The Harmful Nature of Inequality Myths

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Economy: President-elect Barack Obama argues big tax hikes on the rich are needed in part to help redress the growing wealth gap in America. Unfortunately, that argument doesn't pan out when you look at the data.

Speaking to NBC's Tom Brokaw on Sunday, Obama laid out his views: "It turns out," he said, "that our economy grows best when the benefits of the economy are most widely spread. And that has been true historically."

He followed up by saying, in the last 15 years or so, "You've seen a huge shift in terms of resources to the wealthiest and the vast majority of Americans taking home less and less. Their incomes, their wages have flatlined at a time that costs of everything have gone up, and we've actually become a more productive society."

Our new president might want to talk to some of his sterling economic advisers about this, because he got virtually all of it wrong.

Start with the notion that our economy grows "best" when its benefits are most widely spread.

In fact, America's fast-growing economy has always bred differences in income. Some people are smarter, more talented, better educated and trained, or more entrepreneurial. In a free-market society — or relatively free, anyway — they'll do better. But they make the rest of us richer, too. We may envy them, but we're better off.

As for spreading the wealth, the definitive data come from the Gini ratio, calculated by the Census Bureau. Simply put, the Gini ratio measures income dispersion in a society — that is, inequality.

Go back to 1947, as the U.S. emerged from World War II and the Great Depression. Since that year, the U.S. has had the most amazing run of wealth and income creation of any economy ever. We are today the richest country on earth, and No. 2 isn't close.

Yet, over that time, according to the Census Bureau, U.S. income inequality has risen by 15%. Why? Fast-growing economies are almost always accompanied by income inequality — it was true of the U.S. in the past, and it's true of India and China today.

This isn't a bad thing. We benefit from this. The rich earn a lot of income, yes, but they pay even more in taxes. They also create thousands of businesses, millions of jobs and trillions in income.

That said, it's shocking to discover a little-known truth: The U.S. today has one of the most progressive tax codes in the industrialized world. And it's gotten more so over time.

As IRS data show, in 1980, the top 1% earned 8.5% of all adjusted gross income but paid 19% of all taxes. By 2006, that same group's share of AGI had risen to 22%, but its share of taxes had soared to 40%. That is, their tax bill rose faster than their income share.

A recent OECD study looked at federal tax rates paid by the rich vs. low-income workers in rich countries. The U.S. ratio is 1.3 — vs. an average of less than 1.2 for other wealthy nations. As American Enterprise Institute economist Kevin Hassett noted, "the U.S. redistributes far more than the typical developed country."

Unfortunately, the focus on inequality obscures a key fact: Americans aren't taking home "less and less," as Obama says. Nor have wages "flatlined." Indeed, incomes are growing for everyone.

Again, census data tell the story.

Incomes for the poorest one-fifth of all earners have grown on average 3.9% a year since 1994. Meanwhile, those in the middle three-fifths of incomes — broadly speaking, the middle class — have grown by 3.4% to 3.6% a year. Incomes grew after inflation, too. So it's simply wrong to say there was no growth.

To correct these imaginary inequities, Obama talks about hitting the top 5% of incomes with new, higher taxes. But guess what? That'll only punish the millions of Americans who rely on the top earners for jobs and incomes. During a time of national recession, such policies aren't only unwise — they could prove disastrous.

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