Fixing the Budget

The debate about balancing the budget and dealing with the fiscal crisis facing the US is intense and warped.  It is warped because the two things that need to be done — a) significant entitlement reform and b)  tax increases — are resisted every step of the way.   First, taxes.  Please consider the following charts:

1) The percentage of income earned by the top 10% of Americans
2) The GINI index representing income distribution before taxes and transfers
3) The GINI index representing income distribution after taxes and transfers  (0 = perfect equality 1.00 = maximum inequality)

OK, note a couple of things.   The relative percentage of income held by the top 10% of the population has been steadily increasing since the late seventies, now at a level greater than any other time in history.    As I noted in my post last December on the tax debate, this correlates with a decrease in tax rates for the wealthiest.  Moreoever, while there has been little real growth in wealth for the poorest, the richer you are, the more your wealth has increased in the past three decades.   The wealthiest 10% of Americans are wealthier than anyone other country’s top decile, while the bottom 10% are way back, below Greece.  (Charts for this stuff can be found on that December post).

Next, consider the Gini co-efficient.   Created by Italian sociologist Corrado Gini, it is a well regarded statistical analysis of the distribution of wealth in a society.   To reach 1.0 all wealth would be in the hands of one person; to reach 0 everyone would have equal wealth.   Note that the OECD average before taxes is 0.45, while the US is at 0.46.  This suggests that the pre-tax distribution of wealth in the US is pretty close to average for the industrialized world.   However, after taxation and transfers the OECD average is 0.31 while the US is at 0.38.   Taxes have meant a transfer of some wealth to the poor, but not a lot.   The US is in fact last among the OECD states in that regard.

US taxation appears to be the least progressive of any industrialized state.  Portugal is tied at .38, but it’s pre-tax/transfer level was .54.  Poland is next at .37, but pre-tax/transfer it was .57.    Some like Germany begin at .51 and taxes and transfers move them to .30.

Note the following map:

As far as the Gini index is concerned, the US has more in common with China, Venezuela, Mexico and Argentina than Western Europe and Japan.

What does all this mean?  Combined with the argument I made last December I believe this is a strong argument for significant tax reform.   I agree with blogger Vern Kaine that the “tax the rich” mantra is often used purely for emotion, and that tax increases to the wealthy tend to be accompanied by deductions and loopholes that do them no harm.   That is why simply increasing the percentage taken from those earning higher may do little to improve the problem.

I could use this information to argue for greater transfers of wealth through taxation and government spending in order to move us further towards equality on the Gini index.  I am not doing that now.   Right now I’m arguing that the evidence is strong that given our budgetary mess we can ask the wealthiest Americans to contribute a bit more.

There is significant tax revenue that can be gained relatively easily, and likely with little harm to the economy. According to a New York Times “balance the budget” application, there are ideas already on the table to do that.  Going back to the Clinton era estate tax would bring in $32 billion by 2015, $104 billion by 2030.  Allowing the Bush cuts to expire on those earning over $250,000 would bring in $54 billion by 2015, $115 billion by 2030.   Payroll taxes for money earned over $106,000 would add $50 billion by 2015, $100 billion by 2030.  A 5.4% millionaire’s surcharge would add $50 billion by 2015, $95 billion by 2030.  A plan to eliminate loopholes would gain $136 billion by 2015, $315 billion by 2030.   Reducing the mortgage benefits for high income families would gain $25 billion/$54 billion, and a consumption tax would bring in $41 billion/$280 billion.   These together could bring in $488 billion by 2015, and over $1 trillion by 2030.

If we added this with entitlement reforms such as raising the age of retirement, limiting social security payments to wealthier individuals, and limiting the growth in medicare payments, we’d be in the black easily.  If we combine that with cutting military spending, recognizing that in the 21st century we don’t need a 20th century style military behemoth, we’d have excess money to invest in creating a productive future and ultimately we could reduce tax rates for everyone.

Tax increases and entitlement reform tend to be lose-lose issues.  Yet no budgetary solution is possible without a mix of those.   For taxes, I’d NOT recommend simply passing the tax increases I list above.  That was just to demonstrate that money is available.   Instead I’d recommend a reform of the system that eliminates most deductions and loopholes and is at least slightly more progressive.   At least until we get our fiscal house in order we need more taxes.

Entitlement reform finds Democratic opposition, often in the form of denying there really is a problem.   Wisconsin Representative Paul Ryan’s solution that relies on incentives for finding low cost care runs into the same problem — you can’t wish this away.  Most costs are near end of life, and aren’t related to wasteful use of funds.    Is it really necessary to spend so much right at the end of life, trying to squeeze out a few more months on the planet, while neglecting to cover so many who have real problems in the middle of life?  With life expectancy rates higher than ever, what is wrong with increasing the retirement age?   And with the country facing potential economic crisis, why should the wealthy get transfer payments from social security?

