‘Poor’ Assumptions in the Tax Debate | Wall Street Journal | 05.04.01

Now that House and Senate conferees have agreed on a $1.3 trillion tax cut, Democrats are lining up to attack this package as a giveaway to “the rich.” Many Republicans have taken this critique to heart by crafting tax cuts weighted toward “fairness” instead of economic stimulus. But all these criticisms are based on a vision of America that doesn’t exist and may never have existed: a Never-Never Land of “the rich” and “the poor,” two distinct and largely unchanging groups.

To buttress their vision of a stratified America, Democrats cite some seemingly alarming statistics: 12.5% of the population remains trapped in poverty, they argue, despite the long expansion, even as the top 5% saw their incomes double from the late 1970s through the end of the 1980s and grow larger still since then. But is this the whole story?

To see the real America, we need to follow people as they move through life, year by year, not just catch them in one place in life on the one day a pollster happens to call. The most respected but not the only effort at that is the University of Michigan’s Panel Study of Income Dynamics, which was launched in 1968 and now includes about 6,750 families. What do their findings tell us about how the real America looks?

First of all, yes, some people in the real America live in persistent poverty, stuck on the bottom rung of life. Some, but not many. They total about 1/2 of 1% of American families, if the bottom rung means an income in the lowest one-fifth of the earning population, year after year for a decade and more. About one-third of the families showing up in the bottom one-fifth of earners in one year will have risen to a higher income level by the next year. During the 16 years from 1975 to 1991, slightly more than 80% who started at the bottom moved to middle-class incomes or above. About 30% increased their incomes so much that by period’s end they were rich — that is, among the top one-fifth of all earners.

With poverty-level incomes today exceeding middle-class incomes of the 1950s and the incomes of all but the Carnegies, Rockefellers and their circles in the first decade of the 20th century, “poverty” in America has become a relative concept. People are poor because they fare less well than others, not because they face true indigency. And understood that way, for all but a sad few, poverty is something that, if it comes (and it appears to come at one time or another for about 30% of Americans), soon goes away.

Very high incomes have proven not quite so transient, but neither do the “rich” stay reliably rich in the real America. Not by a long shot. In the 1980s only about 6% of all families had incomes in the top 20% of the population every year throughout the decade. Even among the very wealthy — the top 1% at the decade’s start — more than half had dropped not only out of the top 1% but out of the top one-fifth of earners at decade’s end.

At the same time that many families were moving out of the top income bracket, many others were moving in. More than 40% of American families had a year in the top one-fifth of families during the 1980s. And according to a 1995 analysis of the Michigan data by the Dallas Federal Reserve Bank, over the 16-year period from 1975 to 1991, roughly 60% of families with incomes found themselves among “the rich,” that is among the top 20%, for one or more years. There is no reason to believe that this period was special.

In other words, wealth is highly transient in our dynamic economy. It should be no surprise, then, that, many of yesterday’s dot-com millionaires find themselves struggling to meet their mortgages today. Historically, such swings in income and wealth are closer to an American rule than to a New Economy exception. In the early 19th century, Tocqueville wrote that “the rich are constantly becoming poor. . . The rich daily rise out of the crowd and constantly return thither.”

More than 150 years later, this up-and-down picture — not a “Les Miserables”-like tableau of the permanently privileged and the permanently downtrodden — remains the real portrait of the real America.

How do tax cuts fit on this canvas?

If poverty is largely transient, then taxing and spending policies should be designed so as not to create barriers to upward mobility. The Bush plan does a good job of identifying and at least mitigating barriers to upward mobility built into the current tax code, and this is an area where Congress has followed the president’s lead.

If wealth is also transient, then most tax cuts for the rich actually go to middle-class people who briefly find themselves with a surge of income. Taxing such surges at other than middle-class rates means snatching away capital that would otherwise go to . . . what? Most people who find their income surging will make investments to lock in some security, so they won’t find themselves dependent on the government or anyone else in the future.

Congressional Democrats probably don’t want to sock it to this essentially middle-class group or to aggravate the nation’s looming crisis in retirement incomes. More likely, the people they really want to hit are the persistently rich, Warren Buffet for example. In fact, focusing on the persistently rich may open a route toward a compromise of Republican and Democratic differences over the top rate, the tax issue most sharply dividing the parties.

Such a focus would probably lead to making the top bracket apply only to those taxpayers whose incomes had crossed the current threshold for the top rate in, say, four of the previous five years. Imposing the top rate only on the persistently rich would be simple, and — as Democrats prefer in tax policy — it would be targeted.

It would also mean that Congress — both Republicans and Democrats — had left their Never-Never Land vision of America behind and had begun to make tax policy to fit the real America. With the economy as fragile as it has been, a tax cut rooted in the nation as it actually exists should become a high priority for everyone.