Fairness, Obama and Income Redistribution

President Obama is going to Kansas today to deliver a speech about "fairness" in our society. It is a remarkably bad bit of political theater. The Kansas locale was chosen because about 100 years ago, president Theodore Roosevelt spoke at the same location on the same theme. Apparently, the political gurus at the White House think that someone other than three history professors will care that Teddy Roosevelt once spoke about fairness at that location.

Asid from the politics of it, however, Obama's speech is remarkable in its dishonesty. The theme today is that income in our society is unfairly distributed as a result of the supposed increasing concentration of wealth in the top 1% to use the Occupy Wall Street number. Despite the fact that we have all been told over and over again about this increasing concentration of wealth, it turns out that this is just not true. Indeed, the explanation for this is set forth in a remarkable article in the Wall Street Journal by Alan Reynolds of the Cato Institute. (That article is well worth reading in its entirety and can be reached by clicking on the title to this post.)

Reynolds makes a number of points. First, he takes on the accepted wisdom on the percentage of income received by the 1%. According to the Congressional Budget Office the share of income received by the 1% grew from 8% in 1979 to 17% in 2007. That's pretty dramatic, right? Reynolds, however, points out that the report requested by Obama and the Obamacrats stopped in 2007, and he questions why that it. In fact, if one measures this same figure in 2009, the 1% got only 11% of income, a decline of more than a third in just two years. The reason, of course, is that the bulk of the income of the wealthy comes from capital gains, interest, dividends and small business income, categories that were severely hurt by the recession.

Reynolds, however, does not stop there. He goes back and looks at the various tax changes that account for the rise in income percentage from 8% to 11% for the top 1%. In 1987, small business owners were allowed to report income for that business on their own tax returns by becoming subchapter S corporations. This shifted enormous sums that used to be reported as corporate income to personal income. Between 1986 and 1988, the portion of income for the 1% that came from small business doubled. This change alone accounts for more than a third of the overall increase from 1979 to 2009.

Another tax shift that raised the percentage of the 1% was the drop in capital gains taxation. In 1979, capital gains were more than three times higher than they are today. In the intervening years, each time that the capital gains tax was cut, the amount of income from capital gains reported rose dramatically. This makes sense. Back in 1979, folks were hesitant to sell properties or other capital assets because they would lose half the gain to taxes. Now, capital gains taxes plays a very small part in determining whether or not to sell. Taking the tax issue out of the decision is a very good thing for the economy. It allows capital to be used much more efficiently. It also means that there is a boost in the reported income of the 1% just because assets turn over more frequently. In reality, however, this increase is not due to any change in the fairness of income distribution, just instead to a change in behavior caused by taxes.

Another change in taxes was the cut in dividend taxation. With the cap of 15% on dividends, there has been a marked increase in income from dividends. Back in 1979, the top 1% put more of its assets into tax free investments like municipal bonds and less in stock that paid dividends. Back then, the tax rate for dividends was 70%, so there was no point in buying stock for income. All of this additional money in stocks raised the value of all companies. These higher stock prices mean capital gains for everyone and higher tax revenues overall. Again, this switch from tax free investments in 1979 to taxable investments in 2009 is another reason for the increase in the percentage of income received by the 1%.

So, it seems that there has been very little real change in income distribution since 1979; the reported change is due to modifications in the tax code that shifted the income around. In other words, there is no truth in Obama's claim that fairness has been diminished.

Going further, Obama's premise gets even weaker. Of the twenty largest economies in the world, which one has the most progressive tax system? In other words, in which of the countries that make up the bulk of the world's economy do the richest 1% pay the highest percentage of taxes? The answer is the USA. That's right, we have the most progressive tax code, the rich pay more here relative to the poor than anywhere else. So if things are unfair in the USA as Obama will claim later today, they are much worse everywhere else in the world.

Maybe next time Obama gives a big speech, he can go to Mount Vernon in Virginia and speak about the benefits of telling the truth. After all, George Washington spoke there about that cherry tree.