The Simple Rules of Wealth Inequality

A great deal of confusion surrounds America’s extreme inequality, what causes this inequality, and how we can check and then reverse it.

That needn’t be. Ultimately, economic inequality comes down to the concentration of wealth at the top, and we can explain the dynamics of that concentration in a few simple rules — and one not so simple, but understandable, computation.

Rule One: For those at the top, every tax is a wealth tax.

In America, we have many types of taxes. We have income taxes, sales taxes, excise taxes, property taxes, and estate taxes. For most of us, how we’re taxed matters. Sales taxes impact our spending decisions. Income taxes impact how hard we work, how much we save, and when we retire.

For those at the top, the type of tax doesn’t matter so much. From the perspective of the wealthy, every tax amounts to a wealth tax. Why should that be the case? Income, sales, and other existing taxes don’t particularly influence the spending decisions the wealthy make or such mundane judgments — to them — as how many hours they work, when they may be able to retire, or whether they need the additional income from a spouse’s job.

Our existing taxes only impact the wealth of our ultra-wealthy. Tax payments, to be more specific, only determine how fast or how slow the wealth of the wealthy grows.

Rule Two: Wealth concentrates at the top when we have insufficiently taxed wealth.

Thomas Piketty’s best-selling book, Capital in the Twenty-First Century, has one core takeaway, the simple notion that the wealth of those at the top will grow at a rate faster than the rate of growth for a nation’s overall wealth, unless taxes on the wealthy reach a sufficiently high level.

The reason? The super-wealthy have built-in advantages over the rest of us when it comes to growing wealth. They hire professionals to manage their investments. They have the financial wherewithal to make high-yielding investments — provide the seed money for a promising start-up, for instance — that the rest of us don’t have the resources to make. And the living expenses of the ultra-wealthy consume only a tiny portion of their wealth compared to the rest of us.

Only stiff taxation on the rich can level the wealth accumulation playing field.

Rule Three: Wealth doesn’t concentrate when the rich pay their fair share of taxes.

Politicians and pundits often tell us that the rich must pay their fair share of tax. Nobody disputes that point. The dispute centers on how we define “fair share.”

Let’s start our defining here: Society suffers when wealth continually concentrates at the top. If the rich are increasing their wealth at a rate faster than society at large, the concentration will continue. Inequality will become more extreme, to the detriment of most all members of that society.

So when are the rich paying their fair share in tax? They’re paying that fair share when wealth is no longer concentrating at the top. Over the past four decades, unfortunately, American tax policy has offered a shining example of the exact opposite. We’ve had a tax system that has sped the concentration of wealth. Since 1980, our tax policy in the United States has taxed work more and wealth less. As a direct result, taxes on America’s wealthy have declined dramatically.

A recent Institute for Policy Studies briefing paper estimates that billionaire tax payments, as a percentage of their wealth, have dropped by an astounding 79 percent since 1980.

We can, fortunately, measure how tax policy is impacting wealth concentration and, in the process, estimate how far short of “fair share” the taxes rich people pay end up falling.

Suppose the aggregate wealth of a nation doubles over a given period and, during that same period, the wealth of the nation’s topmost group — say the top .01 percent — quadruples. Without knowing anything else, we’d know that the top .01 percent’s share of that nation’s wealth has doubled over that period. Similarly, if the wealth of the nation’s top .01 percent had increased eight-fold while the country’s aggregate wealth merely doubled, we’d know that the wealth share of that nation’s top .01 percent had quadrupled.

That’s roughly what happened in America over the last four decades. In 2018, the wealth of the average American ran about 8.4 times the wealth of the average American in 1980. But the wealth of the average top .01 percenter in 2018 ran 35 times the top .01 percenter average in 1980. Do the division: 35 divided by 8.4 matches up to slightly more than a four-fold increase in the wealth share of the top .01 percent: from 2.3 percent in 1980 to 9.6 percent in 2018.

That’s runaway wealth concentration — and increasingly extreme inequality — in action.

Things didn’t have to work out that way. They would have not worked out that way if we taxed the wealthy more heavily.

Between 1950 and 1980, we did tax the wealthy more heavily. The wealth of the average American in 1980 ran approximately five and a half times the wealth of the average American in 1950. The wealth of the average top .01 percenter in 1980, meanwhile, also ran about five and a half times the wealth of the average top .01 percenter in 1950. The end result: Top .01 percenters had the same share of the nation’s wealth in 1980 as they had in 1950: 2.3 percent.

At that level of wealth concentration, the average top .01 percenter held about 230 times as much wealth as the average American. In dollar terms today, a 2.3 percent wealth share for the top .01 percent would have fewer than 13,000 households sharing over $2.5 trillion in wealth, an average wealth of approximately $200 million per household.

American society found that level of wealth concentration far from ideal, but tolerable. The more than four-fold increase in wealth concentration since 1980, by contrast, has been intolerable.

How did that transformation occur? America’s tax policy changed radically. After three full decades at the “fair share rate”, the tax payments required of America’s wealthiest dropped precipitously. The taxes paid by top .01 percenters, as a percentage of their wealth, dropped more than four percentage points below the fair share rate — the rate that would have prevented American wealth from concentrating at the top.

Put another way, tax policy in America between 1950 and 1980 kept wealth of the average member of the top .01 percent at 230 times the net worth of the average American. Then, changes in tax policy allowed the wealth of America’s average top .01 percenter to increase to 960 times the wealth of the average American.

If we’re ever going to stop — and reverse — America’s extreme inequality, the radical tax policies of the past four decades must change and must change soon.

Phoenix attorney Bob Lord, an Institute for Policy Studies associate fellow, has practiced tax law for most all of the years since 1980.