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PREFACE TO THE PAPERBACK EDITION

The United States, 2016: Redistribution vs. Growth

The first edition of Shattered Consensus was published in mid-2015, just as Donald Trump was beginning his improbable campaign for the Republican presidential nomination. The book presented a disquieting thesis: that the political consensus holding the United States together through the postwar era was coming apart and that, as a consequence, the nation was headed into an extended period of instability and upheaval. It set forth various factors—rising debt, slow economic growth, and ideological polarization—to explain why the political environment in the United States was ripe for such an upheaval. There was no way to foretell what events might trigger it, how it would proceed, or how it might eventually conclude. But the tinder was dry, the book suggested, and thus vulnerable to some combustible spark.

While it is premature to conclude that Donald Trump and the voters supporting him will provide that spark, it is nevertheless clear that they have succeeded in challenging some of the main presuppositions of the postwar order, including the longstanding bipartisan consensus around free trade, liberal immigration policies, globalism, and the central role of the United States in policing the international system. Because his positions lie so far outside the mainstream consensus that has shaped U.S. policy through the postwar era, leaders in both political parties, along with many pundits and corporate leaders, have expressed shock and alarm at Trump’s rise and at the possibility that he might be elected president of the United States. Whether or not that happens, his campaign has demonstrated how shaky the postwar consensus now is.

There are many factors that might account for the turbulence roiling the United States today, but economic stagnation combined with the rising costs of the entitlement state are probably the most important ones. Populist resentment against “the establishment” arises mainly from the effects of stagnating incomes, the loss of high-paying jobs, and the heavy taxes required to meet the costs of government, with illegal immigration mixed into the situation as an aggravating factor. The U.S. economy has been growing at a rate of under 2 percent per year for a decade and a half, compared with the 3.5 percent average for the period from 1950 to 2000—which goes a long way toward explaining why middle-class incomes have not been increasing, and why Trump’s populist themes have struck a chord with so many voters. The postwar order in the United States depends heavily upon robust economic growth to meet the rising costs of government and to fulfill the aspirations of an upwardly mobile population. Economic stagnation, if it continues as it has since 2000, could easily bring about the upheaval that was forecast in Shattered Consensus.

Unfortunately, neither of the major political parties is now offering a plausible set of policies to deal with the “growth crisis” threatening the stability of the American polity. While Trump is on the right track with his proposals for reductions in taxes, spending, and regulations, his proposals to protect the U.S. economy from foreign competition would do more to impede than to promote economic growth. Still, the policies he recommends are far superior in this regard to those on offer from the Democrats.

Barack Obama did little during his eight years in office to address the problems of stagnation and the costs of the welfare state; in many ways, he made those problems worse by pushing an expensive new health-care program (passed on a party-line vote) and nearly doubling the federal debt from $10.6 trillion in 2009 to about $20 trillion by the end of 2016, with very little to show for all the new spending. Hillary Clinton, prodded to the left by Senators Bernie Sanders and Elizabeth Warren, promises more of the same, with an added emphasis on higher taxes for the wealthy as a means of dealing with income inequality. The 2016 Democratic Party Platform contains a laundry list of proposals for higher taxes, trade protectionism, universal health care, subsidies for “clean energy,” free college tuition, an increase in the minimum wage, added regulations for banks, and new rules to make it easier for public and private sector unions to organize. Redistribution, plus a heavy dose of regulation, seems to be the Democrats’ answer to America’s growth crisis.

There are at least three problems with the progressive focus on redistribution: it does not promote growth; it does not reduce inequality; and the public does not favor it.

Public opinion polls over the years have consistently shown that voters overwhelmingly reject programs of redistribution, in favor of policies designed to promote overall economic growth and job creation. More recent polls suggest that while voters are increasingly concerned about inequality and question the high salaries paid to executives and bankers, they nevertheless reject redistributive remedies such as higher taxes on the wealthy. According to these studies, voters reject redistributive policies because they do not believe the government is capable of implementing them in effective ways. While voters are worried about inequality, they are far more concerned with economic growth, and they are skeptical of the capacity of governments to do anything about inequality without making matters worse for everyone.

Here, as is often the case, there is more wisdom in the public’s outlook than in the campaign speeches of Democratic presidential candidates or in the books and opinion columns of progressive economists. Leaving aside the morality of redistribution, the progressive case is based upon a significant fallacy: it assumes that the U.S. government is actually capable of redistributing income from the wealthy to the poor. For reasons of policy, tradition, and institutional design, this is not so. Whatever one may think of inequality, redistributive fiscal policies are unlikely to do much to reduce it, but they will place burdens on businesses and consumers that retard economic growth.

