Income inequality: government, Warren Buffett and growth

By Chrystia Freeland
November 30, 2012

When Branko Milanovic, a World Bank economist, published “The Haves and the Have-Nots,” a study of global income inequality last year, one of his most striking observations was the extent to which the subject was taboo in the United States.

As Milanovic explained, “I was once told by the head of a prestigious think tank in Washington, D.C., that the think tank’s board was very unlikely to fund any work that had ‘income’ or ‘wealth inequality’ in its title. Yes, they would finance anything to do with poverty alleviation, but inequality was an altogether different matter.”

“Why?” Milanovic asked. “Because ‘my’ concern with the poverty of some people actually projects me in a very nice, warm glow: I am ready to use my money to help them. Charity is a good thing; a lot of egos are boosted by it, and many ethical points earned even when only tiny amounts are given to the poor. But inequality is different: Every mention of it raises, in fact, the issue of the appropriateness or legitimacy of my income.”

I recalled Milanovic’s remarks this week when I found myself on a panel at the Brookings Institution, one of those Washington research groups, discussing income inequality, including the research collected in a new book published by Brookings titled “Inequality in America.” In reply, Kemal Dervis, the vice president of Brookings, who co-wrote the book and led the panel, joked that if he turns up on the job market next month, we will know he overstepped the mark.

It was a characteristically polished line – Dervis is a former Turkish cabinet minister – but the truth is that the Brookings event was a sign of the recent sea change in the U.S. public discourse about income inequality.

As recently as this summer, it still seemed like Americans were allergic to any explicit discussion of income inequality. That was the reasoning of Republicans and of many previously nonpartisan wealthy businessmen who responded to President Barack Obama’s call for higher taxes on millionaires and billionaires with accusations of class war.

But at the polls in November, something surprising, at least for the Romney strategists, happened. A very muted, democratic version of class war was fought, and the lower classes won. As Mitt Romney put it in a conference call with his donors after the vote, a coalition of less well-off Americans re-elected Obama because he promised to use government to improve their lot.

Even the patriarch of American capitalists, Warren E. Buffett, has decided it is OK to talk about income inequality. In an op-ed in the New York Times and the International Herald Tribune this week, Buffett pointed out that the wealth of the 400 richest Americans has increased more than fivefold over the past 20 years. As Buffett put it, “My gang has been leaving the middle class in the dust.”

The Brookings panel confirmed that assessment and offered three important takeaways about the causes and consequences of rising income inequality. One was that government matters. Like most students of the subject, the assembled economists agreed that rising inequality was driven partly by economic forces like the technology revolution and globalization.

But the state can choose to mute the impact of the invisible hand. Paradoxically, in much of the Western world, and particularly in the United States, even as the power of these economic shifts has become more profound, government efforts to mitigate them have become weaker. As Buffett pointed out, the effective tax rate paid by the 400 top earners in 1992 was 26.4 percent. By 2009, it had fallen to 19.9 percent – even as the pretax gap between the plutocrats and everyone else had widened.

A second theme of the Brookings discussion helps to explain one reason that has happened: The economy has gone global, but nation-states have not. Higher taxes on the rich may be a logical response to rising income inequality, but actually levying those taxes is getting harder in an age of global capital flows. Buffett said it was “sickening” that rich people and companies use the Cayman Islands to lower their tax bills, but moral outrage is a weak weapon against international tax arbitrage.

If you are still not convinced that all this matters, consider the third, and most striking, possibility raised at the Brookings panel. Set aside any moral or political concerns you may have about rising income inequality – worries about poverty, justice, undue political influence or even social mobility.

According to Dervis, and the research collected in “Inequality in America,” a growing number of economists suspect that once inequality passes a certain point, it may jeopardize economic stability and economic growth.

As the book argues, “rebalancing of the distribution of income may play a role in unlocking the U.S. economy’s growth potential in a sustainable way.”

Now that is a truly radical thought, and it brings us back to Milanovic’s earlier view that income inequality was a forbidden subject in the United States.

