Thursday, January 20, 2011

A new tax slab for the uber-rich?

Fascinating graphic from the Economix which highlights the magnitude of income differentials at the highest income levels. As can be seen, for the bottom 90 to 95 percent of Americans, the income distribution is relatively flat, whereas at the mid-90s, the line suddenly kinks upward.

Brad DeLong has a log income distribution which Paul Krugman compares to "a long street running up a hill, in which rising altitude goes along with rising income".

The emergence of this distribution has important consequences. Conventional income profiling which classified people into categories of the poor, rich and middle-class is no longer relevant. A fourth category of the uber-rich has emerged at the highest income level, distinct from the mere-rich. This category, a small percentage of the total population (most often no more than 5%), earn several times more than the mere-rich and own a staggering share of the national wealth.

This has profound implications for all social, political and economic policy making. This massive income differentials at the top and the resultant concentration of wealth has dramatically altered power equations within societies. The mere-rich have been replaced by the uber-rich as the power-elite.

The incentives and the psychology that drives the uber-rich are different from those of the mere-rich when the latter formed the power-elite. This has implications for economic policy making. For example, there arises the issue of a separate higher tax bracket for the uber-rich and other changes to the taxation system. Currently, the uber-rich are enjoying the taxation rate that was designed for the mere-rich.

This assumes greater significance in view of the major share of the incomes of the uber-rich coming from financial markets through some form of capital-gains. It cannot be any coincidence that in the US, such incomes are taxed at a marginal rate of 15%, compared to wage and other incomes which are taxed at 39.6%.

Further, as Paul Krugman writes, "if you’re in the middle of the income distribution, your uphill neighbor is about as much richer than you than your downhill neighbor is poorer, but in the upper reaches that’s no longer true". Psychologically, the fact that the mere-rich have been superseded by the uber-rich in such a short time would have a profound impact on their psyche and the relationship between these two groups at the top of the income distribution. Will this lead to a social consolidation between the mere-rich and the middle-class to form the countervailing elite? How will this impact political power equations and relationships at the top of the income distribution?

Income distribution trend follows the same pattern every where. The graphic below illustrates India's income distribution of more than ten years back, which shows a gradually rising graphic. The income distribution today would be strikingly similar to that of the US.

Update 1 (12/4/2011)

Nancy Folbre makes the case for a higher and separate tax rate for the millionaires. As she shows, high marginal tax rates have been the historical norm. She also finds limited historical evidence to support the view that tax increases dampen economic growth.

Update 2 (1/5/2011)

Paul Krugman points to newly released IRS documents which show that the top 400 income tax payers had an average tax rate of less than 17% in 2007. Further, they accounted for more than 10% of all capital gains income in America. Krugman writes,

"Conservatives often try to sell the notion that reducing the capital gains tax is about helping small business people. But you really want to think of the fact that a significant chunk of that tax break is going to just 400 people.

And when you think about financial regulation, you similarly want to bear in mind that when asset prices rise, a tiny handful of people get a large chunk of the gains; I don’t know this for sure, but I’d bet that they somehow end up bearing a much smaller share of the losses when the bubble bursts."

Another reason for a higher tax slab for the uber-rich?

Update 3 (18/5/2011)

One of the most important driving forces behind widening income inequality - declining tax rates at the top, even as incomes balloon. With an average income of $270 million in 2008, the typical household in the Top 400 made 4,700 times as much as the average American filing a 1040 form. This CBPP chart shows that between 1992 and 2008, the average share of their incomes that these households paid in federal taxes dropped from 26 percent to 18 percent, while their annual incomes shot up by over 700 percent, after inflation.

Update 4 (26/5/2011)

Economix draws attention to the latest figures released by Tax Policy Center on income distribution in the US for 2011.

The difference in income between a household at the 50th percentile and a household at the 51st percentile is $1,237 ($42,327 versus $43,564). But the difference in incomes between a household at the 98th percentile and the 99th percentile is $146,118 ($360,435 jumps up to $506,553). The gaps become even wider at the extreme top of the income ladder: A family at the 99.5th percentile makes $815,868; its neighbor at the 99.9th percentile makes more than double that, at $2,075,574 a year.

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