COLUMN-On inequality

Sun Feb 16, 2014 6:04pm EST

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(The opinions expressed here are those of the author, a columnist for Reuters.)

By Lawrence Summers

Feb 16 (Reuters) - Inequality has emerged as a major economic issue in the United States and beyond.

Sharp increases in the share of income going to the top 1 percent of earners, a rising share of income going to profits, stagnant real wages, and a rising gap between productivity growth and growth in median family income are all valid causes for concern. A generation ago, it could have been plausibly asserted that the economy's overall growth rate was the dominant determinant of growth in middle-class incomes and progress in reducing poverty. This is no longer plausible. The United States may well be on the way to becoming a "Downton Abbey" economy.

So concern about inequality and its concomitants is warranted. Issues associated with an increasingly unequal distribution of economic rewards will likely be with us long after the cyclical conditions have normalized and budget deficits finally addressed.

Those who condemn President Barack Obama's concern about inequality as "tearing down the wealthy" and un-American populism have, to put it politely, limited historical perspective. Consider a sampling of past presidential rhetoric.

President Franklin D. Roosevelt, talking about the financial industry in his first Inaugural Address in 1933, said "Practices of the unscrupulous money changers stand indicted in the court of public opinion . They know only the rules of a generation of self-seekers. They have no vision and when there is no vision the people perish."

By his re-election campaign in 1936, this had become: "We had to struggle with the old enemies of peace - business and financial monopoly, speculation, reckless banking.  They are unanimous in their hate for me - and I welcome their hatred."

President Harry S. Truman later observed, "The Wall Street reactionaries are not satisfied with being rich.These Republican gluttons of privilege are cold men.  They want a return of the Wall Street economic dictatorship."

John Kennedy, dismayed by a steel price increase in 1962, privately cursed the steel executives - though the quote quickly became public - and had FBI agents storm into corporate offices and subpoena business and personal records. He very likely ordered the Internal Revenue Service to audit steel executives' personal tax returns. President Richard Nixon also turned to the tax authority, announcing in 1973 that he had "ordered the IRS to begin immediately a thoroughgoing audit of the books of companies which raised their prices more than 1.5 percent above the January ceiling."

President Bill Clinton, in a major economic speech of his 1992 campaign, complained, "America is evolving a new social order, more unequal, more divided, more impenetrable to those who seek to get ahead. Although America's rich got richer  the country did not  the stock market tripled but wages went down."

Many more examples can be cited to demonstrate that it is neither unusual nor un-American to be concerned about income inequality, the concentration of wealth, or the influence of financial interests. Given the public's frustration with stagnant incomes and an increasing body of evidence linking inequality to reduced equality of opportunity, reduced demand for goods and services and increased alienation from public institutions, demands for action are reasonable.

The challenge is in knowing what to do. If total income were independent of efforts at redistribution, the case for reducing incomes at the top and transferring the proceeds to those in the middle and at the bottom would be compelling. Unfortunately this is not the case. Technological changes and globalization, for example, have made it possible for those with great entrepreneurial talents to operate faster and on a larger scale than ever before - and gather profits on an unprecedented scale.

It is easy to conceive of policies that would have reduced the earning power of a Bill Gates or a Mark Zuckerberg by making it more difficult to start, grow and globalize businesses. But it is far harder to see how such policies would raise the incomes of the remaining 99.9 percent, and such polices would surely hurt them as consumers.

It is true that there has been a dramatic increase in the number of highly compensated people in finance over the last generation. But recent studies reveal that most of the increase has come as the value of assets has increased - asset management fees as a percentage of assets remained roughly constant. Perhaps some policy could be found that would reduce these fees, but the beneficiaries would be the owners of financial assets - a group heavily tilted towards the very wealthy.

So it is not enough to identify policies that reduce inequality. To be effective they must also raise the incomes of the middle class and the poor. Tax reform has a major role to play here. Apart from its adverse effects on economic efficiency, our current tax code allows a far larger share of the income of the rich than the poor or middle class to escape taxation.

For example, last year's increase in the stock market represented an increase in wealth of about $6 trillion - with the lion's share going to the very wealthy. The government is unlikely to collect as much as 10 percent of this figure given capital gains exemption, the ability to defer unrealized capital gains, and the absence of any tax on gains on assets passed on at death.

Another example is provided by our corporate tax system. Because of various loopholes the ratio of corporate tax collections to the market value of U.S. corporations is at a near record low.

Then there is the reality that the estate tax can be substantially avoided by those prepared to plan and seek sophisticated advice. Closing loopholes that only the wealthy can enjoy would enable targeted tax measures like the Earned Income Tax Credit, which raise the incomes of the poor and middle class more than dollar for dollar by incentivizing working and saving.

It is ironic that those who profess the most enthusiasm for market forces are least enthusiastic about curbing tax benefits for the wealthy. Sooner or later inequality will be addressed. Much better that it be done by letting market forces operate and then working to improve the result than by seeking to thwart their operation. (Lawrence Summers)

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