Worrying about the poor is one thing. To contend that equality is necessary for growth is an altogether different and more radical idea. Three decades later, trickle-down economics has met its antithesis. We are set for one of the great battles of ideas of our time.

33 comments

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I think part of the sensitivity on the topic of income inequality has to do with our current fiscal shape and how it should be remedied.

We’ve got a major revenue v. spending gap, and a large segment of folks seem to believe that taxes hikes will fix the problem. The reasoning says, ‘geez, all these rich people have done so well (income inequality), let’s fix the problem by raising their taxes.’

Net net, taxes are most likely going up, but all the tax hikes in the world aren’t going to close the gap. I think a lot of rich folks would pay more taxes if coupled with spending cuts. Looking at future revenue and spending projections, the spending curve is the scary one.

Posted by jambrytay | Report as abusive

Absent the economic number crunching, the underlying theory seems to make sense. At higher incomes a greater percentage of outgo goes towards “investment” rather than purchases. However, much of this “investment” is merely offsetting accounting entries. Purchasing Apple stock on the NASDAQ doesn’t give Apple any money to invest; it merely transfers share and cash balances between two third party accounts.

Ultimately, a thousand middle class people buying a thousand Fords does a lot more for the economy than a millionaire buying a thousand shares of Ford.

Posted by Hildy | Report as abusive

Ms Freeland writes another interesting, thought-provoking piece. I think it’s fair to say that, at least empirically, income equality promotes economic growth better than supply-side economics, which actually foments economic inequality. I mean, we’ve had trickle-down policies in place now for about 3 decades and for about 3 decades the gap between the rich and everyone else has been growing into a chasm. How much more “experimenting” can our economy take?

The über-rich’s insistence on squelching any open discussion of income inequality should be seen as a signal telling us that it’s ever more important that we do have such a public discussion, without the plutocrats mucking up the conversation with propaganda promoting their point-of-view without any promotion of the opposing point-of-view.

Just yesterday I was alarmed to see an ad encouraging people to tell their legislators to oppose raising taxes on stock dividends. It portrayed a retired, Middle Class, elderly couple fretting over the possibility that the government is considering raising taxes on what is suggested to be a primary source of their income, stock dividends. However, the truth is that there is a relatively small number of very wealthy people who represent those who would be most affected by such a tax hike, but certainly not in any way that might threaten their way of life, as that commercial suggests.

I won’t allow myself to forget hearing Mitt Romney say that discussions regarding the distribution of wealth should be reserved for quiet rooms. That says it all.

Posted by flashrooster | Report as abusive

It should not be radical to suggest that if median – not just average/mean – wages are higher, the country will do better economically? In fact it would be common sense if not for the religious belief that markets know best.

How many foreign properties and yachts and luxury goods do a family of four earning $20K a year possess? That should be all we need to know to see why the idea of equality and growth rising together makes sense.

Thanks for the article Chrystia!

Posted by Benny27 | Report as abusive

We have all these brilliant academics asking questions and doing studies – but if they knew that people in a majority of cases make independent decisions that create their lot in life. Government seizing the money and trying to redistribute it – just move the decision out of their hands into an organization ripe with political power, cronyism and incompetence.
There is no equality of talent or outcomes. I could be a wealthy man had I decided to take a different path. Should some people have a harder path than others – born into poverty. However – even these individuals have the opportunity to excel and do. You will always have people who make poor decisions, but handing people money does not improve there lot or self worth – it is a gift. Romney was not against improving the poor’s lot – he was against waste and fraud of the handouts – that enslave the poor. I am not edging for tax breaks for the wealthy – but this equality of incomes creates a judge that sits between the employer and employee. This purely and academic fairy tale talked about by academic idealists who have no basis in reality because they have never participated in creating commerce of any sort. Run a business if you can – that will sober this discussion up real quick.

Posted by xit007 | Report as abusive

“Re-balancing of the distribution of income” as a way to unlock growth is not a radical thought. It is a continuing process that in the past has taken place through what a think tank might have called the “underground economy.” That re-balancing mechanism stalled out as many thought it better to sit on growing piles of cash waiting for a better day to use it. There is no battle looming here in the equality of income definition. There is only the realization to awaken to that the money sitting idle is rapidly losing its ability to generate any return through normal market channels.

