Tax cuts widen US income gap

President Bush's tax cut promises to have a side effect that bothers many Americans: widening the gap between rich and poor.

The wealthy benefit a bit less under the Senate bill - expected to pass yesterday - than under the House version, and in both plans these benefits are phased in slowly.

But the benefits are big, and they will come at a time when income inequality has already been growing, by most measures, in the world's flagship capitalist democracy.

The nation's top 400 taxpayers, for example, saw their average income more than double - to $110 million - in the years from 1995 to 1998, one new study finds. Meanwhile, since much of that surge came from low-taxed capital gains, the federal tax rate for that elite group effectively fell from 30 to 22 percent. To be sure, these were boom years for stock options, but during the same period, the nation's overall tax rate rose slightly, to 14.6 percent.

The tax-cut package enjoys solid public support. But debate over the details is also reviving a time-honored tension between Americans' traditional aversion to taxes, and their populist outrage if public policy leaves common folk economically behind.

Last fall, Democratic presidential candidate Al Gore tried mightily, and seemingly in vain, to tap the outrage factor regarding Bush's bestowals on "the top 1 percent."

Public views on tax fairness are complex. Most Americans support Bush's tax-cut proposals. A USA Today/CNN Gallup poll yesterday showed the number rising to 67 percent, from 60 the week before. Yet polls also show a desire for more tax-cut benefits to go to lower-income taxpayers.

Such ambivalence goes far back. The revolution of 1776 was instigated in good measure by men of money, angered at the prospect of an arrogant king and Parliament taking more of their wealth.

But even then, periwigged prosperity coexisted with the ideal of upward mobility for ordinary Americans. From Shays' Rebellion of 1787 to Teddy Roosevelt's trust-busting, this populism has acted as a check against the power of corporations or a wealthy elite.

Now, as Congress moves to reconcile the House and Senate tax plans, the balance of these old values is being tested again.

"The higher your income, the more you will benefit from this tax cut," says Joel Slemrod, an economist at the University of Michigan Business School in Ann Arbor, who did the study on the richest 400 tax filers.

Tax experts generally agree that the GOP tax-cut plan will indeed widen income disparities.

But Bush and congressional Republicans rest the tax cut on their own argument of fairness: It is the prosperous who pay the bulk of income taxes, so they should get most of the tax relief.

Also, the House and Senate plans cut all tax brackets, and target some significant benefits at working families. The per-child credit, for example, would rise from $500 to $1,000.

And the wealthy will have to wait for many of their benefits under both bills. The Senate bill "backloads" repeal of the estate tax, for instance, scheduling it for 2011. That leaves lots of time for a subsequent Congress to reverse course.

The administration is expected to fight for a final package similar to that passed by the House, the measure closest to Bush's proposal and which gives more benefits to the well-heeled.

Tax bill's effects

The Senate plan would trim the top income-tax rate to 36 percent, instead of the 33 percent sought by Mr. Bush and passed by the House.

But even the Senate bill, when fully in place, would give $57.6 billion a year, or 35 percent of the bill's total tax benefits, to the top 1 percent of taxpayers (who make $373,000 or more), calculates the Center for Tax Justice, a liberal lobbying group in Washington.

The bill's benefits for the wealthy - averaging $44,293 a year for the top 1 percent - are proportionately a bit more than their share of the tax burden, according to the Center on Budget and Policy Priorities (CBPP), a Washington think tank. These numbers include estate and payroll taxes (such as Social Security) as well as the income tax.

Critics on the left say any tax cut should be more progressive.

Len Burman, a senior fellow at the Urban Institute in Washington, says that while the free market should determine pre-tax income, "the nice thing the tax system can do is reallocate that income a bit."

"We should invest in poor kids," says Betsy Leondar-Wright, of the group Responsible Wealth, which opposes repealing the estate tax. That tax, she argues, acts as a modest bulwark against an aristocracy of wealth that goes against American ideals.

At present, those in the top income brackets are already getting a bigger share of total income than at any time since World War II, says Robert Greenstein, director of the CBPP.

One key reason has been a booming stock market. That means new income for those who own stock - income that now typically faces a 20 percent tax rate, not the 39.6 percent rate that the very rich pay on regular income.

Mr. Slemrod's study bore this out for the top 400 taxpayers, who were not necessarily the same individuals from year to year in the IRS data. A growing share of their income in the 1990s boom came from capital gains, including stock options. That explains their falling effective tax rate.

But Republicans see low taxes as fuel for the economy. The wealthy will save, rather than spend, much of their tax break. That supplies a fresh pool of capital to feed economic growth.

The growth factor

William Beach, an economist at the conservative Heritage Foundation in Washington, argues that the tax cut will stimulate the creation of new jobs that enable those at the bottom of the ladder to rise from poverty.

A study he did with another Heritage economist, Mark Wilson, finds that the full rate cuts sought by Bush, if all were made retroactive to Jan. 1, would add 1.6 million jobs by 2011 and expand the nation's economic output by an extra $248 billion. Those jobs will be needed by immigrants, legal and illegal, he says. "The tax system does a poor job of narrowing the gap between the rich and poor."

Academic economists, however, have had difficulty verifying this "supply-side" thesis.

In the US, the income tax started out in 1914 hitting only the rich. But it was changed from a "class tax" to a "mass tax" during World War II because of the need for higher government revenues. The top marginal rate - the tax paid on a new dollar of ordinary income - has ranged from as high as 90 percent in 1964 to 28 percent in 1988. But the effective rate - the percentage of income actually paid to Washington - has never been as high as the marginal rate.

Moreover, despite a boost in the top rate in 1993, from 33 to 39.6 percent, capital investment boomed and the nation thrived.

In Europe, some nations with the highest tax burdens, such as those in Scandinavia, also are about as prosperous as the US.

In fact, when growth rates of various industrial nations are compared, those with less income inequity than the US tend to perform better over the long run, maintains Edward Wolff, an economist at New York University.

The US has had several years of rapid growth. But some small European nations, such as the Netherlands, Finland, and Sweden have grown faster.

Mr. Beach holds that the gap is largely explained by those nations having older populations, which have had time to amass wealth.

(c) Copyright 2001. The Christian Science Monitor