Ultimately our problems are not that severe.   Common sense tax increases, spending cuts, and a new approach to military and defense policy could put us in a position not only to balance the budget but to invest in infrastructure to rebuild productive capacity for the 21st century.   We could explore the potential of alternate energies, technologies so solve or avoid problems emerging in the environment, and be prepared for an increasing rate of global and domestic change.   We are not facing an existential crisis if we have the courage to embrace a few politically difficult choices and recognize that the only feasible path will be bi-partisan, will require painful compromises, but can yield a much brighter future.

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  1. #1 by Sean Patrick Hazlett on April 12, 2011 - 06:26

    America’s Gini coefficient is disturbing to say the least. I believe that it is actually worse than Russia’s (though I haven’t checked the data recently).

  2. #2 by brucetheeconomist on April 12, 2011 - 15:06

    Looks interesting. I hope to look at this more this evening.

  3. #3 by pino on April 13, 2011 - 03:09

    The relative percentage of income held by the top 10% of the population has been steadily increasing since the late seventies, now at a level greater than any other time in history.

    The US is in fact last among the OECD states in that regard.

    America’s Gini coefficient is disturbing to say the least.

    Whoa Nellie!

    First the first: Top 10% of income holders.

    There are two ways that the wealth becomes “concentrated” in the hands of the top 10%. One is to hold the population steady and give the top 10% more money. The other is to allow the population to grow and expand AND make sure that population responsible for the growth is poor.

    Dirt poor.

    Who might be dirt poor and expanding our population?

    Just after immigration exploded in the US, the wealth appears to trend towards the top 10%. I suggest that as millions of poor, bone crushingly poor, immigrants come to America, the numbers are skewed.

    Next the second: The GINI

    We WANT to create a system where the successful are rewarded. When you begin to transfer too much wealth you become like Greece.

    Move on to the third: There is significant tax revenue that can be gained relatively easily, and likely with little harm to the economy.

    There are very VERY few things that the government can do more efficiently than the private sector. Removing money from that sector is done at a loss to the economy.

    Finally the fourth: Taxing the rich.

    You can’t tax your way out of this. The rich simply don’t have enough money to get you out of the hole we’ve dug ourselves in. They simply don’t have it.

    An easier method would be to forbid government to grow anymore than 2% annually. That’s it. Just grow slower than the economy.

    Balanced in a matter years.

    • #4 by pino on April 13, 2011 - 03:10

      Hmm…my graph failed to make it through.

      Scott, can you edit it in?

  4. #5 by renaissanceguy on April 13, 2011 - 09:28

    Why does everyone forget that there are two parts to a budget–the income and the expenditures. Cut the expenditures!

  5. #6 by Scott Erb on April 13, 2011 - 12:10

    RG: my post calls for cuts in spending and tax increases. Only by doing both will the budget be fixed, that’s political reality and that’s how the numbers work out.

    Pino, it’s not success that’s rewarded in the US these days, but wealth. That’s why the income of the top 1% has gone up nearly 300% in the last 30 years, 95% for the top 20%, 25% for the middle (40-60% – average earners) and only 16% for the bottom fifth. The increase in wealth started around 1980. At that time debt was 30% of GDP, by 1990 it was 60% of GDP. We took a very wrong turn in the 80s and now have a crisis that is 30 years in the making. While I would argue that we’ve become almost third world in how wealth is distributed here (and that it doesn’t reward true work and innovation), at this point I’m simply pointing out, with empirical examples, that the wealthy can afford to pay a bit more to help us out of this crisis. Our wealthy are the least taxed and most well off of any in the advanced industrialized world.

    Germany, whose Gini index after taxes and transfers is only .30, is handling the recession better than we are, showing growth and economic vibrance. So the comparison with Greece is totally off base. Successful states are ones that take care of their middle class; we don’t. One reason is that Germany didn’t de-regulate to the point that the middle class started to disappear and manufacturing died. They still produce and have a current account surplus. I don’t think Americans realize just how bad our economy has been devasted by 30 years of bi-partisan mismanagement. We’re looking at a real decline and perhaps a collapse here if common sense doesn’t prevail. This is NOT caused by immigration — immigration if anything helped the US economy in the 90s. This is a broad based problem.

    One big problem is too much faith that the market does things better. It does a lot of things right, but unregulated it can lead to massive failures. We need a public sphere — if it’s too much “private sector” then wealth rules, wealth takes care of itself, and the public ends up losing out. That’s what’s brought our country to the verge of economic crisis. Markets are not magic. Unregulated, they can be train wrecks.