Posted by Anonymous | Report as abusive

Chrystia,
What Warren Buffet knows, empirically and/or instinctively is that the gains for his gang have come at the expense of everyone else.
No longer do employees participate in the productivity growth of the companies that employ them. While at the same time those companies are growing ever more prosperous their contribution to the countries that foster them have dramatically decreased.
For a capitalist society to function as a liberal democracy there needs to be a balance among the interests that business both serves and depends upon. Broadly, those interests are those of the community (customers and infrastructure), employees and shareholders.
For the last 30 or so years the interests of shareholders have taken an increasing share of the collective pie at the expense of employees and the society as a whole.
It is this imbalance that is responsible for the extremes in wealth and income inequality. Ultimately, the economy must weaken simply because people are on the whole poorer and the prospects for their futures and those of their children are greatly diminished. They can no longer afford education and productivity must inevitably suffer.
Of course a weaker economy will mean even more extreme inequality which will cause the economy to weaken further, and so on leading to an inexorable downward spiral.
Add ideologically motivated austerity programs to the mix and you have all the ingredients for serious social upheaval. Society becomes tinder box of resentment that grows more flammable with every degree of the widening of the gap between rich and everyone else. Any spark might set it off.

Posted by 14Juillet | Report as abusive

who gets to buy things? 

machines don’t buy things……….machines are designed to be slaves……..all work, no pay.

the person who owns the machinery, may be able to stash his wealth in an $80M painting……..the financier gets his slice, too

but, the worker at Walmart, can’t afford anything other than stuff at Walmart……..same for McDonald’s, et al…….

remember the adage, attributed to Henry Ford,…. he paid his workers, high enough wages to buy his product

Posted by Robertla | Report as abusive

The way those 400 richies, or any other wealthy person for that matter made their money, wasn’t just with their own sweat. They crucially needed the efforts of their workers. Yes, they might have had a good idea, or maybe just a crooked idea, but it would be impossible for them to carry it out by themselves.

Virtually all the wealthy make their money by getting a little money from a lot of people, with the help of a lot of people. We are all in this together. The workers cooperate with the wealthy, if they are given a fair deal. If they are not, if they are treated with hubris, instability will follow, i.e., all hell will break loose, and the rich will pay, even with their lives. “Let them eat cake” is not a long term option.

It is clear that anger against the rich is growing in the US. They can either listen, or push on to the next stage. Hopefully, the ballot box will be sufficient to reverse the growing inequality.

Posted by xcanada2 | Report as abusive

This is an important debate for the US to have, and long overdue! Without a robust, functioning and economically viable middle class, there is not enough horsepower to drive the economy. The wealthy need to understand this……

Posted by JohnnyRacer | Report as abusive

“a coalition of less well-off Americans re-elected Obama because he promised to use government to improve their lot.”

Isn’t this exactly what Romney and the wealthy do? That is, use the machinery of government to increase their wealth, privilege and lot? To look at these mass collections of wealth and wonder how to tax it is the wrong solution. The only way to “unlock the U.S. economy’s growth potential in a sustainable way” is to level the playing field and eliminate the system which allowed these people to amass such a fortune to begin with. That means, ultimately, ending the monopolies and regulations that keep small startups and individuals from free competition in both products and ideas.

As Bastiat said, Government is the great fiction, through which everybody endeavors to live at the expense of everybody else. Every law helps one person or party just hurts another. Even so called “equality” laws. The only way to have income equality is to have equality of liberty in all things.

Posted by LysanderTucker | Report as abusive

If this be “one of the greatest battles of our time”, it will be the final choice of the American people between our “engine of success”, capitalism, and our “engine of our destruction”, socialism. “We, the people” have already rejected communism with finality, as has most of the developed world.

To present this “issue” as a moral one is a challenge to the very fundamentals of exceptionalism that Americans have always cherished and embraced. “We, the people” accept the reality that all men and women are NOT equal.

