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IV. The Price of Inequality It was one of those revealing moments. Responding to an e-mail message from a Canadian viewer, Robert Novak of ''Crossfire'' delivered a little speech: ''Marg, like most Canadians, you're ill informed and wrong. The U.S. has the longest standard of living -- longest life expectancy of any country in the world, including Canada. That's the truth.'' But it was Novak who had his facts wrong. Canadians can expect to live about two years longer than Americans. In fact, life expectancy in the U.S. is well below that in Canada, Japan and every major nation in Western Europe. On average, we can expect lives a bit shorter than those of Greeks, a bit longer than those of Portuguese. Male life expectancy is lower in the U.S. than it is in Costa Rica. Still, you can understand why Novak assumed that we were No. 1. After all, we really are the richest major nation, with real G.D.P. per capita about 20 percent higher than Canada's. And it has been an article of faith in this country that a rising tide lifts all boats. Doesn't our high and rising national wealth translate into a high standard of living -- including good medical care -- for all Americans? Well, no. Although America has higher per capita income than other advanced countries, it turns out that that's mainly because our rich are much richer. And here's a radical thought: if the rich get more, that leaves less for everyone else. That statement -- which is simply a matter of arithmetic -- is guaranteed to bring accusations of ''class warfare.'' If the accuser gets more specific, he'll probably offer two reasons that it's foolish to make a fuss over the high incomes of a few people at the top of the income distribution. First, he'll tell you that what the elite get may look like a lot of money, but it's still a small share of the total -- that is, when all is said and done the rich aren't getting that big a piece of the pie. Second, he'll tell you that trying to do anything to reduce incomes at the top will hurt, not help, people further down the distribution, because attempts to redistribute income damage incentives. These arguments for lack of concern are plausible. And they were entirely correct, once upon a time -- namely, back when we had a middle-class society. But there's a lot less truth to them now. First, the share of the rich in total income is no longer trivial. These days 1 percent of families receive about 16 percent of total pretax income, and have about 14 percent of after-tax income. That share has roughly doubled over the past 30 years, and is now about as large as the share of the bottom 40 percent of the population. That's a big shift of income to the top; as a matter of pure arithmetic, it must mean that the incomes of less well off families grew considerably more slowly than average income. And they did. Adjusting for inflation, average family income -- total income divided by the number of families -- grew 28 percent from 1979 to 1997. But median family income -- the income of a family in the middle of the distribution, a better indicator of how typical American families are doing -- grew only 10 percent. And the incomes of the bottom fifth of families actually fell slightly. Let me belabor this point for a bit. We pride ourselves, with considerable justification, on our record of economic growth. But over the last few decades it's remarkable how little of that growth has trickled down to ordinary families. Median family income has risen only about 0.5 percent per year -- and as far as we can tell from somewhat unreliable data, just about all of that increase was due to wives working longer hours, with little or no gain in real wages. Furthermore, numbers about income don't reflect the growing riskiness of life for ordinary workers. In the days when General Motors was known in-house as Generous Motors, many workers felt that they had considerable job security -- the company wouldn't fire them except in extremis. Many had contracts that guaranteed health insurance, even if they were laid off; they had pension benefits that did not depend on the stock market. Now mass firings from long-established companies are commonplace; losing your job means losing your insurance; and as millions of people have been learning, a 401(k) plan is no guarantee of a comfortable retirement. Still, many people will say that while the U.S. economic system may generate a lot of inequality, it also generates much higher incomes than any alternative, so that everyone is better off. That was the moral Business Week tried to convey in its recent special issue with ''25 Ideas for a Changing World.'' One of those ideas was ''the rich get richer, and that's O.K.'' High incomes at the top, the conventional wisdom declares, are the result of a free-market system that provides huge incentives for performance. And the system delivers that performance, which means that wealth at the top doesn't come at the expense of the rest of us. A skeptic might point out that the explosion in executive compensation seems at best loosely related to actual performance. Jack Welch was one of the 10 highest-paid executives in the United States in 2000, and you could argue that he earned it. But did Dennis Kozlowski of Tyco, or Gerald Levin of Time Warner, who were also in the top 10? A skeptic might also point out that even during the economic boom of the late 1990's, U.S. productivity growth was no better than it was during the great postwar expansion, which corresponds to the era when America was truly middle class and C.E.O.'s were modestly paid technocrats. But can we produce any direct evidence about the effects of inequality? We can't rerun our own history and ask what would have happened if the social norms of middle-class America had continued to limit incomes at the top, and if government policy had leaned against rising inequality instead of reinforcing