The 1% Myth and the Victimization of America

A common liberal argument aimed at America's free market economy and reinforced in President Obama's budget proposal A New Era of Responsibility is that, over the last 25 years, the rich have gotten richer while the poor have gotten poorer. While this assertion should be of concern to anyone interested in domestic and economic policy, a critical examination of the data reveals the claim to be almost certainly spurious and uncovers an even more interesting question -- what is the motivation for the current administration to propagate such a claim?

The following chart, produced by Thomas Piketty and Emmanuel Saez, and displayed in the President's budget proposal, demonstrates that over the last 25 years, the share of income going to the top 1% has consistently increased and therefore, one must conclude the share going to everybody else has gotten smaller.

chart 1

This would seem to provide compelling evidence for the argument that in America's free market economy "the rich get richer, while the poor get poorer." This deserves a closer look.

Alan Reynolds, a senior fellow at the Cato Institute, has demonstrated that three major factors missing from the Picketty-Saez data, when included in the calculation, significantly reduce the apparent growing trend in income inequality. Reynolds argues that changes in the tax code, the large expansion of tax sheltered investments, and the growth of transfer payments to individuals can explain the growing trend in the Picketty-Saez data over the past 25 years.

According to Reynolds, "studies based on tax return data provide highly misleading comparisons of changes to the U.S. income distribution because of dramatic changes in tax rules and tax reporting in recent decades." Since 1979, the highest marginal individual tax rate has been reduced from 70% to 35%, while over that same period the corporate tax rate for businesses making over $100,000 has been reduced only from 46% to 39%. This has led to a shift in individuals reporting income on corporate returns to reporting it on individual returns by filing as S-corporations.

Beside changes in the tax code, two major variables cancel out much of the remainder of the growth in income inequality.  The first is the large expansion in tax sheltered investments like IRAs and 401(k)s. In 2007, there was an estimated 4.75 trillion dollars in these types of accounts, up from 400 billion 20 years earlier or an increase of nearly 1200%. The second variable is the growth in government transfer payments to individuals; which increased 214% during the same period (inflation adjusted). These variables are not accounted for in the Picketty-Saez data, because the majority of this money is not reported on income tax returns.

The Picketty-Saez data seems even more distorted when compared with the 2007 study published by the U.S. Department of the Treasury entitled, "Income Mobility in the U.S. from 1996 to 2005", which tracked almost 100,000 tax returns over a 10-year period. The study found that, controlling for inflation, nearly 58% of the poorest income group in 1996 had moved to a higher income group by 2005; 26% achieved middle or upper-middle income status and more than 5% made it into the highest income group. For individuals initially starting in the middle income group, 42% had moved to the upper-middle (29.6%) and highest (12.5%) income quintiles. Of those starting in the highest income quintile, over 30% had moved down by the end of the study period.

chart 2

The study concluded that economic growth resulted in rising incomes for most taxpayers over the study period with the median incomes of all taxpayers increasing by 24% after adjusting for inflation. The only groups to experience a decline in income were those initially in the top 1% and the top 5% groups. The study found that there was substantial income mobility of individuals during the study period, which was unchanged from the previous decade. A major point of the study is that income mobility in the U.S. works down as well as up, a sign that opportunity and merit drive American success.

The validity of the Picketty-Saez data and arguments aimed at growing income inequality are crucial when considering the current administration's plan to increase taxation on the highest earners to fund policy initiatives which will require a significant increase in government spending and intrusion into the private market. The plans to increase taxes only on the highest earners are especially remarkable considering the share of taxes the highest earners already pay.

chart 3According to 2008 IRS income statistics, the top 1% make 22% of income and pay 40% of total income taxes and the top 5% make 37% of income and pay 60% of total income taxes. The top 1, 5, 10, and 25% of wage earners pay a hugely disproportionate amount of taxes. This is the kind of data the current administration would like most Americans to remain ignorant of.

The bottom line, is that the policy initiatives being pursued by the current administration are expensive and will require huge expansions in government spending. To accommodate this spending the government will have to increase taxes. But consider this; could a politician advocate for a tax increase on the majority of the public and win - in any election? The answer is NO because regardless of the economic situation, the majority of individuals will always feel like they know how to spend their money better than the government does. However, could a politician advocate for a tax increase on a very small percentage of the public, argue it will be enough to finance spending that will benefit the majority, and win? The answer is clearly YES.

President Obama, using the recipe described above, repeatedly stated during his campaign that he would absolutely NOT raise taxes on anyone who makes less than the top 5% of earners -- the ones supposedly getting richer while the rest of us were getting poorer. In reality, as presented by the nonpartisan Congressional Budget Office in their analysis of the President's budget, this solution of raising taxes on only the top 5% will not provide enough revenue to support the huge expansions he is proposing.

As you can see, the Obama administration's budget (demarcated with the dotted lines) leaves revenue as a percent of GDP far too low to pay for the government services he is offering --
chart 4

and this already assumes the repeal of Bush's tax cuts for the rich. His only option then is to raise taxes on the rich to a higher level but that mechanism won't get him close to a balanced budget. Inevitably, he will need to institute a broad-based tax increase - an increase that if advocated for from the onset of his campaign, would have most likely resulted in an election defeat.

In The Constitution of Liberty, F. A. Hayek stated that, "It would probably be say that the illusion that by means of progressive taxation the burden can be shifted substantially onto the shoulders of the wealthy has been the chief reason why taxation has increased as fast as it has done and that, under the influence of this illusion, the masses have come to accept a much heavier load than they would have done otherwise."

The 1% Myth was a useful tool deployed by Liberals to make the majority of the American public feel like victims so they would vote for the candidate who offered them the prospect of seizing from the rich and redistributing to average Americans what rightfully belonged to them in the first place. It was a wonderful distraction to prevent the majority of the public from realizing that they were the real target all along.

While the data show that the public should not be overly concerned regarding growth in inequality, they should be extremely concerned about politicians willing to use invalid arguments like the 1% Myth to advance an agenda of increased government spending, taxation, and regulation that will almost certainly lead to economic stagnation, and a reduction in opportunity for ALL Americans.

Andrew Foy, MD and Brenton Stransky are authors of The Young Conservative's Field Guide. They can be contacted through their website at
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