We look around us and see the beautiful or handsome and the ugly and a majority somewhere in between. There are the young and the old and a majority somewhere in between. There are the smart and the dumb and a majority somewhere in between. There are the skilled and the unskilled a majority somewhere in between. There are the motivated and the unmotivated and a majority somewhere in between. There are the persistent and those easily discouraged and a majority somewhere in between. There are those born of wealth and those born at pubic expense a majority somewhere in between.

The mix of above “resources” in each of us at any given time largely determines how “successful” we will be in our “pursuit of happiness”. Note that our Constitution does NOT promise “happiness”, but only that we may pursue it without undue interference. Capitalism is a system that rewards “winners” and penalizes “losers”, therefore each is necessary for it to bless us with it’s bounty. It is necessary and inevitable that in the end there be people of “above average” income and “below average” income. In America, such is expected. It is just, the polar opposite of unjust.

In nature the survival of the fittest is the supreme law. “We, the people”, being sentient, have in our civil societies tempered many, but not all, related absolutes by more compassionate considerations. There is no reason to believe this will not continue.

But there is a point at which the exceptional will not put forth extra effort from which they, personally (or their families), do not benefit. There is also a point at which the slothful will cease to put forth any effort at all, content to remain ignorant, unskilled, unmotivated and indolent, subsisting at such minimal level as their society established and funds as a “floor of existence” on the sweat of others.

Think of the “points” above as the fuel and the air necessary if an engine is to run. Too much or too little fuel and the engine cannot run. Too much or too little air and the engine cannot run. So, while there is a useful range of operation between these extremes of both fuel and air, if an airplane runs out of fuel the engine stops. Without power to keep it aloft, the plane must descend and there is significant difference whether it is still “under control” or not when it reaches the ground. So an intelligent and competent “operator” is necessary.

The American economy is no different from the above. So were we to exchange “equality of opportunity”, a noble aspirational goal, for “equality of income” we commit our society to descend from where it is. Can we instead pursue “adequacy of income” as a “right”. I don’t think so. If we would be an economic “doctor”, let us “First do no harm”.

You can never expect “liberals” and “conservatives” to agree as to specifically what is a “need”, what is a “want”, and with what priority and amount each should be funded. There will never be “agreement” as to what is an “adequate income” or whether that should be “adequate” to marry, to have a family, or whether such family should be limited or unlimited in size, and to what extent there should be “government subsidy”.

You seem concerned that rising “inequality” will, at some point, result in such civil unrest as to disrupt our economy and our society. While this is undoubtedly true in the absolute sense, look around you. “We, the people” are not in the streets screaming against injustice and demanding freedom. By and large, we still have justice and freedom such that everyone is at the mall or online spending.

Posted by OneOfTheSheep | Report as abusive

I hope the Brookings discussion about income distribution (and wealth distribution) was/is nuanced enough to distinguish between simple inequality and the extreme case of it. Egalitarians have usually focused upon equality of opportunity and used outcomes as test cases to find where or how opportunity may have been unfairly manipulated or subverted, but they have not taken equality of outcomes as the goal or measure of whether a system is egalitarian. The metaphor of the “even playing field” expresses that distinction. When outcomes are extremely (or just consistently) one-sided on a broad scale (i.e., over broad groups of people or series of events), the system is almost certainly not egalitarian.

Egalitarianism is based upon the concept of justice or, in simpler terms, fairness.

Posted by bcrawf | Report as abusive

I doubt if any significant faction of the electorate is pushing for income “equality” in the literal sense. I have not heard any serious politician espousing the idea that all persons in the country should have identical incomes.

The phrase is shorthand for the notion that the distribution of wealth in this country has become obscenely, and ultimately unworkably, lopsided. What is needed is a revision of our economic and political system that is a little more fair, balanced and just, where the uber-wealthy pay in more. America had that balance not all that long ago, when executives were not earning hundreds of times more than the folks they employed (and the folks they employed could afford to buy the products they made, send their kids to college, and buy a home).

There may be a few in American politics arguing for literal income equality, but for most the phrase is short-hand for a more rational distribution of wealth, including a more rational tax system.

