Dyman Associates Insurance Group of Companies: Better Insurance Against Inequality

Paying taxes is rarely pleasant, but as April 15 approaches it’s worth remembering that our tax system is a progressive one and serves a little-noticed but crucial purpose: It mitigates some of the worst consequences of income inequality.

If any of us, as individuals, are unfortunate enough to have income drop significantly, the tax on that income will plummet as well — and a direct payment, or negative tax, might even be received from the government, thanks to the earned-income tax credit. In this way, the tax system can be viewed as a colossal insurance system, guarding against extreme income inequality. There are similar provisions in other countries.

But it’s also clear that while income inequality would be much worse without our current tax system, what we have isn’t nearly enough. It’s time — past time, actually — to tweak the system so that it can respond effectively if income inequality becomes more extreme.

I made this argument in 2003 in my book “The New Financial Order” (Princeton University Press). And now there is substantial evidence that inequality has been rising rapidly. In his monumental new book, “Capital in the 21st Century” (Belknap Press), Thomas Piketty of the Paris School of Economics documents a sharp increase in such inequality over the last 25 years, not only in the United States, but also in Canada, Britain, Australia, New Zealand, China, India, Indonesia and South Africa, with people with the highest incomes far outstripping the rest of society. The book is impressive in its wealth of information but it is short on solutions.

Professor Piketty talks about instituting a “global tax on capital” but acknowledges that it is a utopian idea and says that “it is hard to imagine the nations of the world agreeing on any such thing anytime soon.” He talks about raising the rate of the top tax brackets and raising inheritance taxes but sees “little reason for optimism” that this will happen. There have been big increases in taxes on the rich in the past, but he points out that these tax increases were put in place only in response to wars — specifically, World War I and World War II.

Let’s try not to have another major war. Instead, there are some positive things we can do now. As I said in my 2003 book, it would be wise to start amending the tax system immediately. I suggested this fundamental reform: Taxes should be indexed to income inequality so that they automatically become more progressive — meaning that the marginal tax rate for the highest-income people will rise — if income inequality becomes much worse. Ian Ayres of Yale and Aaron Edlin of the University of California, Berkeley, made a similar argument in 2011 in The New York Times.

There is a practical reason for starting now. If we wait until income inequality is much more severe, we will have a whole class of new superrich who will probably feel entitled to their wealth and will have the means to defend their interest. That’s already gone far enough. We shouldn’t let it become more extreme.

There is also a theoretical reason. It is what the psychologists Yaacov Trope of New York University and Nira Liberman of Tel Aviv University called temporal construal theory. They showed that people are more idealistic and generous when dealing hypothetically with the distant future than they are about actions they need to take today. That’s why it pays to ask people to decide on measures to uphold egalitarian ideals when they don’t have to cough up the money immediately.

In a draft research paper in 2006, Leonard Burman, director of the Urban-Brookings Tax Policy Center; Jeffrey Rohaly, also of the policy center, and I analyzed a kind of inequality-indexed tax system. (We called it the “Rising-Tide Tax System.”) With the benefit of hindsight, we came up with a system that could have been put in place in 1979 — when inequality was much milder in the United States — and that could have prevented any increase in after-tax inequality through 2006.

Though our proposal worked in theory, we found that putting it into effect would encounter difficulties. For the system to be effective, the top tax bracket would have had to rise to well over 75 percent — a political nonstarter, in our view. We also believed that there would have been negative economic effects, including more tax avoidance. So we concluded that the proposal wasn’t ready for advocacy. We held off from finishing and publishing that paper.

Today, though, there are some possibilities that might alleviate, at least partially, any increasing inequality in future years.

In testimony before the Senate Finance Committee last month, Mr. Burman proposed a version of inequality indexing that might be politically acceptable today. His idea was to integrate inequality indexing with inflation indexing: Instead of just linking tax brackets to inflation as measured by the Consumer Price Index, as we have done for years, he proposed that the adjustments also take account of rising inequality, if it occurred. He proposed a system to offset the loss in tax revenue that inflation indexing would produce, in a way that would get us closer to a target distribution of after-tax income; if inequality worsened, higher tax brackets would bear a bit more of the burden, and people at the bottom would bear less.

A relatively minor change like this should be politically acceptable. It is a reframing of inflation indexing, which is already a sacrosanct principle, and would be revenue-neutral. By 2025, Mr. Burman argued, it could pay for a doubling of the earned-income tax credit, “with more than $100 billion left over to adjust middle-income tax liabilities.”

Such a plan would be a nice first step toward making our tax system manage the risk of future increases in inequality.

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