it, which is what actually happened. But we can compare ourselves with other advanced countries. And the results are somewhat surprising. Many Americans assume that because we are the richest country in the world, with real G.D.P. per capita higher than that of other major advanced countries, Americans must be better off across the board -- that it's not just our rich who are richer than their counterparts abroad, but that the typical American family is much better off than the typical family elsewhere, and that even our poor are well off by foreign standards. But it's not true. Let me use the example of Sweden, that great conservative bete noire. A few months ago the conservative cyberpundit Glenn Reynolds made a splash when he pointed out that Sweden's G.D.P. per capita is roughly comparable with that of Mississippi -- see, those foolish believers in the welfare state have impoverished themselves! Presumably he assumed that this means that the typical Swede is as poor as the typical resident of Mississippi, and therefore much worse off than the typical American. But life expectancy in Sweden is about three years higher than that of the U.S. Infant mortality is half the U.S. level, and less than a third the rate in Mississippi. Functional illiteracy is much less common than in the U.S. How is this possible? One answer is that G.D.P. per capita is in some ways a misleading measure. Swedes take longer vacations than Americans, so they work fewer hours per year. That's a choice, not a failure of economic performance. Real G.D.P. per hour worked is 16 percent lower than in the United States, which makes Swedish productivity about the same as Canada's. But the main point is that though Sweden may have lower average income than the United States, that's mainly because our rich are so much richer. The median Swedish family has a standard of living roughly comparable with that of the median U.S. family: wages are if anything higher in Sweden, and a higher tax burden is offset by public provision of health care and generally better public services. And as you move further down the income distribution, Swedish living standards are way ahead of those in the U.S. Swedish families with children that are at the 10th percentile -- poorer than 90 percent of the population -- have incomes 60 percent higher than their U.S. counterparts. And very few people in Sweden experience the deep poverty that is all too common in the United States. One measure: in 1994 only 6 percent of Swedes lived on less than $11 per day, compared with 14 percent in the U.S. The moral of this comparison is that even if you think that America's high levels of inequality are the price of our high level of national income, it's not at all clear that this price is worth paying. The reason conservatives engage in bouts of Sweden-bashing is that they want to convince us that there is no tradeoff between economic efficiency and equity -- that if you try to take from the rich and give to the poor, you actually make everyone worse off. But the comparison between the U.S. and other advanced countries doesn't support this conclusion at all. Yes, we are the richest major nation. But because so much of our national income is concentrated in relatively few hands, large numbers of Americans are worse off economically than their counterparts in other advanced countries. And we might even offer a challenge from the other side: inequality in the United States has arguably reached levels where it is counterproductive. That is, you can make a case that our society would be richer if its richest members didn't get quite so much. I could make this argument on historical grounds. The most impressive economic growth in U.S. history coincided with the middle-class interregnum, the post-World War II generation, when incomes were most evenly distributed. But let's focus on a specific case, the extraordinary pay packages of today's top executives. Are these good for the economy? Until recently it was almost unchallenged conventional wisdom that, whatever else you might say, the new imperial C.E.O.'s had delivered results that dwarfed the expense of their compensation. But now that the stock bubble has burst, it has become increasingly clear that there was a price to those big pay packages, after all. In fact, the price paid by shareholders and society at large may have been many times larger than the amount actually paid to the executives. It's easy to get boggled by the details of corporate scandal -- insider loans, stock options, special-purpose entities, mark-to-market, round-tripping. But there's a simple reason that the details are so complicated. All of these schemes were designed to benefit corporate insiders -- to inflate the pay of the C.E.O. and his inner circle. That is, they were all about the ''chaos of competitive avarice'' that, according to John Kenneth Galbraith, had been ruled out in the corporation of the 1960's. But while all restraint has vanished within the American corporation, the outside world -- including stockholders -- is still prudish, and open looting by executives is still not acceptable. So the looting has to be camouflaged, taking place through complicated schemes that can be rationalized to outsiders as clever corporate strategies. Economists who study crime tell us that crime is inefficient -- that is, the costs of crime to the economy are much larger than the amount stolen. Crime, and the fear of crime, divert resources away from productive uses: criminals spend their time stealing rather than producing, and potential victims spend time and money trying to protect their property. Also, the things people do to avoid becoming victims -- like avoiding dangerous districts -- have a cost even if they succeed in averting an actual crime. The same holds true of corporate malfeasance, whether or not it actually involves breaking the law. Executives who devote their time to creating innovative ways