Posted by cutbow | Report as abusive

A consumer society can’t afford to leave too much money in too few hands. The economy slows down because too many are not able to do more than see to their immediate needs.

The economy seems to do the best when money changes hands frequently by the largest numbers.

Maybe the only attitude toward money that somehow fits the facts and history is; “you can’t take it with you” and it is very frustrating trying to hang onto it while you’re still alive.

The harder the wealthy cling to their mega incomes, the more the middle and lower income groups cling to their austerity. That situation doesn’t seem to do the wealthy any favors and it can mean life or death to those at the bottom. The bottom can become more “toxic” and can even make life very difficult for the upper tiers. If too many of the middle join the bottom, the situation can become explosive. Syria is committing suicide now. I don’t ever expect to see much good come out of what is going on there. I suspect those people are going to be living in ruins for some time. Libya is already experiencing shortages and power outages. We feed ourselves illusions about the unquestionable benefits of democracy and capitalism and forget all the less obvious conditions that must be present for the role models to work well.

The social attitudes and ethics of the upper income people is not nonpareil. In the modern global society – they don’t really know much more than the lower tiers and mega wealth doesn’t get them the exclusive social control or superior take on global issues they once enjoyed. They tend to look like overfed and rather pampered consumers but with a lot more power at their discretion and even their whims.

Every society needs some deep pockets with the heft and stamina to stand up to mob rule or excessive government control. Or so it seems to me.

But I’m 62 years old and am thinking that everything I thought was right about the world may be out of date or irrelevant now. I bought a lot of baloney in those years too and now it’s just plain embarrassing to have to reexamine it all. “Repentence” is best when you’re young. They can still do something with it.

Posted by paintcan | Report as abusive

In current times, countries with greater income inequality tend to grow faster not slower.

Posted by ar559995 | Report as abusive

An absolutely outstanding article!

Kudos to you for describing the situation in the US without any emotional hype whatsover.

When this country can reach the point where the American people can at least acknowledge that the growing inequality in wealth is a problem, we might have a chance to save this country.

However, since we can’t even acknowledge we have a “wealthy problem” and are in extreme denial it exists at all, we don’t have a prayer of saving this country.

Posted by Gordon2352 | Report as abusive

That’s all very nice and prudent, but we’re past event horizon.

Once inequality passes certain point, we have revolutions.

Posted by satori23 | Report as abusive

There was once income equality… in the USSR.

I’d prefer Obama’s idea about mutual responsibility and fairness, and historically proven fact that slavery in any form is economically disadvantageous in the end, whether this goes about American slaves in 19th century, or the modern, Chinese ones that work for two-three bucks a day to make up corporate super-profits.

Posted by UauS | Report as abusive

There was once income equality… in the USSR.

I’d prefer Obama’s idea about mutual responsibility and fairness, and historically proven fact that slavery in any form is economically disadvantageous in the end, whether this goes about American slaves in 19th century, or the modern, Chinese ones that work for two-three bucks a day to make up corporate super-profits.

Posted by UauS | Report as abusive

It is a battle the plutocrats will lose either peacefully or otherwise. Soon we could have an American “street.”

Posted by PCScipio | Report as abusive

I never hesitate to discuss or critique articles here at Reuters. The topic of income inequality is surely of interest to almost anybody alive today. This is a great article.

Today, Sunday, I just want mention the new book I just finished reading by the same Chrystia Freeland.

It’s title is,
Plutocrats: The Rise of the New Global Super-Rich and the Fall of Everyone Else.

I’ve been reading all my long life, and I must say that this book, Plutocrats, is a seminal work of our times. Page after page, from beginning to end.

Posted by AdamSmith | Report as abusive

Income inequality reminds me of what Albert Einstein wrote in his book, Thoughts and Opinions, which I can only paraphrase here.

Einstein said that it’s impossible for any human to give more to society than he/she receives.

He said that the great libraries of the world, so important to progress, are filled with books written by other people, most of whom are long dead.

He said the same for the streets and roads we travel and walk on, all built by the sweat and labor of others that are now dead.