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One need only look at the effects of federal tax and spending programs over the past three and a half decades to see the limitations of the redistributive agenda. The chart to the right, based upon data compiled by the Congressional Budget Office, displays the national shares of before- and after-tax income for the top 1 percent and the top 10 percent of the income distribution from 1979 through 2011, along with the corresponding figures for the bottom 20 percent. For purposes of this study, the CBO defined “income” as market income plus government transfers, including cash payments along with the value of in-kind services and payments such as health care (Medicare and Medicaid) and food stamps. The CBO treated tax credits, including cash refunds on the payroll tax for low-income families, as a tax variable, although for budgetary purposes those credits are accounted as spending. The chart represents a general portrait of the degree to which federal tax policies redistribute income from the wealthiest to the poorest groups and to households in between.

The chart illustrates two broad points: First, the wealthiest groups gradually increased their share of national income (both pre- and after-tax) over this period of thirty-plus years. Second, federal tax policies had little effect on the overall distribution of income.

Across this period, the top 1 percent of the income distribution nearly doubled its share of pre-tax national income, from about 9 percent in 1979 to more than 18 percent in 2007 and 2008, before it fell back after the financial crisis to 15 percent in 2010 and 2011. (Some studies suggest that by 2014 it was back up to 18 percent.) Meanwhile, the top 10 percent increased its share by a third, from about 30 percent in 1979 to 40 percent in 2007 and 2008, before it fell to 37 percent in 2011. The bottom quintile maintained a fairly constant share of national income through the period.

Many people would be surprised to learn that the federal fiscal system does not do more to reduce inequalities in income arising from the free-market system. Yet there are perfectly obvious reasons—on both the tax and the spending side—why redistribution does not succeed in the American system, and probably cannot be made to succeed.

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First, on the tax side: The income tax yields revenues to the government through two main sources: (1) progressive taxes on ordinary income (salaries and wages), and (2) taxes on capital gains, which are taxed at somewhat lower rates to encourage investment. For most of the period from 1979 to 2011, taxes on capital gains yielded less than 10 percent of total income taxes and about 4 percent of total federal revenues. In terms of the income tax, most of the action is in taxes on ordinary income.

The highest marginal income tax rate oscillated up and down throughout this period, beginning at 70 percent during the Carter presidency, falling to 50 percent and then to 28 percent and up slightly to 31 percent in the Reagan/Bush years, then rising to 39.6 percent in the 1990s under the Clinton presidency, before going down again to 35 percent from 2003 to 2011. (It is now back up to 39.6 percent.) The highest rate on capital gains moved within a narrower band, beginning at 28 percent in 1979 and falling as low as 15 percent from 2005 to 2011. (The highest rate is currently 23.8 percent.)

Throughout this period, the top 1 percent of the income distribution lost between 1 and 2 percent of the income share to taxes, regardless of the tax rates. In 1980, that group claimed 9 percent of before-tax income and 8 percent of after-tax income; in 1990 the figures were 12 percent and 11 percent; and in 2010, 15 percent and 13 percent. The top 10 percent of the income distribution generally lost more of its income share to taxes, between 2 and 4 percent, probably because those households take a greater share of their income in salaries rather than capital gains. At the other end, the lowest income quintile gained very little (about 1 percent on average) in the income share due to the progressive tax system. In 2011, for example, the poorest 20 percent of households received 5 percent of pre-tax national income and 6 percent of after-tax income.

Many in the redistributionist camp attribute this pattern to a lack of progressivity in the income tax system, an explanation that overlooks the fact that income taxes in the United States are at least as progressive as those in many other developed countries. The highest marginal rate in the United States was 35 percent from 2003 to 2012 and today is 39.6 percent for top earners, a rate not far out of line with those of America’s chief competitors, including Germany, France, the United Kingdom, and Japan, where the highest marginal rates range between 40 and 46 percent.

A study published by the Organization for Economic Cooperation and Development in 2008 found that the United States actually had the most progressive income tax system among all twenty-four OECD countries, measured in terms of the share of the tax burden paid by the wealthiest households. According to the Congressional Budget Office, the top 1 percent of earners paid 39 percent of the personal income taxes in 2010 while claiming 15 percent of before-tax income, and the top 20 percent of earners paid 93 percent of federal income taxes in 2010 but claimed just 52 percent of before-tax income. Meanwhile, the bottom 40 percent of the income distribution paid zero net income taxes. For all practical purposes, those in the highest brackets already bear the overwhelming burden of the federal income tax, while those below the median income have been taken out of the income tax system altogether.

