: tax
deductibility rules for
401(k) pensions and other retirement
accounts; tax treatment of capital
gains and dividends; and the
impact of capital ownership on middleclass
eligibility for student financial aid.
Retirement accounts. The 401(k)
has proved to be one of the most
important savings vehicles in
America. It is one of the primary
ways that many people have begun
investing in capital markets.
To encourage 401(k) usage, the government
makes contributions tax-deductible.
But that tax deduction
provides a bigger benefit to people in
higher income tax brackets than it does
to people in lower brackets.
For example, a family with an
income of $50,000 is in the 15 percent
bracket, so when it puts $5,000
into a 401(k) it saves 15 percent of
$5,000 in taxes: $750. But a family
making $200,000 is in the 33 percent
tax bracket, so when it puts $5,000
into a 401(k), it saves 33 percent of
$5,000 in taxes: $1,650.
This same tax deductibility issue
means that all sorts of accounts -- from
529 college savings accounts, to IRAs,
and so on -- typically provide the greatest
participation incentives to people in
the highest tax brackets, that is, the people
with the highest incomes.
Capital gains and dividends. In the
wake of the Bush tax cuts, long-term
capital gains tax rates are now
between 5 percent and 15 percent.
The rates are ostensibly progressive:
People in or below the 15 percent
personal income tax bracket (which
applies to married couples making
$60,000 a year) get the lower capital
gains rate. But that benefit is a pittance
compared with the benefit
wealthy people get from having their
capital gains and dividends taxed at a
rate of just 15 percent.
Here's how the math works:
Personal income tax rates go as
high as 35 percent. So, by shifting
money out of regular savings
accounts (where interest is taxed at
the personal rate) and into capital
investments, where gains and dividends
are taxed at 15 percent, people
in the highest tax bracket can effectively
give themselves a 20 percentage-
point tax cut.
But that tax-rate gap is far lower
for families making less
than $178,000 per
year. For example,
those with
incomes between
$60,000 and
$178,000 pay income
taxes in the 25
percent to 28 percent range.
Yet they still pay the top
capital gains rate of 15 percent.
So the incentive for
them to invest their savings
instead of socking money
away in safe, low-interest
accounts is smaller than it is for
wealthier people -- the tax-rate
gap is between 10 and 13 percentage
points.
Below $60,000, the personal rates
are between 10 percent and 15 percent,
and the capital gains rate is 5
percent. So the incentive to
invest is even
smaller: a gap of
just 5 to 10 percentage
points.
Rather than encourage capital ownership
among the middle and working
classes, the Bush administration's dividend
tax rate cuts for high-income people
have further skewed the incentives
in the wrong direction.
Financial aid. One major reason for
the middle class to save and to invest
in capital is to pay for rising college
tuition. But while college planning
would seem to be a perfect place for
people to start investing in capital
outside of their retirement accounts,
financial aid rules often discourage it.
When middle-class families -- and
especially their college-age kids -- try to
save money, financial aid rules penalize
them by translating their higher asset
holdings into lower financial aid awards.
The net impact can be thought of as a
tax on middle-class savings that is added
on top of the taxes people already pay.
For example, a family that makes
$50,000, pays its taxes, and then
decides to save money for college in a
529 college savings plan may lose the
lion's share of the benefit of those savings
when it qualifies for lower financial
aid awards. This is an exclusively middle
class problem, since the rules don't have
any impact on people not receiving
financial aid to begin with.
A capital idea. Economists don't
know whether the stagnating wage
growth of recent years will be a persistent
feature of the economy. But the
returns on capital investment are as high
as they've ever been. So at least until
there is some clarity in the wage picture,
the clarion call for progressives ought to
be: Democratize capital ownership!
In the current order of things, the
well-off are benefiting from higher
wage growth and higher capital
income growth than everyone else.
On top of that, they've been enjoying
a third helping of dessert in the
form of preferential tax incentives
that have been much more generous
to them than to the middle and
working classes.
Providing incentives for more people
to share in the modern economy's
rewards through savings and investment
-- that is, democratizing capital
ownership -- would establish a kind
of hedge for the middle class against
just the sort of problem the country
has experienced in the past three
decades, where the economy grows,
but the incomes of typical workers
stagnate or even fall.
