By Jason J. Zhang
“The rich get richer and the poor get poorer,” or so the aphorism goes. In the context of U.S. wealth and income inequality, this is the bleak truth. Statistics from the World Inequality Database show 21% of the U.S. national income is going to the population’s richest 1%, with nearly 50% going to the top 10% (World Inequality Database 2023). Equally staggering is aggregate data for overall wealth, with 66.6% of total wealth in the United States owned by the top 10% of earners—the lowest 50% of earners hold only 2.6% of total wealth (Statista 2023). Recognizing similar cases internationally, the World Economic Forum declared income inequality the greatest threat to the world economy in 2017 (WEF 2017, 11). The alarming nature of recent statistics has raised a few key questions. What are the long term effects of inequality and how should governments intervene—if they should at all?
Skeptics of financial redistribution will agree that economic inequality is an inevitable byproduct of a globalizing world. In fact, a certain level of inequality can be desirable in stimulating innovation and growth, but the cause for concern lies with growing imbalance between certain group’s contributions and their received benefit (Brown 2017, 3). The detriments towards society caused by the growing chasm between the nation’s top, middle, and lower income groups brings into question the justifiability of the “contribution gap.” This essay establishes that arresting rising economic inequality is in society’s best interest, while examining suggested redistribution measures and proposing a method of government intervention.
Analysis and Concerns of Inequality
The origin of income inequality has been largely disputed; yet almost all theories can be grouped as structural or institutional. Structural theories track socio-political development and trends in global markets, largely encompassing more than a singular nation’s actions (Brown 2017, 49). Institutional theories encapsulate the effects on inequality stemming from an individual country’s macro economies such as monetary or fiscal policy (Brown 2017, 49). The most prevalent structural theories emphasize the effects of globalization through international trade as a catalyst for class division. Reduced barriers to trade following the “silent revolution” in the 1980s sparked a trade deficit giving way to rise of imports in industries hiring low skilled labour (Boughton 2002; Borjas and Freeman 1992, 214). The increase in offshoring production generated downward pressures on the earnings and employment of less skilled workers. Coinciding with trade and immigration is the rise of skill biased technological change, favouring workers with higher levels of education and understanding of new technology (Siegel 1999, 1). U.S. immigration and trade data from the 1980s also aligns with the Heckscher-Ohlin trade model through which the U.S. imports goods, requiring less skilled labour while immigration supplements the comparatively scarce low skill domestic labour force (Jones 2008; Borjas and Freeman 1992, 214).
Institutional theorists state that a key driver of income inequality is falling tax progressiveness in the last 50 years (Polacko 2021). Since 2010, average tax rates paid by the top 1% of U.S. (see Figure 1) have been roughly equal to or even less than other Americans (PIIE 2020). The United States and other countries have also seen a marked drop in marginal income tax rates with the U.S. experiencing a drop of more than 50% since 1950 (see Figure 2). The striking reduction of tax progressivity “probably explains much of the increase in the very highest earned incomes” (Piketty 2014, 495-496).
Escalating income inequality has been connected with numerous undesirable societal effects. Kelly (2000) determined income inequality had a strong impact on violent crime returning, an elasticity coefficient above 0.5. Likewise, strain theory posits that more inequitable societies place higher social value on economic success, driving individuals to achieve it through crime (Polacko 2021). Wilkinson and Pickett (2009) found correlations between life expectancy and income inequality in which the life expectancy gap was more than four years between the least and most equitable nations. Rise in inequality has also impacted social mobility. Economist Miles Corak studied the connection between Intergenerational Income Elasticity —elasticity between parental and offspring income later in life— and income inequality (measured through Gini coefficient), summarizing his findings in his famous Great Gatsby Curve (GGC) (Corak 2013, 82). The GGC shows parental income is a much more indicative determinant for intergenerational mobility in less equitable countries. As inequality rises, there is a greater disparity in available resources available to children from high and low income households, directly affecting an offspring’s future income and mobility potential (Polacko 2021).
