I had the opportunity to see Tim Noah speak last night about his new book The Great Divergence. It’s a book-length version of his Slate series on the rise of income inequality since 1979, and I’m not sure that there’s a whole lot different in the book, other than it’s in print rather than on a website or in a PDF, and that there’s a “solutions” chapter that Noah worked hard last night to disclaim (although he did the right thing by assembling solutions that would actually work, rather than solutions that were politically feasible at the present time).
Noah basically attributes the growth of income inequality since 1979, a time frame in which it has doubled, to the decline of the labor movement, a modicum of structural and technological factors, and the rise of Big Finance and runaway executive compensation. One audience member asked whether the massive reduction in tax rates contributed to this. After all, the timing lines up pretty well: in 1981, Ronald Reagan took the top marginal tax rate from 70% to 28%, and it has settled at 35%. What’s more, taxes on things like capital gains and dividends have been slashed over this time as well.
Noah balked at the idea. He basically said that pre-tax income is where to look, and that explains this growth. Noah addressed some of this in part 8 of his inequality series at Slate (I haven’t read the book).
While I appreciate Noah’s work, I just think he’s wrong in this case, and that the analysis ignores the relationship between tax policy and compensation. It’s clear that something happened in corporate boardrooms around the 1970s and through to today, where they decided to give their CEOs massive amounts of money through salary and stock options. And why is that? Well, the fact that the top marginal tax rate had been cut in half, so more of that compensation would actually go to the individual, has to have something to do with that. Boards are basically puppets for the corporation, and they know their backs will get scratched if they rise to an executive position. So it’s a mutually beneficial situation. And if the money they designate in pay packages gets to the target rather than the government, they have all the incentive in the world to expand it more and more. This is true on income and on capital gains taxes, which is why you see executive stock packages explode during this period.
The fact is that Americans paid the lowest tax rate in 30 years to the federal government in 2009. So executives get the signal very strongly – the top rates have been slashed, so it’s time to take more out of their companies in the form of compensation. When top marginal rates were high, it made more sense to grow the company, rather than give yourself more money, large sums of which would just revert to the federal government.
This just seems elemental to me. The flattening of the top end of the tax code, even as the tax code has grown more progressive at the bottom with the advent of the Earned Income Tax Credit, surely plays a role in the runaway compensation at the top, which leads to income inequality.
For history of top marginal tax rate, see here.