Wednesday, July 14, 2010

Of Quintiles and Gaps

I was reviewing the 2007 household income & tax tables from the CBO.

Let me start by saying that federal government spending needs to be gotten under control and reduced. The federal government has to learn that it can’t spend money it doesn’t have and we would all like to have more of our money to spend. I say “our money” because every dollar generated in this economy is the result of someone’s hard work.

However, that is a problem that cannot be resolved without also reforming the tax code. The basic problem in the U.S. today is the growing disparity between the wealthiest households and everyone else.

Let’s consider a few numbers (all dollar amounts are in 2007 dollars so everything is adjusted for inflation.)

In 1979, the boundary between the lowest quintile of households and the 2nd quintile was $17,400 in minimum adjusted income. Minimum adjusted income is total household income divided by the square root of the number of people in the household. So for a household of 4 to be in the 2nd quintile would require a pre-tax income of $17,400*2 = $34,800.

In 1979 the boundary between the 2nd quintile and the 3rd was $27,600, between the 3rd and the 4th $37,900 and between the 4th and the 5th $52,800.

So in 1979, in order to be in the top quintile, a family of 4 would have to have a household income of $105,600. The boundary into the top 1% in 1979 was $167,500 so a family of 4 would need a household income of $335,000 to be in the top 1%.

Now the good news is that since 1979, the boundaries for all quintiles and the top 1% have increased. That means everyone has more money to spend. A “fair” share of the increase would mean approximately the same percentage increase for everyone. Mathematics being what it is, that would mean that the top brackets would still gain more dollars than anyone else because they started out with more.

Assume for a moment that all increases were equal to the percentage gain experienced for the boundary into the middle quintile (the 3rd) since 1979 which was 24.3%. The gap in real dollars between the 2nd quintile boundary and all the others would still have increased.

For example, in 1979 the gap between the boundary into the 2nd quintile and the 5th quintile was $35,400. If both groups had grown at the same percentage of 24.3%, by 2007 the gap would have grown to $43,993.

In 1979 the gap between the boundary into 2nd quintile and the top 1% was $150,100. If both groups had grown at the same percentage of 24.3%, by 2007 the gap would have grown to $186,537. That’s a lot of money.

Yes these are big differences, but relative to where things started, this is actually a fair distribution of the increased prosperity.

Now some people would argue that this in fact isn’t fair and that the lower quintile boundaries should have gone up by a higher percentage in order to keep the gaps from growing so much. I sort of agree with that but I’d settle for everyone benefitting by the same percentage.

However that’s not what happened. What happened is that the boundaries grew by different percentages and do I have to tell you which grew by the larger percentages?

The 2nd quintile boundary grew by 17.8%, the 3rd by 24.3%, the 4th by 41.5%, the 5th by 52.4% and the boundary into the top 1% by a whopping 110.7%.

This is an unfair distribution of the increased prosperity.

The gap between the 2nd quintile and the 5th quintile grew from $35,400 to $54,200 and between the 2nd quintile and the top 1% grew to $332,400.

Now what do you think is going to happen when we reduce federal spending? Guess who’s going to get an unfair share of the money being saved? For you Tea Party types, try real hard now, you can do it.

In parallel with reducing government spending we desperately need to reform the tax code so that the benefit of the reduced spending falls more upon the lower income quintiles than the higher income ones. As a matter of fact, I don’t see why the highest quintile needs any tax reduction at all.

If you want to restore a healthy robust economy this is how you do it. Why you ask? Because the households in the lowest four quintiles have a much higher propensity to consume (in other words they’re going to spend the money) and they’re most likely to spend it locally. This would strengthen small businesses in towns and cities all over the country rather than having the money invested in large corporations or, worst of all, in foreign countries.

You will hear every right wing wacko telling you this is Socialism. Oh my god, the “S” word. Quick, let’s all go run under our beds while the working and middle classes get their pockets picked again. Ignore those assholes; this is what needs to be done.

Ignore the Supply Side types as well. They’ll tell you that we should cut taxes more for the upper quintile because they’ll invest the money and it will “trickle down” and create jobs. Like daddy George H.W. Bush, and just about every real economist has said, this is voodoo economics. Trickle down my ass. Give the working stiffs the money, let them spend it at local small businesses and let the prosperity trickle up. That is how you build a strong economy.

Now, in case you’re thinking that somehow using quintile boundaries is some kind of trick, let’s quickly consider average pre-tax income.

In 1979, the average pre-tax income for the lowest quintile, the 1st, was $16,600, for the highest quintile, the 5th, it was $140,300 and for the top 1% it was $550,000. So the gap between the 1st and the 5th was $123,700 and between the 1st and the top 1% was $533,400.

By 2007 those gaps had grown to $246,300 and $1,854,600 respectively. Now let’s look at the percentages. The average income of the 1st quintile grew by 10.8%; the income for the 5th quintile grew by 88.7% and the income for the top 1% by 240.5%.

For the other quintiles, the 2nd, 17.7%, the 3rd, 19.2% and the 4th, 28.6%. The boundaries, for a family of 4, in 2007 were, for the 2nd, $41,000, for the 3rd, $68,600, for the 4th, $100,000 and for the 5th, $149,400. In order to be in the top 1% in 2007, a family of 4 would have required a minimum adjusted income of $705,100.

Here’s the bottom line. For the past 30 years, ever since Donald Regan talked Ronald Reagan into dramatically reducing the top income tax percentages, the gap in income and wealth between the top households and everyone else has grown dangerously wide.

Those reductions did two things. First it immediately widened the already enormous gap in discretionary income between the wealthy and the not so wealthy and we all know that money begets money. The second thing it did was make unrestrained greed worthwhile!

The marginal taxed rate went from 70% in 1981, to 50% in 1982, then to 38.5% in 1986 and then to 28% in 1987. It went back up to 39.6% in 1993 and is currently at 35%.

If you want to know why you can’t pay your mortgage, why you’re maxing out your credit cards and why the very thought of college tuition makes you go into a cold sweat, this is probably it.

The disparity is utterly ridiculous. If the distribution had been fairer, far fewer people would be having the kind of money troubles that are common these days and the economy would be a hell of a lot stronger.

Something has to be done to correct this.

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