Experts: Obama, McCain tax plans won't close income gap

WASHINGTON — There are no easy ways for the presidential candidates to close the nation's gap between rich and poor, now bigger than any time since the 1920s.

Sens. Barack Obama and John McCain say their economic plans can narrow the income gap. Obama's tax plan offers a classic way to do that by increasing taxes on the rich, but economists think neither plan is likely to bring dramatic changes.

"Taxes are not going to solve the income-gap problem," said Roberton Williams, principal research associate at the nonpartisan Tax Policy Center. "Nobody's going to stand for the kind of confiscatory taxes you would need."

He and others said there are many other factors affecting income, including the tumultuous financial markets, technological change, global competition, the erosion of labor unions and corporate pensions, as well as federal tax and regulatory policies. Changing those policies to reduce income inequality could involve politically difficult measures, such as higher taxes or higher minimum wages and subsidies, none of which the candidates are considering.

Obama and McCain offer the kind of income strategies their political parties have been championing for years.

Obama, the Democrat, sees a role for government in helping people gain opportunities for education, training and work, while the wealthy who benefit most from society have an obligation to contribute more to the collective good.

McCain, the Republican, espouses a version of what some call the "trickle-down" theory that allows the rich to keep more of their income, on the theory that they will invest and spend, thereby creating jobs and wealth.

Republican loyalists said this concept worked well during Ronald Reagan's presidency, as the three-year tax cut that began in October 1981 helped pull the nation out of its worst recession since the Great Depression and triggered eight years of prosperity.

Democrats said too many lower-income earners never enjoyed the benefits of that boom, sustained, in part, by collapsing oil prices and record federal budget deficits.

Obama wants to return the two top income-tax rates to pre-2001 levels in 2011, the same rates as during the Clinton era, which had the longest sustained economic expansion in U.S. history.

That would mean a top income-tax rate of 39.6 percent, far less than the 70 percent top rate that existed until 1981 or the 50 percent top rate of 1982-86, not to mention the top rates of more than 90 percent that prevailed from the end of World War II until 1963.

The nation's top 1 percent of earners had a 22.9 percent share of all pretax income in 2006, according to a March study by Emmanuel Saez, an economist at the University of California, Berkeley. The top 1 percent earned more than $382,600 in 2006.

The top 1 percent's share of the national-income pie had hovered at 9 percent to 10 percent from the 1950s through the 1970s, and began climbing in the 1980s. While Americans at all income levels increased their wealth during the 1990s, the top 1 percent's income exploded. Since George W. Bush became president, their share has kept growing while everyone else's income barely rose.

Obama's tax plan aims to close the income gap a bit. A Tax Policy Center analysis found that those in the lowest 20 percent of income earners, making less than $18,981 a year, would have a 5.5 percent boost in after-tax income next year, if his plan were enacted. Those in the top 5 percent, making more than $226,918, would see after-tax income drop by 0.1 percent.

Under McCain's plan, if enacted, the 20 percent at the bottom would have a 0.2 percent increase in after-tax income next year, while the top 5 percent would gain 3.3 percent. Once McCain's plan is phased in fully, during 2012, top earners would gain 5.3 percent and the lowest 0.9 percent.

After-inflation median household income last year was $50,233, according to the U.S. Census Bureau. The top 1 percent earned more than $603,402, and the top 10 percent earned more than $160,972, according to the Tax Policy Center.

Saez found that from the mid-1920s to 1940, the top 10 percent of income earners had about a 45 percent share of national income. That declined to about 32.5 percent during World War II and remained about 33 percent through the 1970s, as the government maintained its highly progressive tax structure.

During the past 25 years, however, Saez said "the top [10 percent] share has increased dramatically ... and has now regained its prewar level."

The gap closed a bit from 1993 to 2000, when Bill Clinton was president, the top two tax rates went up and the economy boomed. Saez found real incomes grew by 2.4 percent a year for the bottom 99 percent, while the top 1 percent had a 10.1 percent annual increase then.

Only the rich gained much during the Bush years of 2002 to 2006, however. The top 1 percent saw real annual pretax incomes grow at an 11 percent clip, while everyone else's income grew at an annual rate of 0.9 percent.

During those years, "the top 1 percent captured almost three-quarters of income growth" Saez wrote.

In recent years, the soaring financial markets and hedge funds exploiting exotic financial instruments enabled the very rich to make huge amounts of money. The current financial crisis is taking its toll.

"What's happening now in financial markets should help make the gap smaller," said Ann Owen, a former Federal Reserve Board economist and now associate professor of economics at Hamilton College in New York.

Beyond financial-market gains, Saez said, top salaries exploded in recent decades, while lower salaries didn't. While those results largely are market-driven and difficult to change, economists said, the income gap could narrow if the next president changes not only tax policy but also regulatory and other fiscal policies.

Income, said Tax Foundation economist Gerald Plante, can be affected by changes in the minimum wage, farm subsidies, health care and other factors.

Obama's campaign officials said his policies will build middle- and lower-class prosperity, notably by reining in health-care costs, providing incentives for retirement savings, making college more affordable and helping to stabilize the housing market by keeping families in their homes.

McCain's plan calls for keeping more wealth in the hands of those who earn it.

"It is a disgrace to call for America to be competitive in the global economy and then turn around and tax corporations ... at over 35 percent," former Republican Rep. Jack Kemp said on McCain's behalf. McCain wants to cut that rate to 25 percent.

Williams, of the Tax Policy Center, was skeptical that either candidate would have much impact on shrinking the rich-poor divide.

"The bulk of the gap has been caused by pure income growth," he said, and the factors driving that are unlikely to change much.