The Cure For Income Inequality Is Malaise

The new theme for Obama and de Blasio is the "crisis of income inequality."  And with the top guys having adopted it as the theme, it now gets talked up all over the place by the parroters of the approved talking points.  For example, here we have Jason Furman, Chair of the President's Council of Economic Advisers, in a Business Week interview on December 19:

Two trends have made life harder for middle-class families. First, the overall growth rate in the economy slowed after 1973 as our productivity slowed. The second is that income inequality began a steep increase, starting in the late ’70s. 

The late '70s?  Yes, that was the low point for income inequality as measured by government data for the share of national income going to the top 1% of earners, as compiled by left-wing economists Piketty and Saez.

But was the late '70s a good time for Americans?  For those too young to remember, July 15, 1979 was the date that President Jimmy Carter went on TV and delivered what is forever known as the "malaise" speech, although the word "malaise" was not actually used.  Read the speech to get an understanding of Carter's sense of the national mood at the time.  Here is an excerpt:

I want to talk to you right now about a fundamental threat to American democracy. . . . The threat is nearly invisible in ordinary ways. It is a crisis of confidence. It is a crisis that strikes at the very heart and soul and spirit of our national will. We can see this crisis in the growing doubt about the meaning of our own lives and in the loss of a unity of purpose for our nation.  The erosion of our confidence in the future is threatening to destroy the social and the political fabric of America.

Why the erosion of confidence?  Two reasons stand out.  One was the government price controls on energy that led to shortages throughout the economy, including long waiting lines to get gasoline.  And the other was ludicrously high marginal income tax rates, including a top rate of 70% at the Federal level.   In New York, combined state and local income tax rates approached 19%.  In simple terms, the government was taking away the ability of the people to get ahead by hard work.

Measured income inequality has increased substantially since that time.  Mostly it is an artifact of the government policies and statistics, but there is also a real element.  With marginal tax rates (federal plus state and local) for top earners in the 80+% range for many people in the late '70s, people stopped reporting or recording income at high levels.  In 1979, most tax shelters were legal, and their use was an art form.  The basic idea was to defer income from one year to the next, and then the next, by various rollovers and non-cash deductions.   Or you could just hold on to appreciating assets and not sell them.  Some people with good connections and lawyers could get ahead by owning the right assets and gaming the tax system; but nobody could get ahead by working hard and earning cash income subject to ordinary income tax.  Is it any wonder that Americans had "lost confidence in the future"?    

In 1986 a major federal tax reform under President Ronald Reagan brought the top federal marginal rate down all the way to 28%.  Most tax shelters also became illegal at that time.   Suddenly many high incomes started getting reported and taxed.  Equally as important, it became possible again to get ahead by the straightforward method of working hard and earning cash taxable as ordinary income.  

So we know how to reduce income inequality as measured by the government data.  Just jack up the income tax rates high enough that nobody can get ahead by hard work any more, and all those high incomes will go away.  Of course, we should also expect the return of "malaise."  That's the cure for income inequality.