to divert shareholder money into their own pockets probably aren't running the real business very well (think Enron, WorldCom, Tyco, Global Crossing, Adelphia . . . ). Investments chosen because they create the illusion of profitability while insiders cash in their stock options are a waste of scarce resources. And if the supply of funds from lenders and shareholders dries up because of a lack of trust, the economy as a whole suffers. Just ask Indonesia. The argument for a system in which some people get very rich has always been that the lure of wealth provides powerful incentives. But the question is, incentives to do what? As we learn more about what has actually been going on in corporate America, it's becoming less and less clear whether those incentives have actually made executives work on behalf of the rest of us. V. Inequality and Politics [I]n September the Senate debated a proposed measure that would impose a one-time capital gains tax on Americans who renounce their citizenship in order to avoid paying U.S. taxes. Senator Phil Gramm was not pleased, declaring that the proposal was ''right out of Nazi Germany.'' Pretty strong language, but no stronger than the metaphor Daniel Mitchell of the Heritage Foundation used, in an op-ed article in The Washington Times, to describe a bill designed to prevent corporations from rechartering abroad for tax purposes: Mitchell described this legislation as the ''Dred Scott tax bill,'' referring to the infamous 1857 Supreme Court ruling that required free states to return escaped slaves. Twenty years ago, would a prominent senator have likened those who want wealthy people to pay taxes to Nazis? Would a member of a think tank with close ties to the administration have drawn a parallel between corporate taxation and slavery? I don't think so. The remarks by Gramm and Mitchell, while stronger than usual, were indicators of two huge changes in American politics. One is the growing polarization of our politics -- our politicians are less and less inclined to offer even the appearance of moderation. The other is the growing tendency of policy and policy makers to cater to the interests of the wealthy. And I mean the wealthy, not the merely well-off: only someone with a net worth of at least several million dollars is likely to find it worthwhile to become a tax exile. You don't need a political scientist to tell you that modern American politics is bitterly polarized. But wasn't it always thus? No, it wasn't. From World War II until the 1970's -- the same era during which income inequality was historically low -- political partisanship was much more muted than it is today. That's not just a subjective assessment. My Princeton political science colleagues Nolan McCarty and Howard Rosenthal, together with Keith Poole at the University of Houston, have done a statistical analysis showing that the voting behavior of a congressman is much better predicted by his party affiliation today than it was 25 years ago. In fact, the division between the parties is sharper now than it has been since the 1920's. What are the parties divided about? The answer is simple: economics. McCarty, Rosenthal and Poole write that ''voting in Congress is highly ideological -- one-dimensional left/right, liberal versus conservative.'' It may sound simplistic to describe Democrats as the party that wants to tax the rich and help the poor, and Republicans as the party that wants to keep taxes and social spending as low as possible. And during the era of middle-class America that would indeed have been simplistic: politics wasn't defined by economic issues. But that was a different country; as McCarty, Rosenthal and Poole put it, ''If income and wealth are distributed in a fairly equitable way, little is to be gained for politicians to organize politics around nonexistent conflicts.'' Now the conflicts are real, and our politics is organized around them. In other words, the growing inequality of our incomes probably lies behind thegrowing divisiveness of our politics. But the politics of rich and poor hasn't played out the way you might think. Since the incomes of America's wealthy have soared while ordinary families have seen at best small gains, you might have expected politicians to seek votes by proposing to soak the rich. In fact, however, the polarization of politics has occurred because the Republicans have moved to the right, not because the Democrats have moved to the left. And actual economic policy has moved steadily in favor of the wealthy. The major tax cuts of the past 25 years, the Reagan cuts in the 1980's and the recent Bush cuts, were both heavily tilted toward the very well off. (Despite obfuscations, it remains true that more than half the Bush tax cut will eventually go to the top 1 percent of families.) The major tax increase over that period, the increase in payroll taxes in the 1980's, fell most heavily on working-class families. The most remarkable example of how politics has shifted in favor of the wealthy -- an example that helps us understand why economic policy has reinforced, not countered, the movement toward greater inequality -- is the drive to repeal the estate tax. The estate tax is, overwhelmingly, a tax on the wealthy. In 1999, only the top 2 percent of estates paid any tax at all, and half the estate tax was paid by only 3,300 estates, 0.16 percent of the total, with a minimum value of $5 million and an average value of $17 million. A quarter of the tax was paid by just 467 estates worth more than $20 million. Tales of family farms and businesses broken up to pay the estate tax are basically rural legends; hardly any real examples have been found, despite diligent searching. You might have thought that a tax that falls on so few people yet yields a significant amount of revenue would be politically popular; you certainly wouldn't expect widespread opposition. Moreover, there has long been an argument that the