Wealth Tax Examination
A popular and frequent recommendation for tackling rising income inequality is the implementation of net wealth taxation. This section seeks to explore the tradeoffs associated with such a policy accounting for administration, effectiveness and proposed benefits.
A net wealth tax, typically defined as “an annual tax imposed on the net value of all assets…” stems from the belief that income does not sufficiently measure taxable capacity (Tanabe 1967). Proponents of wealth taxes argue its necessity on the grounds of equity for low income earners and revenue potential. In fact, the Wealth Tax Commission analyzed that a “one-off wealth tax of 5% on total wealth above £500,000 payable at 1% per year would raise at least £260 billion” (Advani, Chamberlain, and Summers 2020, 26). So why aren’t more countries adopting wealth taxes? It seems the drawbacks of wealth taxation are just as, if not more pronounced: mainly its difficulty in implementation and potentially negative impact on existing tax structure. Due to the high mobility of affluent families, critics have predicted the flight of top earners from the country, weakening the national tax base (PGPF 2023). The late Ikea billionaire’s departure from Sweden serves as a prime example (Arroyo 2015). An effective net wealth tax requires valuation of all personal assets, which is straightforward with open market property (stocks, bonds etc) but immensely difficult with ambiguous assets such as corporations with no public share transactions (Tanabe 1967). In fact, administrative difficulty was the main factor behind OECD countries like Austria, Finland, Germany and Sweden repealing their wealth tax laws (OECD 2018, 16).
Policy Suggestion
Following the above examination, this section proposes a similar solution with potentially less drawbacks: implementing a two part system of taxation and educational redistribution. Specifically, a recipient based national inheritance tax with exemptions for low inheritances. The tax revenue generated would be redistributed into job training programs, serving as an effective, feasible and long-term solution to both wealth and income inequality. The following section seeks to justify this approach from an equity, efficiency and administrative standpoint.
According to OECD (2021) 20 out of 36 OECD countries implement an inheritance tax. The U.S. adopted an estate tax, but it is only currently applied to 12 states and each state has exemption thresholds with the highest being $12.92 million (Yushkov 2023). Compared to other forms of wealth taxation, inheritance taxes have a few marked advantages. As opposed to net wealth taxation which is levied periodically —usually annually— an inheritance tax would only take place upon transfer of wealth, reducing the administrative burden of yearly valuation (OECD 2021). Such a national inheritance tax could also compensate for the high exemptions and low coverage of the U.S. estate tax. From an equity standpoint an inheritance tax is superior to estate taxes in that it is levied against the amount of wealth received by each recipient, as opposed to overall wealth bequeathed by the donor (Adam et al. 2011). Turning to OECD aggregate statistics (see Figure 4), it is clear a substantial amount of wealth is inherited, with the U.S. share of inheritance in overall wealth estimated to be above 60%. This inherited wealth can reduce opportunity by providing recipients an imbalanced headstart not linked to personal efforts, which in turn could influence future hiring and income prospects.
An inheritance tax could correct for these factors, reducing the opportunity gap whilst breaking down dynastic wealth. It reaps the double benefit of reducing income and wealth inequality. Additionally, the exemption threshold should insure against an inheritance tax becoming a perverse incentive. Although empirical literature on inheritance taxes are quite limited, studies have shown that for such a levy to be effective, tax revenues must be paired with a government redistribution program, hence the key role of job training programs (Alstott 2007; Elinder, Erixson, and Waldenström 2018). Improving access to low cost colleges and vocational training would better prepare young people for jobs requiring learned skills. In fact, Harvard economist Lawrence Katz estimates sectoral training programs can raise earnings by 20-40 percent (PIIE 2020).
As economic inequality rises, governments must not fall prey to inaction. Through effective policy design, inheritance taxation can be a robust tool to tackle this crisis. But no matter which method, this issue cannot be ignored. To quote Adam Smith, “No society can surely be flourishing and happy, of which the far greater part of the members are poor and miserable” (Smith 1999).
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