How should America deal with Income Inequality?

MCT Campus

Over the last twenty years the gap between the wealthy and the impoverished has continued to widen

Robeal Tesfamichael, Staff Writer

In two opposing articles, Authors Timothy Noah and Richard Epstein differ in how they believe taxation should be enforced in the economy.

I believe, along with Noah, that Epstein’s assertion that a flat tax being best for the economy is false and there is multitude of points he made that Noah can refute. Since the economic collapse that occurred in 2007 Epstein claims that the progressive tax has decreased the contribution of the wealthy and made them less likely to engage in investment and spending during a recession in which the economy should be dependent on the rich to create wealth. Epstein illustrates his claim using statistics.

“In 2009, the top one percent of tax returns paid 36.7% of all federal individual income taxes and earned 16.9% of adjusted gross income…compared to 2008 when those figures were 38% and 20%, respectively,” Epstein said. With these figures being the lowest since 2003, Epstein was able to depict the strong dependence on high-income earners to fund the transfer system during the recession to further the notion that a flat tax is the best approach to increasing economic growth being that with lower tax rates the wealthy will have far more ability to invest and spend in the economy which immediately lead to growth.

However, Timothy Noah can display the unfairness behind Epstein’s point by revealing how the economic collapse occurred in the first place. National Public Radio originally reported a story called the “Giant Pool of Money,” in which Alex Blumberg and Adam Davidson explored some of the triggers creating the housing crisis that ultimately led to the recession. During September 25th, 2009 “This American Life” (radio show) later updated the previous report, calling it “Return to the Giant Pool of Money.” Radio host, Ira Glass, interviews Adam Davidson and reviews the original story along with updates from those that gave their experiences in the original broadcast.

The giant pool of money refers to the worlds saving’s; this money is watched over and controlled by individuals from multiple countries including the United States, China, India, Saudi Arabia, Abu Dhabi etc. Investment managers for the giant pool of money sought only to grow the amount strictly through safe investments as they didn’t want to risk losing any of the money. ”The government lowered its federal interest rate to one percent on one of their favorite safe investments, treasury bonds, and in doing so rendered it non-profitable.” Davidson said.

Management investors of the giant pool of money decided to move onto, what they thought would be, a new low-risk investment: residential mortgages from the U.S housing market. This occurred due to the ongoing process of individuals receiving mortgages from brokers, brokers selling the mortgages to small banks, and the small banks selling the mortgages to the investment firm at wall-street. Wall-Street would, quote, “accumulate thousands of mortgage checks from small banks in a matter of months and since mortgages typically last around twenty to thirty years, they could expect checks to continue to arrive for years,” Davidson said. Wall-Street would then regularly sell shares of their loan-backed securities (in this case it’s also called “mortgage-backed securities”) to investors, including those in charge of the giant pool of money.

Earlier on, wall-street would only buy mortgages that were safe but by the year 2003 the vast majority of people that were qualified and capable of acquiring a mortgage had received them. The demand for mortgage-backed securities from investors was rising as the supply for it was becoming harder to come by; now in the midst of a shortage of securities wall-street needed to find a way to buy more mortgages from small banks. Also, small banks were facing much competition being that many, if not most, most banks were engaging in the same method of buying up mortgages from brokers and selling them to wall-street; because of this,, commission for bank employees began to depend on the amount of mortgages they could acquire and sell to investors. In order to lend more mortgages, bank employees began to lend money to individuals who originally would never have been qualified enough to receive a loan. This was able to transpire because the requirements for individuals to acquire loans from the bank, having been so loose and reduced, became “N.I.N.A” (No Income, No Asset) loans; banks, quote,  “no longer needed information about an individual’s financial assets in order to give loans and could now engage in extreme subprime lending. “

Due to the new guidelines, banks didn’t have to carry mortgages for decades in order to get paid back; now they would sell those mortgages to wall-street whom would sell those mortgages to the investors of the giant pool of money. With the foreclosure rate of American homes being relatively low the banks felt that the worst case scenario was for the rate to increase by ten percent which would still allow them to make a profit. However, they misunderstood the financial risk.

“A bunch of new kinds of mortgages to people who wouldn’t have qualified for them in years past their data in which the low home foreclosure rate was based on became irrelevant,” Davidson said. This was evident as the hosts of This American Life stated that by spring of 2009 the foreclosure rate had risen to almost fifty percent. Needless to say, banks suffered mightily from that mistake.  With that being said, Noah can counter Epstein’s argument that a progressive tax, since the economic collapse occurred in 2007, has shown to decrease the contribution of the wealthy from which the economy needs by illustrating the unfairness of the collapse having much to do with the rich taking advantage of the impoverished and their inability to pay for their homes in order to make themselves more money.

Epstein attempts to further his argument with the same statistics (In 2009, the top one percent of tax returns paid 36.7% of all federal individual income taxes and earned 16.9% of adjusted gross income). According to Epstein, at those rates, “if a person at the middle of the income distribution level loses a dollar in income, the federal government loses nothing in income tax revenues. Let a rich person suffer that decline and the revenue loss at the federal level is 40% with more losses at the state level” Epstein said.

If progressive taxation on the wealthy continues then taxable income at the top (the one percent) will only shrink further. Being that it’s a recession the economy at its current state makes the bottom 99% hostage to the continued success of the rich; Epstein believes this to be dangerous as the combination as the combination of high taxation schemes coupled with even more stringent regulations of labor and capital markets, quote, “spells the end of huge paydays of the top one percent.” Epstein firmly believes that undoing the current redistributionist policies by implementing a flat tax rate would be very effective as it will go a long way towards increasing growth in our heavily regulated economy.

However, Timothy Noah can refute this point as well being that the assertion that a flat tax would be pragmatic is wrong; this is because a flat tax would reinforce the trends toward greater income inequality that have been seen over the last several decades. During Noah’s article, he noted that the top 1 percent of income recipients in the United States earned 275 percent more in 2007 than they did in 1979; a period when the earnings of middle-income households grew by less than 40 percent. A flat tax would increase inequality by significantly reducing rates on the most prosperous households, while increasing them on low and middle-income households.

Also, income inequality leads to wasted potential for families who can’t afford give their children an education. According to Martha Bailey of the National Bureau of Economic Research, “The gaps in postsecondary education between the children of low- and high-income families have been widening…..for low-income children, college completion rates increased only 4 percentage points between the generation born in the early 1960s and the one born in the early 1980s. Among high-income children, however, the improvement was 18 percentage points,” Bailey said. Flat taxes being problematic isn’t to deny that our current tax system is dysfunctional but to show that what works for the one percent doesn’t work for the vast majority of Americans.

The recession created the legislative pressures that shaped Epstein’s argument. In order to alleviate the burdens placed on the middle class the government elected to enforce a progressive tax; however, with the economy at its current state Epstein believes it to be counterproductive to do so being that the United States transfer system was becoming increasingly dependent on the wealthy which would inevitably dissuade the rich to invest and spend. Since the rich were needed to create wealth for an economy in the midst of a recession, Epstein believed it to make sense that they shouldn’t have high taxes placed on them.

Despite this Timothy Noah can refute this point simply because the legislation that works for the one percent doesn’t end up well for the vast majority of American citizens. This is because between 1979 and 2007 (before the economic collapse) the earnings for the top one percent of America had increased by 275% as opposed to the income earnings of the middle class which only grew by 40%.  A return to the flat tax would undoubtedly increase the income inequality disparity between the rich and the poor.  Ultimately, there doesn’t seem to be a definitive approach that would make both the wealthy and middle class happy while benefiting the economy.