estate tax promotes democratic values, precisely because it limits the ability of the wealthy to form dynasties. So why has there been a powerful political drive to repeal the estate tax, and why was such a repeal a centerpiece of the Bush tax cut? There is an economic argument for repealing the estate tax, but it's hard to believe that many people take it seriously. More significant for members of Congress, surely, is the question of who would benefit from repeal: while those who will actually benefit from estate tax repeal are few in number, they have a lot of money and control even more (corporate C.E.O.'s can now count on leaving taxable estates behind). That is, they are the sort of people who command the attention of politicians in search of campaign funds. But it's not just about campaign contributions: much of the general public has been convinced that the estate tax is a bad thing. If you try talking about the tax to a group of moderately prosperous retirees, you get some interesting reactions. They refer to it as the ''death tax''; many of them believe that their estates will face punitive taxation, even though most of them will pay little or nothing; they are convinced that small businesses and family farms bear the brunt of the tax. These misconceptions don't arise by accident. They have, instead, been deliberately promoted. For example, a Heritage Foundation document titled ''Time to Repeal Federal Death Taxes: The Nightmare of the American Dream'' emphasizes stories that rarely, if ever, happen in real life: ''Small-business owners, particularly minority owners, suffer anxious moments wondering whether the businesses they hope to hand down to their children will be destroyed by the death tax bill, . . . Women whose children are grown struggle to find ways to re-enter the work force without upsetting the family's estate tax avoidance plan.'' And who finances the Heritage Foundation? Why, foundations created by wealthy families, of course. The point is that it is no accident that strongly conservative views, views that militate against taxes on the rich, have spread even as the rich get richer compared with the rest of us: in addition to directly buying influence, money can be used to shape public perceptions. The liberal group People for the American Way's report on how conservative foundations have deployed vast sums to support think tanks, friendly media and other institutions that promote right-wing causes is titled ''Buying a Movement.'' Not to put too fine a point on it: as the rich get richer, they can buy a lot of things besides goods and services. Money buys political influence; used cleverly, it also buys intellectual influence. A result is that growing income disparities in the United States, far from leading to demands to soak the rich, have been accompanied by a growing movement to let them keep more of their earnings and to pass their wealth on to their children. This obviously raises the possibility of a self-reinforcing process. As the gap between the rich and the rest of the population grows, economic policy increasingly caters to the interests of the elite, while public services for the population at large -- above all, public education -- are starved of resources. As policy increasingly favors the interests of the rich and neglects the interests of the general population, income disparities grow even wider. VI. Plutocracy? In 1924, the mansions of Long Island's North Shore were still in their full glory, as was the political power of the class that owned them. When Gov. Al Smith of New York proposed building a system of parks on Long Island, the mansion owners were bitterly opposed. One baron -- Horace Havemeyer, the ''sultan of sugar'' -- warned that North Shore towns would be ''overrun with rabble from the city.'' ''Rabble?'' Smith said. ''That's me you're talking about.'' In the end New Yorkers got their parks, but it was close: the interests of a few hundred wealthy families nearly prevailed over those of New York City's middle class. America in the 1920's wasn't a feudal society. But it was a nation in which vast privilege -- often inherited privilege -- stood in contrast to vast misery. It was also a nation in which the government, more often than not, served the interests of the privileged and ignored the aspirations of ordinary people. Those days are past -- or are they? Income inequality in America has now returned to the levels of the 1920's. Inherited wealth doesn't yet play a big part in our society, but given time -- and the repeal of the estate tax -- we will grow ourselves a hereditary elite just as set apart from the concerns of ordinary Americans as old Horace Havemeyer. And the new elite, like the old, will have enormous political power. Kevin Phillips concludes his book ''Wealth and Democracy'' with a grim warning: ''Either democracy must be renewed, with politics brought back to life, or wealth is likely to cement a new and less democratic regime -- plutocracy by some other name.'' It's a pretty extreme line, but we live in extreme times. Even if the forms of democracy remain, they may become meaningless. It's all too easy to see how we may become a country in which the big rewards are reserved for people with the right connections; in which ordinary people see little hope of advancement; in which political involvement seems pointless, because in the end the interests of the elite always get served. Am I being too pessimistic? Even my liberal friends tell me not to worry, that our system has great resilience, that the center will hold. I hope they're right, but they may be looking in the rearview mirror. Our optimism about America, our belief that in the end our nation always finds its way, comes from the past -- a past in which we were a middle-class society. But that was another country. --Paul Krugman is a Times columnist and a professor at Princeton.
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