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What Produces Inequality of Income and Wealth? What Should Be Done About It?
Raymond Richman, 5/27/2014

From an economist’s viewpoint, the present distribution of income after tax is greater than it needs to be in a market economy. Some inequality is necessary as an inducement to work hard, to excel, to save, to invest, and to innovate, the essentials of a productive and growing economy. But the present inequality in the U.S. is excessive and greater than it needs to be even at the present rates of the personal income tax. But that is not because the personal income tax is not progressive enough. The rates are progressive but a lot of income escapes taxation or is taxed at special low rates. More important, much of the taxes paid by corporations is really paid by customers of the corporation. Shareholders bear little of the burden of the corporate income tax and since ownership of corporations is highly concentrated in the hands of the rich, the rich get richer faster. Moreover, the personal income tax allows property to be depreciated over and over again and taxes dividends and capital gains, highly concentrated in the hands of the rich, at lower rates than ordinary income. There are some reforms of the personal income tax that would increase the progressive incidence of the tax without raising rates. Of course, there is another tax that reduces inequality of wealth between generations, the federal estate tax.

What produces inequality? A French economist, Thomas Piketty, a sort of new Marxist, has just written a book that is little more than a tract. Some have even questioned his data. The book argues that capital accumulation, because the return on capital grows at a higher rate than the economy grows, inevita bly leads to greater and greater inequality of wealth. Marx actually argued that capital accumulation would tend to diminish the rate of return on capital as capital accumulated relative to other inputs. That follows from the universal acknowledgment of the law of diminishing returns. Were it not for innovation, new products and methods of production, the marginal return on capital would diminish as capital accumulated, to zero. (Has that been happening and is that the reason for so little new private investment and our slow recovery? That’s a good question.) Regardless, our French economist seems to believe that progressive taxation is ineffective. He ignnores the everchanging membership among millionaires and billionaires and seems never to have heard of estate taxation.

Our view is that the excessive accumulation of wealth is due to the fact that shareholders of corporations bear little of the burden of the corporate income tax and, therefore that corporations should be treated like partnerships. Corporate earnings would be taxed as personal income and subject to the progressive rates of the personal income tax. The estate tax should be made more progressive and would reduce the inequality as wealth passes from one generation to another.

The inequality of income and wealth is not the same as inequality of consumption. There is much less inequality of consumption. If one takes consumption as the measure of inequality, the income and wealth distribution of the consumption of goods and services,  the rich just pay more for what they consume but the inequality is not nearly as great. The rich consume less food than the poor, at least so far as calories are concerned, but they do spend more on luxury restaurant food, more luxurious and multiple houses, expensive autos, private airplanes, servants, more expensive entertainment, yachts, etc., etc. But no one would be alarmed by it as they are by the Piketty data on wealth distribution.

That is not to say that we need not be concerned at all about the inequality of income and wealth and that we ought to do nothing to slow or retard economic growth. Warren Buffett illustrated the defect of our income tax system when he remarked that in 2012 he paid a lower rate of personal income tax that his secretary. He did not say how that strange result came about. It is simple enough. Most of his income consisted of capital gains and dividends both taxable in 2012 at only 15 percent. There is no reason why consumed capital gains should be taxed at lower rates than other income. That is a result of Congressional use of an incorrect definition of income.

The low rate of tax on dividend income received by personal income tax payers is based on the theory that income derived from corporations has already been taxed. Didn’t any of the economists advising the members of the House and Senate and Presidents mention the fact that nearly all economists at our universities believe corporations pass a large part of the tax burden on to their customers and their employees. Shareholders may bear some part of the burden but how much is uncertain. Taxing corporate earnings as personal income would end this inequity.

To make matters worse, the economic effects of the corporate income tax cause corporations to borrow unwisely, buy back their shares in lieu of paying dividends, and engage in other undesirable practices. Moreover, it handicaps corporations that export their products because under world trade rules the corporate income tax may not be rebated to exporters while sales taxes and value-added taxes which are the rule in the rest of the world may be rebated.

We propose a simple solution. Abolish the Corporate Income Tax and tax shareholders on their share of the earnings of the corporation. This is nothing new. Partners are taxed on their share of the partnership’s income. The Corporate Income Tax came into being as a result of Piketty-like thinking that their separate taxation was justified by the fact that under law they are considered a person distinct from their shareholders, which under scrutiny is a foolish argument. Especially these days when most States permit partnerships and proprietorships to be established as limited liability companies.

The federal estate tax is a great levelling instrument by taxing at progressive rates the accumulated wealth of the very rich families. Conservatives are foolish to oppose estate taxes because one of the virtues of the estate tax is that it does not reduce incentives to save or invest very much if at all.

There are other problems which can be resolved. One is the treatment of depreciation. The ownership of commercial real estate is highly concentrated and the properties are depreciated over and over again by successive purchasers. Successive owners of the Empire State Building have deducted as a depreciation expense what they paid or it.  Have you ever wondered why hotels change owners periodically? Each successive owner can depreciate the price he pays. The seller sells the hotel when he no longer can deduct a large depreciation allowance. The buyer pays a larger sum for the hotel than he would if the law provided that property could only be depreciated once.

The progressive personal income tax, the taxation of corporate earnings as personal income, reform of the tax treatment of capital gains, and limiting depreciation to the original cost of the asset, and progressive estate taxation is all that is necessary to reduce with the excessive inequalitiy of income and wealth. The Piketty tract should be recognized for what it is – junk

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