For several generations, progressive reformers have looked to the income tax as the instrument through which they might take resources from the rich and deliver them to the poor. In reality, the income tax—in the United States, at least—is not a sufficiently large revenue source for the national government to do the job that the redistributionists want it to do. In 2010, when the federal government raised $2.144 trillion in taxes, just 42 percent of that sum came from the individual income tax, while 40 percent came from payroll taxes, 9 percent from corporate taxes, and the rest from a mix of estate and excise taxes. Since the early 1950s, the national government has consistently relied upon the income tax for between 40 and 50 percent of its revenues, with precise proportions varying from year to year as economic conditions change.

Payroll taxes account for nearly as large a share of federal revenue, and these taxes fall more heavily on the wages and salaries of the working and middle classes than on the incomes of the wealthy, whose salaries far exceed the maximum earnings subject to those taxes and who derive income disproportionately from capital gains. In 2010, the wealthiest 1 percent paid just 4 percent of payroll taxes (and 39 percent of income taxes). The top quintile of earners paid 45 percent of payroll taxes (and 93 percent of income taxes), while the middle quintile paid 15 percent of all payroll taxes (and just 3 percent of income taxes). The more widely shared burdens of the payroll tax tend to counteract the redistributive effects of the income tax.

An increase in the top marginal tax rate in 2010 from 39.6 to, say, 50 percent might have yielded around $100 billion in additional revenue, assuming no corresponding changes in tax and income strategies on the part of wealthy households and no negative effects on investment and economic growth (all risky assumptions). That is real money, to be sure, but it would represent only about 0.5 percent of GDP (using 2010 figures), or less than 3 percent of total federal spending—not enough to permit much in the way of redistribution to the roughly 60 million households in the bottom half of the income scale.

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Turning to the spending side of fiscal policy, we encounter a murkier situation due to the sheer number and complexity of federal spending programs. The House of Representatives Budget Committee estimated in 2012 that the federal government spent nearly $800 billion on ninety-two separate antipoverty programs that provided cash assistance, medical care, housing assistance, food stamps, and tax credits to the poor and near poor. The number of people drawing benefits from antipoverty programs has more than doubled since the 1980s, from 42 million in 1983 to 108 million in 2011. The redistributive effects of these programs are limited, however, because most of the funds are spent on services to assist the poor, while only a small fraction is distributed in the form of cash or income. This means that most of the money goes to providers of services, who are generally in the middle class or upper middle class, and not to poor or near-poor households. Senator Daniel Patrick Moynihan once tartly described this dynamic as “feeding the horses to feed the sparrows.”

The American welfare state evolved in the direction of services rather than income in part because the American people have long viewed poverty as a condition to be overcome rather than one to be subsidized with cash. Many also believe that the poor would squander or misspend cash payments and so are better off receiving services and in-kind benefits like food stamps, health care, and tuition assistance. Regarding aid to the poor, then, Americans have built a social service state but not a redistribution state.

Social Security is the only substantial federal program that transfers money income from one group to another, in this case from workers and employers to retirees. It is by far the largest of all federal programs, claiming $850 billion or 24 percent of the federal budget in 2014. It is funded by a payroll tax split equally between employees and employers. As of 2014, about 59 million Americans were collecting benefits under Social Security, with an average benefit of $1,260 per month. Social Security has a progressive benefit formula and it contains a feature (Supplemental Security Income) that provides cash benefits to elderly, blind, or disabled persons with incomes below the poverty line. Nevertheless, it was designed and it still functions to provide income for retirees, not to redistribute income from the wealthy to the poor.

The National Bureau of Economic Research, in a series of studies on the redistributive aspects of Social Security, concluded that the program transfers income in various complex ways but does not transfer it from the rich to the poor. One NBER study by Julia Lynn Coronado, Don Fullerton, and Thomas Glass bluntly concluded that “Social Security does not redistribute from people who are rich over their lifetime to those who are poor. In fact, it may even be slightly regressive.” This is partly because wealthier recipients tend to live longer and partly because they are more likely to have nonworking spouses also eligible to collect benefits.

