July 24, 2007 / 10:47 PM / 12 years ago

Fed chief stumbles into U.S. income inequality debate

NEW YORK (Reuters) - Despite his best efforts to stay removed from politics, Federal Reserve Chairman Ben Bernanke has waded into the controversial debate about growing income inequality in the United States.

U.S. Federal Reserve Chairman Ben Bernanke speaks at a Senate Banking, Housing and Urban Affairs committee hearing in Washington in this July 19, 2007 file photo. Bernanke has waded into the controversial debate about growing income inequality in the United States. REUTERS/Jason Reed

At issue are loopholes in the U.S. tax system that allow high-earning private equity and hedge fund investors to claim most of their incomes as capital gains rather than regular income. This lets them to be taxed at only a 15 percent rate, barely half what many working Americans must pay.

Asked during Congressional testimony last week if the tax system was partly to blame for the rising gap in incomes between rich and poor in the U.S., Bernanke said: “Tax policy is not the major factor. The major factors are technological change. And to a lesser extent globalization.”

But critics say this stance gives short-shrift to evidence showing taxes can play a part in altering disparities between rich and poor.

“Tax policy can definitely play a role in mitigating inequality,” said Len Burman, director of the Tax Policy Center in Washington. “It’s kind of ironic that over the past six years, as inequality has widened to its worst levels since the Great Depression, the tax system has become much more regressive.”

By Bernanke’s own admission, income inequality has increased sharply over the last three decades.

Between 1979 and 2006, the Fed chairman noted in a speech earlier this year, income for the top 10 percent of U.S. earners rose 34 percent, while wages for the poorest 10 percent advanced just 4 percent.

The gulf gets even more striking at the very top of the ladder. Between 2004 and 2005, the average income of the top 1.0 percent of U.S. households increased by $102,000 after adjusting for inflation, according to the Center on Budget and Policy Priorities. In contrast, the average income of the bottom 90 percent of households increased by $250.

With this in mind, Democrats in the U.S. Congress introduced a bill last month aimed at putting an end to the tax rules for hedge funds and private equity partnerships, making many on Wall Street nervous.

Proponents of the existing tax structure, including the Fed Chairman, argue it encourages risk-taking and entrepreneurship. Without it, they say, economic growth would suffer.

“There’s talk in Washington D.C. right now about raising taxes on hedge fund managers. I think it’s a terrible idea,” says Donald Luskin, chief investment officer at Trend Macrolytics in Menlo Park, California. “We need more people to do more investing. And whenever you raise the taxes on something, you get less of it.”

Yet detractors argue there is nothing entrepreneurial about making speculative bets with other people’s money, which is essentially what investment vehicles like hedge funds and private equity funds do.

“These investors take what looks to most people like ordinary income and convert it to capital gains treatment. It’s very hard to justify,” said John Podesta, who served as White House chief of staff under Bill Clinton and is now head of the Center for American Progress in Washington.

Princeton economist and New York Times columnist Paul Krugman proposed in a recent article that these investors were more like “a waitress whose income depends on a mix of wages and tips” than “an entrepreneur who sinks his life savings into a new business.”

PIMCO fund manager Bill Gross, who manages over $100 billion himself, agrees.

“Of course the wealthy fire back in cloying self-justification, stressing their charitable and philanthropic pursuits,” Gross wrote in his latest investment outlook.

“Perhaps. But with exceptions for the Gates and Buffetts, the inefficiencies of wealth redistribution by the Forbes 400 mega-rich and their wannabes are perhaps as egregious and wasteful as any government agency, if not more.”

Even billionaire investor Warren Buffet has derided the U.S. tax system for unfairly favoring the rich: “If you’re the luckiest one percent of humanity, you owe it to the rest of humanity to think about that other 99 percent.”

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