Phil Donelson

“We’ve borrowed too much, we’ve spent too much, and we’ve dramatically over-regulated every aspect of the private sector in our country and now we are threatening to raise taxes on top of it,” said Republican Senator Mitch McConnell on NBC’s Meet the Press this past Sunday.

Though seemingly unaware of the regulatory history of US financial sector, or his own position on certain forms of spending, Mr. McConnell clearly outlined his opposition to President Obama’s latest deficit reduction plan.

The plan introduced this week by Mr. Obama would reduce the US federal deficit by more than $3 trillion over the next decade. An aspect of the plan that is gaining the most attention is the “Buffett Rule” – named after billionaire Warren Buffett, who has often called for higher tax rates on the richest Americans. The proposal would ensure that individuals who earn over $1 million per year pay at least the same percentage of their earnings in taxes as middle-income individuals.

Taxation in the United States is such that those who make money from capital gains and dividends are often taxed at a lower rate than those who earn from normal wages. It’s the difference between the marginal tax rate (on dollars earned), and the effective tax rate (the percentage of total income that you actually pay in taxes). Mr. Buffett noted that he only paid 17.4 percent of his taxable income last year, while the people in his office paid between 33 to 41 percent. Buffett’s tax rate would effectively put him in the $8,500 to $34,500 tax bracket, when he really made close to $40 million.

This week, Mr. Obama promised to veto any deficit reduction legislation that does not include increasing taxation on the wealthy; Speaker John Boehner (R-OH) has said he will not support any legislation that increases taxes. For Washington, that’s downright harmonious.

But with all of the—admittedly entertaining—political posturing and sparring on the deficit comes an important opportunity to look at some of the underlying economic trends that have created the situation the United States now finds itself in.

Consider the following:

• 46 million Americans were living below the poverty line in 2010
• Last year in the United States, the top 20 percent of earners controlled 49.4 percent of the nation’s income, and the top one percent controlled 24 percent of income
• The median household income in 2010 was $49,500 adjusted for inflation – the same level it was at in 1996
• Similarly, the median earnings for a full-time, year-round employed American male in 2010 ($47,715) was only slightly more than it was in 1972 ($47,550)

America has an inequality problem—it’s an important issue of social justice, but it’s also an issue of economics. Even the great egalitarian Alan Greenspan thinks so.

Skeptics often look at these numbers and either ignore them or deny that they are a problem. Their lines of reasoning often lie in a strong belief in lassiez-faire capitalism, and in light of the skyrocketing top one percent, remain steadfast in their belief that a rising tide lifts all boats. Ironically, John F. Kennedy uttered that phrase in 1963 when household income was doing quite well—family income doubled between 1947 and 1973. After 1973, however, the only thing keeping family income from falling was the rise of dual-income households; males were beginning to do worse year after year despite growing GDP. A look at incomes of men in their thirties today shows that they are earning barely more than their fathers’ generation did at the same age. It remains to be seen when exactly the rising tide of the past 40 years will lift the rest of the boats.

A more interesting, but ultimately dubious, claim used by certain commentators is that despite rising income inequality, equality of actual living standards has improved. Some argue that if inexpensive goods improve in quality more rapidly than expensive goods, the gap between them narrows, thus narrowing the gaps in quality of life; likewise, if prices of goods that low-income families typically consume rise in price at a slower rate than goods consumed by rich families, income gaps will not reflect real consumption gaps.

Assuming that “cheap” goods were getting better in quality—the results are mixed at best—and rising in price slower than others, this argument does not take into account the larger proportion of household income used by lower-income families to purchase basic goods that everyone needs. Not to mention, for example, the negative health effects of eating inexpensive and lower quality food. As for general quality of life, as income inequality grows, so too do mental illness and other rates of disease.

A bigger issue, though, is that the cost of housing for low-income families has greatly increased in recent years, and the shortage of affordable housing units has increased from 2.7 million to 3.1 million homes. As housing costs crowd out other items in family budgets, there is little room left for purchasing those other basic goods. The standard of living arguments start to fall apart.

From a macroeconomic perspective, a middle class that is worse off year after year means that the economy will not perform at its full potential. Middle class families have to be able to purchase the goods and services that are produced in an economy, which grows the economy and creates jobs, thereby increasing aggregate demand and consumption. This was the case for many years in the United States, but unfortunately the broad-based prosperity that existed 50 years ago is no longer there.

The prospects for one of the defining features of American culture—achieving the American Dream and all its trappings—are also increasingly bleak. Of those born in the bottom fifth of income earning families, over 40 percent remain there as adults, and even fewer move to the higher steps of the economic ladder. Social mobility is actually higher in Canada—though we are not without our problems—and in many European countries than it is in the United States. For a society that prides itself on opportunity and the ability for anyone to get ahead, the reality for many is that opportunity is shrinking and odds are stacked against them from the beginning.

The Buffett Rule is not a panacea for inequality in the United States, but as a guiding principle toward reforming taxation, and more broadly, for how the US economy and society evolve, it is a necessary first step.

Too often are public debates stuck on cutting taxes at all costs, resulting in other aspects of civic life being ignored. A modern society has to be able to establish a sense of citizenship beyond the simplistic ‘taxpayer’ mentality that stops civic dialogue at the price tag. In order to promote a healthy democracy, a fair and prosperous economy, and an ambitious society, there are basic conditions that have to be met. But as we have seen, a situation in which the richest citizens contribute less than middle class citizens undercuts those conditions.

Phil Donelson is a co-editor of the Public Policy and Governance Review, and a second-year student in the Master of Public Policy program at the School of Public Policy and Governance, University of Toronto. He graduated from the University of Toronto in 2010 with a BA (Hon) in Political Science.