"We are the 99%."
The protests on Wall Street have succeeded in creating doubt about whether the degree of wealth and income inequality in this country is politically sustainable. Wealth and income in capitalist societies, and I think in non-capitalist societies as well, is invariably distributed so that the median voter is poorer than the average voter. This isn't a mathematically necessity but it's a strong empirical regularity. The large majority always has a certain brute force on its side, and in a democracy it has the votes too, to take from a small, wealthy minority and redistribute to itself. Ignoring the costs of the redistribution process itself (but those can be very very very large!), the median voter always stands to benefit in the very short run from a general redistribution of wealth. So how is it possible for there to be so many millionaires, and even some billionaires, without them getting mugged by the majority?
It's actually better, by and large, to let the rich keep (most of) their money, but the reasons why are subtle. First, the general case for property rights. Property rights are essential to freedom because they give individuals a certain range of freedom of action in which they can do what they like without worrying about what authorities or superiors think. Property rights also help to create the right incentives for people to work, save, invest, take calculated risks, start entrepreneurial ventures. I think people understand that in everyday life, but they have trouble applying the same principles when the amounts of money at stake are increased by three orders of magnitude or so. To have, say, $10 billion, seems like absurd excess. It's hard to see how any sane person could be motivated by money at that point anyway. (Actually, I think they're usually not, except as a way of "keeping score," so to speak.) Why let them keep it?
One reason is justice: they created a lot of value, they should enjoy the fruits of it. This applies more to some rich people than others. It may explain why there's so much anger at the big Wall Street banks and, at the same time, so much adulation for another uber-rich guy, Steve Jobs. People think that Apple really did a lot of good for the world, so they don't resent Jobs' wealth. People don't think the banks did so much good. Another reason is incentive: crazy as it seems, big money seems to motivate some very rich, talented people to work hard. And we want them to work hard, inventing, planning, inspiring, making decisions. Again, this argument seems more convincing in the case of Steve Jobs than of Wall Street banks. The trouble is that it's hard to tackle the undeserving rich without tackling the deserving rich too. More importantly, there's a trade-off between progressivity and efficiency in taxation, with the taxes that fall on the rich generally being the taxes that most distort the economy.
Since labor is more evenly distributed than capital, capital taxation seems, on the surface, an appealing way to redistribute from rich to poor. Yet a lot of economic research (e.g., Chamley and Judd) finds that the optimal rate of taxation on capital (corporate income, capital gains, and dividends) is zero. Why? One reason is that capital taxation reduces the incentive to save, and savings finance the investment that is crucial to economic growth. Less capital formation means less capital for workers to use on the job means lower wages. Capital taxation also tends to distort the way companies make decisions. For example, suppose Company A makes $1000 of profit one year, and Company B takes a $500 loss. Suppose further that the capital taxation rate (corporate income tax plus capital gains or dividend taxes) is 30%. If A and B remain separate companies, their total after-tax earnings are:
Company A $1000 * (1 - 30%) = $700
Company B -$500 -$500
Now suppose that the companies merge into one company, AB. Its after-tax earnings are:
Company AB $1000-$500=$500 * (1 - 30%) = $350
So the companies can reduce their tax bill and increase after-tax earnings by merging. Bear in mind that there may be no business advantage to the merger at all, no synergies to be exploited, no costs to be shared. If it's sufficiently obvious that the merger is just a tax dodge, the authorities might be able to stop it. However, in other cases a merger might actually make business sense. It will be hard for regulators to tell whether a merger makes business sense or not, if the companies themselves have an incentive to mislead them. Another problem is that companies may manipulate their income streams so as to "smooth" income inefficiently, to avoid taking losses one year and making profits the next, and paying positive taxes on the profits that are not offset by negative taxes on the losses, since the government doesn't reimburse companies for losses.
Capital taxation also distorts firms' capital structure. When firms pay interest on debt, that's not counted as income and not taxable; but when they pay dividends, those are taxable. That creates an incentive for firms to finance investment with debt rather than equity.
