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Business News/ Opinion / Columns/  Does America have an inequality problem in need of fiscal action?

Does America have an inequality problem in need of fiscal action?

US disparities are not as bad as made out to be and a sensible monetary policy would reduce them

Photo: ReutersPremium
Photo: Reuters

In the last decade or more, the topic of inequality has occupied centre-stage in America. In August, its Congressional Budget Office (CBO) published its report on distribution of household income for 2018. It was a revelation. A problem of inequality does come through in the report, but it is vastly overstated. Second, it also shows that fiscal policy is doing its job of mitigating it considerably in the US.

Much discussion on the topic deals with pre-tax and pre-transfer incomes. What matters is that income left in the hands of households (the disposable kind) after taxes, which are transfers to the government, and transfers the other way round from the government to households are accounted for. Fiscal policy does a good job of it. For the bottom quintile, in 2018, US post-tax, post-transfer (post-T&T) income was 68% higher than the pre-T&T income. For the top quintile, post-T&T income was 30% lower than pre-T&T. Put differently, the bottom 20% pulled in 7.5% of the household income post-T&T compared to 3.8% pre-T&T. For households in the 81st to the 99th percentile, the respective proportions were 38.6% and 35.4%. For the top 1%, it was 16.6% and 13.5%. That is as it should be. Social Security transfers in America put more money in the hands of families at the bottom quintile, while taxes take money away from the top quintile.

Longer-term data starting from 1979 reveals a more interesting story. Post-T&T income for the bottom quintile increased by a cumulative 91%. The number for the middle three quintiles is 53%. The bottom quintile has done far better post-T&T than the middle three quintiles. Incomes for households between the 81st and the 99th percentile went up by 92%. Not much of a difference from the cumulative income growth of the bottom quintile. However, if we include the top 1%, that number improves to 120%. That tells us that much of the inequality debate is due to the extraordinary income growth for the top 1%. A breakdown of the top 1% into smaller groups shows us that the top one-tenth of the top 1% get the bulk of their income from capital gains, especially the top 0.01%. More specifically, for the top 0.01%, in 2018, nearly 70% of their income was capital income or gains. No surprise then that incomes in the top 0.01%, grew by a cumulative 538% from $4.9 million to $31.0 million over the past four decades.

The Gini coefficient for income after transfers and taxes is lower than the coefficient for income before transfers and taxes. This is because means-tested transfers and federal taxes in the US are progressive. Although the degree to which transfers and federal taxes reduce income inequality varies from year to year, the extent to which they have done so has increased since 1979.

In 2018, the US Gini coefficient for income after transfers and taxes was 0.437—that is, 0.084 less than what the Gini coefficient was for income before transfers and taxes. That reduction in inequality was larger than in 1979, when transfers and federal taxes reduced the Gini coefficient by 0.060, from 0.412 to 0.352.

What we have learnt so far is that American fiscal policy, far from broken, has been doing its job. More gratifyingly, it has been doing this better in the recent past than in the distant past. The real issue is faster income growth for the top 1% and the top 0.01%. Income from capital and capital gains along with business income have contributed to this (it is up seven-fold since 1979).

That is evident in US data on wealth inequality ( The median wealth of high-school drop-outs was $45,000 in 1989. The median wealth of those with a post-graduate degree was $369,000. A factor of eight. Fast forward to 2019 and the numbers were $18,000 and $484,000.

If we combine the two sets of data—on wealth inequality and income from capital—solutions present themselves. The culprit is not tax cuts, but American monetary policy. Since 2008, it has blown asset-price bubbles, putting more income via capital gains and hence wealth in the hands of its educated elites and the wealthiest among the wealthy. Its response to the pandemic would have worsened wealth inequality further. Now, if the US government chooses a Fed chairperson who is more inclined to persist with accommodative monetary policies or make it easier at the slightest pretext, then the US central bank would continue to enrich the rich further. Far-sighted leadership at the Federal Reserve would restore health to the US economy and distributional fairness to American society.

The second thing is access to higher education. Higher education in the country has become progressively more expensive. Legacy admissions too are a big part of the problem. Making higher education affordable and inclusive would work. Third, the taxation of capital gains would need a fresh look in America. This is so in many developing countries too. Countries will need to decide if capital needs to be incentivized with a lower tax rate, and if so, how patient should that capital be for it to be rewarded with a lower tax rate.

In short, there is nothing systemic about American inequality. Fixing its monetary policy would fix it. But who will bell the cat?

V. Anantha Nageswaran is visiting distinguished professor of economics at Krea University. These are the author’s personal views.

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Published: 22 Nov 2021, 09:58 PM IST
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