And the buildings in most of our human cities, built by the labor and hands of other humans, long gone.

I think Einstein hit the nail on the head. A rich person who thinks he has helped society more than society has helped him is living in a grand delusion.

And then there is the old saying, not from Einstein but from books in the great libraries of the world, that still rings true: Behind every fortune there is a crime.

Posted by AdamSmith | Report as abusive

“A second theme of the Brookings discussion helps to explain one reason that has happened: The economy has gone global, but nation-states have not.”

Isn’t it really a matter of arbitrage and the behavior of markets?

Just as globalism means the actual or potential shifting of production to areas with lower labor prices, doesn’t globalism also mean the actual or potential shifting of profits to jurisdictions (tax markets) with lower taxes (i.e., lower prices on a set of government services which one is required to purchase)?

And just as it is natural for the availability of low labor prices in one area to constrain labor prices in another area, isn’t it natural for low taxes in one area to constrain taxes in another area as well?

Posted by Bob9999 | Report as abusive

Theft is never a “win-win”, anymore than a stage magician’s illusory creations of things from nowhere are anything other than a classy trick. A pig in a dress is still a pig.

Posted by drjdsjr | Report as abusive

The rich have been getting richer, but have they been creating more jobs with their extra wealth? Obviously not. They are sticking their money in off-shore accounts.

Ergo: Tax breaks for the rich does not translate into investment in jobs. It does the opposite: it causes boom-and-bust cycles and loss of jobs.

Posted by nkirv | Report as abusive

“the state can choose to mute the impact of the invisible hand” — what evidence is there that it has been market forces that have driven the rising inequality? It was not market forces that have slashed upper income tax brackets and capital gains rates. And market forces seems a poor explanation for the shift of corporate income from workers to executives, usually regardless of performance. Yes, it does seem likely that foreign competition had an impact on low-skill factory jobs, but that doesn’t explain the stagnant wages in fields where qualified labor is purportedly in short supply (engineering, accounting). No, in those cases it was in fact the actions of the state that caused wages to stagnate and in some cases decline.

I think it’s important to make clear that addressing income inequality is not about mucking with the revered invisible hand. The mucking has been underway since before capitalism was even around.

Posted by Sanity-Monger | Report as abusive

One of the greatest property rights enjoyed by wealthy is that of not having their mansions burned down tonight.

It seems to me that if the lives and careers of the American middle class continue to be destroyed by the outsourcing their jobs and unrelenting lowering their wage rates, this important benefit may no longer be available to the wealthy.

Posted by AdamSmith | Report as abusive

@AdamSmith,

Guess you didn’t get the memo. Occupy Wall Street failed. You guys either took your tent home or watched it get trashed. Good riddance.

See how long you remain “free” on the street if you ever try to use one of your wet matches on any American citizen’s legal home. You can’t do what you preach and remain anonymous, and so you seek to incite others to do your dirty work while you remain safely in the shadows scurrying around with other unseen vermin. Bah!

The average American prefers to be on the road, online and in the malls spending. There’s a lot going on when you get your head out of the sand and look around. You don’t seem to “get” that your “revolting” ideas and attitudes are fundamentally anti-American?

Posted by OneOfTheSheep | Report as abusive

is that the medal you get for donating dollars to the president?

Posted by rikfre | Report as abusive

Eliminate the income tax and instead tax consumption. Who will pay more in taxes, the guy with the economy car or the one with the personal jet. The guy with the jet of course – unless loopholes created by corrupt politicians says otherwise.

Posted by keebo | Report as abusive

The people at the top have been squeezing the workers at the lower levels for three decades. How do you think they got rich?

Posted by steelworker | Report as abusive

Incomes became endangered when profits switched to transactions from commodities and actual services. Or when “money,” those pieces of paper with pictures, became more valuable than goods or resources.

Of course, it is a fallacy that we can have “continued growth” without rushing toward catastrophe. How much more profit can come out of transactions before there is nothing left?

Maybe a change back to being customers rather than consumers would help. One has choices as a customer.

Posted by farrago | Report as abusive