    • #7 by pino on April 13, 2011 - 15:57

      Pino, it’s not success that’s rewarded in the US these days, but wealth.

      Of course success is rewarded. It’s how the son of a teacher has moved up the decile chart over the course of 25 years.

      That’s why the income of the top 1% has gone up nearly 300% in the last 30 years,

      You are making a common mistake. It’s not the same 1%. It’s not like the rich guy today is the same rich guy tomorrow. And MORE important to realize is that the poor guy today is not the same poor guy tomorrow.

      When an immigrant population as massive as we have seen comes to the country with no mone-literally no money, that begins to impact how “rich” the bottom of the decile chart is. We forget that today’s poor move up that ladder steadily over their lives.

      Germany, whose Gini index after taxes and transfers is only .30, is handling the recession better than we are, showing growth and economic vibrance.

      The fact that Germany’s GINI is low has as much to do with the fact they are handling the recession well as does the fact that they speak German.

      We’re looking at a real decline and perhaps a collapse here if common sense doesn’t prevail.

      Agreed.

      This is NOT caused by immigration — immigration if anything helped the US economy in the 90s. This is a broad based problem.

      I agree. Immigration is an economic engine. However, immigration does account for some of the GINI score. But we’re not in trouble because of some made up alarm in the difference between the rich and the poor. We’re in trouble because we spend far FAR too much money.

      Markets are not magic.

      Agreed. They are very scientific machines that are well understood.

      Unregulated, they can be train wrecks.

      If you mean “regulated” in terms of ensuring no fraud, coercion or theft, then I agree.

  6. #8 by Scott Erb on April 13, 2011 - 16:04

    I think you’re wrong about the top 1% not being the same. The data suggests there isn’t a lot of upward mobility in the US. It happens, but you can’t argue from a few examples that it’s common. Here’s a study that was more comprehensive:

    http://www.americanprogress.org/issues/2006/04/b1579981.html

    You can link the full report from that page. As you can see, upward mobility in the US is very low, lower than in countries like France which have more taxation and regulation. Germany’s performance has little to do with the recession and a lot to do with their social welfare system. Remember: Germany starts pre-tax and transfer at a rate worse than the US (.51 in Germany vs. .46 in the US). That means its impossible that immigration or other factors are the cause of Germany’s final score.

    Markets are not scientific machines, and in fact can be very destructive if not regulated. The financial mess of 2008 is an example, but in general markets cannot function without considerable state support (see “The Myth of the Free Market” by Mark Martinez). Markets are influenced by power, culture, and other factors — the ‘scientific’ market is more theory than reality. That said market economies are best, and the goal of regulation, taxation and transfers should be to have optimally functioning markets and to assure true opportunity so we can actually have upward mobility rather than the myth of upward mobility.

  7. #9 by classicliberal2 on April 15, 2011 - 19:43

    Limiting Medicare payments isn’t a “reform”; it is, like raising the retirement age, just sadism. You can’t fix the problem with Medicare (and Medicaid with the states) by tampering with the program itself. All you can do is grave injury to those who depend on it. Medicare’s far-too-low reimbursement rates, in fact, are already a major problem for those who use it. The rising cost of Medicare (and Medicaid), on the other hand, is a consequence of the rising cost of health care. There’s no way to fix it if that isn’t addressed.

    Paul Ryan is a third-rate party hack, and I wish the press would spend as much time outlining the actual details of his big “roadmap” as they do swooning over him and puffing up the absolutely ludicrous notion that he’s some sort of responsible, “adult” statesman. His “plan” is some of the ugliest, most naked class warfare the party has ever attempted in public.

    • #10 by classicliberal2 on April 15, 2011 - 19:45

      And another thing (since I hit “post” before I was finished): You’re absolutely right about this:

      “Ultimately our problems are not that severe.”

      I wish that fact got a lot more play, as well.

  8. #11 by brucetheeconomist on April 15, 2011 - 23:11

    On the effect of immigration on the Gini. It seems this assumes dirt poor immigrants. Is that true mostly for illegal immigrants, and are they even being fully picked up in the statistics? I doubt it.

  9. #12 by Faisal on April 17, 2011 - 14:33

    It’s the rich regulating the tax, that’s the reason they adjust so that increase in percentage does no harm to them

  10. #13 by Student on November 9, 2012 - 08:29

    Hello! I just wonder if that map is for the gini coefficient after taxes or pre taxes? I would be very grateful for an answer! I got the impression that it is after taxes, but can’t find it stated anywhere.

    • #14 by Scott Erb on November 9, 2012 - 09:06

      The map seems to be before taxes and transfers. I couldn’t find good comparisons between OECD states and non-OECD states concerning comparisons after taxes and transfers. I think non-OECD states transfer less wealth than OECD states.

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