If we want zero or low capital taxes, we could still impose high taxes on high-end labor incomes. After all, the notorious salaries of the highest-paid CEOs are labor income. If you look at the history of tax rates, there were long periods when the top tax rates were over 70%, or even as high as 90% or more. Of course, in those days, CEO salaries were far lower than they are now, and you can see why: if you're going to be giving the vast majority of your high earnings to the government, you don't have much incentive to negotiate for a high salary. What will you negotiate for, then? I knew a professor who did empirical research on firms in Britain, and met with several CEOs. In one of the most appalling cases (but not atypical), the CEO had to stop the interview because the questions-- about production processes, accounting and profits; basic stuff a boss should know-- were too hard for him. But, as if to redeem himself, the CEO walked across the room and opened a cabinet full of whiskey and other alcoholic beverages, plus a TV with a huge screen. He boasted, when the board meets, they all sat around and watched sports and drank. And why not? If the government's taken away your incentive to work, and your competitors' incentives to work, too, you'll get lazy. I also get the impression that some bosses back then thought attractive and biddable secretaries were one of the perks of the job.
Conservatives used to look back to the 1950s as a golden age. Now that theme seems more common among liberals and progressives. For example, Paul Krugman writes in The Conscience of a Liberal that that time "stands revealed as a paradise lost, an exceptional episode in our nation's history." Those were the times when taxes on the rich were very very high. And the economy seemed to do fine, better than fine. It grew strongly throughout the 1950s and 1960s. Incomes were a lot more equal than now. Shouldn't we try to get back to that?
Not so fast. First, we have to remember the process by which incomes got so equal. It was terrible. The 1929 stockmarket crash and the Great Depression had a leveling effect, destroying many of America's great fortunes, but of course everyone suffered. It would be bizarre to suggest that the sky-high taxes of the 1930s, and the gangsterish experimentalism of the Roosevelt administration, didn't have something to do with why the Great Depression was so long and deep. And then World War II, though presumably necessary, was hardly an experience we would want to repeat.
Second, the strong growth of the 1950s and 1960s partly reflected favorable demographics: the population was a lot younger than now, more people were working. It was also a process of recovery from the 1930s. Contrary to popular belief, recent research finds that the Great Depression was a time of rapid technological progress, which slowed down in the 1950s and 1960s; the latter decades experienced faster growth, of course, but that was because the economy was using more of its capacity, not because capacity was increasing faster. That helps to explain why the 1970s went so badly: by that time, the country had lost its innovative momentum.
The 1950s and 1960s were indeed an exceptional time in the nation's history, and not entirely in a good way. We should not expect to be able to repeat them. We should not really desire to do so. To stay vibrant and innovative, capitalism needs to be a high-stakes game, and that demands tolerance for a very high degree of inequality in income and wealth. We should always remember too, that hardly any of the real poor, the poor by global or historical standards, live here. They live in Africa, in India, in Pakistan, in Bangladesh, in Egypt, in China, in Central America and Mexico, and so forth. In global terms, redistributing from the "1%" to the "99%" is redistributing from the very-rich to the quite-rich. There's no moral merit in that. If the "Occupy" protestors were demanding taxes on the rich to finance more foreign aid, that would be a perhaps misguided but morally creditable cause. Demanding handouts to the American middle class is not.
That's not to deny that the Occupy protestors might have, or might inspire, some good ideas. Megan McArdle proposes a debt jubilee for student loans. And the Fed probably should stop paying interest on banks' reserves at the Fed, even though that will hurt the banks which are struggling anyway. Interest on reserves just gives banks a reason not to do their job, which is to lend money out into the economy. It's these kinds of subtle policies that can sort the deserving from the undeserving rich, that can get the incentives for talented people right. But it's a bad idea to think about what we want income inequality to be, and then to try to get there through the tax code. It's better not to think about it too much at all.