Medicare and Medicaid, two other expensive programs that together claim nearly 25 percent of the federal budget, provide important health-care services to the elderly and the poor, but no actual income. The flow of money through these health-care programs, more than $850 billion in federal funds in 2014 (plus another $180 billion in state funds for Medicaid), goes mainly to hospitals, nursing homes, pharmaceutical companies, doctors, insurance companies, and health maintenance organizations. Both programs have been plagued by fraud and corruption since their origins in 1965 because some doctors, nursing home entrepreneurs, and other providers have sought to game the system for financial advantage, and in many cases have succeeded all too well. No one has ever attempted a study of the redistributive aspects of the flow of funds from Medicare and Medicaid, but one surmises from the nature of these payments that most of the money goes to those in the upper reaches of the income distribution.

The federal government does provide cash assistance to the poor and near poor through two programs: (1) Temporary Assistance to Needy Families (TANF, popularly known as welfare), which currently provides cash benefits to about 4.5 million households at a cost of $17 billion per year to the federal government and about $14 billion (in 2014) to various state governments; (2) Supplemental Security Income (noted above), which provides cash benefits to the disabled poor, aiding about 8.5 million households at a cost of around $50 billion per year to the federal government. These numbers work out to approximately $7,000 on average per year per household under TANF and $6,000 per year per household under SSI, in each case around half of the average benefit under Social Security.

Lower-income working families are also eligible to receive rebates on payroll taxes through the Earned Income Tax Credit (which, again, the CBO counts as a negative tax rather than income). The House Budget Committee estimated that 28 million taxpayers took advantage of this program in 2011, at an estimated cost of $60 billion to the federal government; the average family with children claiming this benefit received $2,900 in tax rebates.

Of the $800 billion spent on antipoverty programs in 2012, less than $150 billion, or about 18 percent of the total, was distributed in cash income, if one includes the tax rebate under the EITC. The rest of the funds were spent on services and in-kind benefits, with the money paid to providers of various kinds, most of whom have incomes well above the poverty line.

With respect to the recipients of federal transfers, the CBO study reveals a surprising fact: households in the bottom quintile of the income distribution receive less in federal payments than those in the higher income quintiles. According to that study, households in the lowest quintile received on average $8,600 in cash and in-kind transfers in 2012; households in the middle quintile about $16,000 in such transfers; and households in the highest quintile about $11,000. Even households in the top 1 percent of the distribution received more in dollar transfers than those in the bottom quintile. The federal transfer system may move income around and through the economy, but does not redistribute it from the rich to the poor.

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It is well known in Washington that the people and groups that lobby for federal programs are generally not those who receive the services, but those who get salaries and income for providing the services. They, as Senator Moynihan observed decades ago, are the direct beneficiaries of most of these programs, and they have the strongest interest in keeping them in place. The nation’s capital is home to countless trade associations, corporate lobbyists, hospital and medical associations, agricultural groups, college and university lobbyists, and advocacy organizations for the environment, the elderly, and the poor, all seeking federal grants or contracts or some form of subsidy, tax break, or tariff.

This concentration of rent seekers is one reason why five of the seven wealthiest counties in the nation border on Washington, D.C., and also why the average income for the District of Columbia’s top 5 percent of households exceeds $500,000, the highest among major American cities. Washington is among the nation’s most unequal cities as measured by the income gap between the wealthy and everyone else. Those wealthy individuals did not descend upon the nation’s capital in order to redistribute income to the poor, but rather to secure some benefit to their institutions, industries, and, incidentally, to themselves. They understand a basic principle that has so far eluded progressives: the federal government is an effective engine for dispensing patronage, encouraging rent seeking, and circulating money to important voting blocs and well-connected constituencies, but not so effective at redistributing income.

James Madison wrote in The Federalist that the possession of different degrees and kinds of property is the most durable source of faction under a popularly elected government. Madison especially feared the rise of a redistributive politics in which the poor might seize the reins of government in order to plunder the wealthy by heavy taxes. He and his colleagues introduced various political mechanisms—the intricate system of checks and balances in the Constitution, federalism, and the dispersion of interests across an extended republic—to forestall a division between the rich and the poor in America and to deflect political conflict into other channels. While Madison’s design did not succeed in holding back the tide of “big government” in the twentieth century, it nevertheless proved sufficiently robust to frustrate the aims of redistributionists by promoting a national establishment open to a boundless variety of crisscrossing interests.

The ingrained character of the American state is unlikely to change fundamentally anytime soon, which is why those worried about inequality should abandon the failed cause of redistribution and turn their attention instead to broad-based economic growth as the only practical remedy for the sagging incomes of too many Americans, and the only reliable means of averting a political upheaval that could easily bring down America’s postwar order.