REFILE-COLUMN-Income inequality: government, Warren Buffett and growth-Chrystia Freeland

Fri Nov 30, 2012 12:16pm EST

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By Chrystia Freeland

WASHINGTON Nov 29 (Reuters) - When Branko Milanovic, a World Bank economist, published "The Haves and the Have-Nots," a study of global income inequality last year, one of his most striking observations was the extent to which the subject was taboo in the United States.

As Milanovic explained, "I was once told by the head of a prestigious think tank in Washington, D.C., that the think tank's board was very unlikely to fund any work that had 'income' or 'wealth inequality' in its title. Yes, they would finance anything to do with poverty alleviation, but inequality was an altogether different matter."

"Why?" Milanovic asked. "Because 'my' concern with the poverty of some people actually projects me in a very nice, warm glow: I am ready to use my money to help them. Charity is a good thing; a lot of egos are boosted by it, and many ethical points earned even when only tiny amounts are given to the poor. But inequality is different: Every mention of it raises, in fact, the issue of the appropriateness or legitimacy of my income."

I recalled Milanovic's remarks this week when I found myself on a panel at the Brookings Institution, one of those Washington research groups, discussing income inequality, including the research collected in a new book published by Brookings titled "Inequality in America." In reply, Kemal Dervis, the vice president of Brookings, who co-wrote the book and led the panel, joked that if he turns up on the job market next month, we will know he overstepped the mark.

It was a characteristically polished line - Dervis is a former Turkish cabinet minister - but the truth is that the Brookings event was a sign of the recent sea change in the U.S. public discourse about income inequality.

As recently as this summer, it still seemed like Americans were allergic to any explicit discussion of income inequality. That was the reasoning of Republicans and of many previously nonpartisan wealthy businessmen who responded to President Barack Obama's call for higher taxes on millionaires and billionaires with accusations of class war.

But at the polls in November, something surprising, at least for the Romney strategists, happened. A very muted, democratic version of class war was fought, and the lower classes won. As Mitt Romney put it in a conference call with his donors after the vote, a coalition of less well-off Americans re-elected Obama because he promised to use government to improve their lot.

Even the patriarch of American capitalists, Warren E. Buffett, has decided it is OK to talk about income inequality. In an op-ed in the New York Times and the International Herald Tribune this week, Buffett pointed out that the wealth of the 400 richest Americans has increased more than fivefold over the past 20 years. As Buffett put it, "My gang has been leaving the middle class in the dust."

The Brookings panel confirmed that assessment and offered three important takeaways about the causes and consequences of rising income inequality. One was that government matters. Like most students of the subject, the assembled economists agreed that rising inequality was driven partly by economic forces like the technology revolution and globalization.

But the state can choose to mute the impact of the invisible hand. Paradoxically, in much of the Western world, and particularly in the United States, even as the power of these economic shifts has become more profound, government efforts to mitigate them have become weaker. As Buffett pointed out, the effective tax rate paid by the 400 top earners in 1992 was 26.4 percent. By 2009, it had fallen to 19.9 percent - even as the pretax gap between the plutocrats and everyone else had widened.

A second theme of the Brookings discussion helps to explain one reason that has happened: The economy has gone global, but nation-states have not. Higher taxes on the rich may be a logical response to rising income inequality, but actually levying those taxes is getting harder in an age of global capital flows. Buffett said it was "sickening" that rich people and companies use the Cayman Islands to lower their tax bills, but moral outrage is a weak weapon against international tax arbitrage.

If you are still not convinced that all this matters, consider the third, and most striking, possibility raised at the Brookings panel. Set aside any moral or political concerns you may have about rising income inequality - worries about poverty, justice, undue political influence or even social mobility.

According to Dervis, and the research collected in "Inequality in America," a growing number of economists suspect that once inequality passes a certain point, it may jeopardize economic stability and economic growth.

As the book argues, "rebalancing of the distribution of income may play a role in unlocking the U.S. economy's growth potential in a sustainable way."

Now that is a truly radical thought, and it brings us back to Milanovic's earlier view that income inequality was a forbidden subject in the United States.

Worrying about the poor is one thing. To contend that equality is necessary for growth is an altogether different and more radical idea. Three decades later, trickle-down economics has met its antithesis. We are set for one of the great battles of ideas of our time.

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