Economists say Obama, McCain can't do much to close wealth gap

WASHINGTON — The gap between rich and poor in America has grown bigger in recent years than any time since the 1920s, and there are no easy ways for the presidential candidates to close it.

Barack Obama and John McCain both say their economic plans can narrow the income gap, and although Obama's tax plan offers a classic way to do that by raising taxes on the rich, economists think neither is likely to bring dramatic changes.

"Taxes are not going to solve the income gap problem," said Roberton Williams, principal research associate at the nonpartisan Tax Policy Center. "Nobody's going to stand for the kind of confiscatory taxes you would need."

He and others said there are many other factors affecting income — including the tumultuous financial markets, technological change, global competition, the erosion of labor unions and corporate pensions, as well as federal tax and regulatory policies. Changing those policies to reduce income inequality could involve politically difficult measures, such as higher taxes, or higher minimum wages and other subsidies.

Obama and McCain offer the kind of income strategies their political parties have been championing for years. Obama, the Democrat, sees a role for government in helping people get opportunities for education, training and work, while the wealthy who benefit most from society have an obligation to contribute more to the collective good.

McCain, the Republican, espouses a version of what some call the "trickle down" theory that allows the rich to keep more of their income, on the theory that they'll invest and spend, thereby creating more jobs and wealth.

Republican loyalists argue that this concept worked well during the Reagan presidency, as the three-year tax cut that began in October 1981 helped pull the nation out of its worst recession since the Great Depression and triggered eight years of prosperity.

Democrats counter that too many lower-income earners never enjoyed the benefits of that boom, which was sustained in part by collapsing oil prices and record federal budget deficits.

Obama wants to return the two top income tax rates to pre-2001 levels in 2011 — the same rates during as the Clinton era, which saw the longest sustained economic expansion in U.S. history.

That would mean a top income-tax rate of 39.6 percent, far below the 70 percent top rate that existed until 1981, or even the 50 percent top rate of 1982-86 — not to mention the top rates of more than 90 percent that prevailed from the end of World War II until 1963.

The nation's top 1 percent of earners, those making more than $603,402 in 2008, had a 22.9 percent share of all pretax income in 2006, according to a March study by University of California-Berkeley economist Emmanuel Saez.

The top 1 percent's share of the national income pie had hovered around 9 to 10 percent from the 1950s through the 1970s, then began climbing in the 1980s. While Americans at all income levels saw their wealth increase during the 1990s, the top 1 percent's income exploded. Since George W. Bush became president, their share kept growing while everyone else's income barely rose.

Obama's tax plan aims to close the income gap a bit. A Tax Policy Center analysis found that those in the lowest 20 percent of income earners, making below $18,981 a year, would see a 5.5 percent boost in after-tax income next year. Those in the top 5 percent, making above $226,918, would see after-tax income drop by 0.1 percent.

Under McCain's plan, the lowest 20 percent would see a 0.2 percent increase in after-tax income next year, while the top earners would gain 3.3 percent. Once McCain's plan is fully phased in, during 2012, the top earners would gain 5.3 percent and the lowest 0.9 percent.

After-inflation median household income last year was $50,233, according to the U.S. Census Bureau. The top 1 percent earned above $603,402, and the top 10 percent earned above $160,972, according to the Tax Policy Center.

Both candidates want to shrink an income gap between classes that widened in the early part of this decade, as the Bush administration implemented multi-trillion-dollar tax cuts in 2001 and 2003.

Saez found that from the mid-1920s to 1940, the top 10 percent of income earners had about a 45 percent share of national income. That declined to about 32.5 percent during World War II, and as government maintained its highly progressive tax structure, remained around 33 percent through the 1970s.

During the past 25 years, however, Saez said "the top (10 percent) share has increased dramatically . . . and has now regained its prewar level."

The gap closed a bit from 1993 to 2000, when Bill Clinton was president, the top two tax rates went up and the economy boomed. Saez found that real incomes grew by 2.4 percent a year for the bottom 99 percent, while the top 1 percent saw a 10.1 percent annual increase then.

Only the rich gained much during the Bush years of 2002 to 2006, however. The top 1 percent saw their real annual pretax incomes grow at an 11 percent clip, while everyone else's income grew at an annual rate of only 0.9 percent growth.

During those years, "the top 1 percent captured almost three-quarters of income growth" Saez wrote.

In recent years, the soaring financial markets and hedge funds exploiting exotic financial instruments enabled the very rich to make huge amounts of money. The current financial crisis is taking its toll.

"What's happening now in financial markets should help make the gap smaller," said Ann Owen, a former Federal Reserve Board economist and now associate professor of economics at Hamilton College in New York.

Beyond financial-market gains, Saez said, top salaries exploded in recent decades, while lower salaries didn't. Some economists say that while those results are largely market-driven and difficult to change, the income gap could narrow if the next president changes not only tax policy but also regulatory and other fiscal policies.

Income, said Tax Foundation economist Gerald Plante, can be affected by changes in the minimum wage, farm subsidies, health care and other factors.

Obama's campaign argues that his policies will build middle and lower class prosperity, notably by reining in health-care costs, providing incentives for retirement savings, making college more affordable and helping to stabilize the housing market by keeping families in their homes.

McCain's plan calls for keeping more wealth in the hands of those who earn it.

"It is a disgrace to call for America to be competitive in the global economy and then turn around and tax corporations . . . at over 35 percent," said former Republican Rep. Jack Kemp on McCain's behalf. McCain wants to cut that rate to 25 percent.

However, Williams of the Tax Policy Center was skeptical that either candidate would have much impact on shrinking the rich-poor divide.

"The bulk of the gap has been caused by pure income growth," he said, and the factors driving that are unlikely to change much anytime soon.


Saez study

Census Bureau data on household income

Tax Policy Center analysis of candidates' tax plans


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