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This Nobel Laureate Has a Plan to Prevent Massive Income Inequality in the Future

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Economists now agree that income inequality has gotten worse over the past few decades. But they continue to argue over what income inequality will look like in the future.

On one side are economists like Tyler Cowen and Erik Brynjolfsson who argue that inequality will keep getting worse. As they see it, technological change is basically dividing America (and much of the world) into two groups of people: A small, super-rich elite comprised mainly of entrepreneurs, innovators, and inheritors of wealth—and then a much larger, lower class of people working for them. If the government doesn’t step in and do something, the divide between rich and poor will only get wider.

On the other side of the debate are economists like Robert Atkinson. These experts think the inequality problem will stop getting worse—and may even start to get better—on its own. They point out that technology has created similar dynamics before and that, every time, the market has adapted in ways that allowed the divide to narrow again. They expect the same thing to happen now, or at some time in the future, without any intervention.

Now another distinguished economist has weighed in. In a New York Times op-ed that ran on Sunday, Robert Shiller, winner of the Nobel Prize in economics last year, warned that income inequality might rise to catastrophic levels—in effect, aligning himself with Cowen, Brynjolfsson, and others who say the trend is likely to continue. But Shiller also introduced a new idea: A change in income tax brackets, designed to take place only if inequality reached certain heights. He hasn't laid out many specifics of how it would work. But the basic idea is that government would stop adjusting the highest-income tax brackets for inflation. Over time, more and more of their income would be subject to the highest tax rates. (Policy makers call this “bracket creep.”) This would generate additional revenue, which Shiller proposes to spend on an expansion of the Earned Income Tax Credit (EITC) or other tax breaks targeted towards the lower- and middle-class.

How precisely would it work? What objections might it raise? Shiller and I spoke on the phone on Sunday about these and other questions:

Danny Vinik: Can you start by talking about the basics of your op-ed today and the rationale behind it?

Robert Shiller: Yeah, the first thing is we’re doing absolutely nothing on inequality. There’s a worry that it could get much worse, particularly because of computers—information technology replacing people. Experts say that’s not the only reason. In fact, that may not be the main reason for the recent increase in the top one percent, but nonetheless, I don’t have to provide a theory for what drives inequality to understand that there is certainly a risk that it will get worse. I think that one of the basic lessons of risk management is that you don’t wait until it happens. You make plans in advance. I think it’s particularly devastating to our society if inequality gets worse, so there should be a plan. I teach finance and risk management is a powerful tool, but you have to do it before the risk takes place. You have to insure your house before it burns down.

DV: Can you talk about your plan to index tax brackets to a form of inequality?

RS: In my 2003 book, I presented a rather extreme version, which was that we would just lock in the current inequality or let it get a little better. If it gets better, then we won’t do anything. But we won’t let it get worse. Then it was in 2006 that I did a paper with Len Burman where we estimated what would’ve happened if such a rule had been in place in 1979. The problem is that inequality has gotten a lot worse since 1979. We’d have to raise tax brackets really high on the rich.

DV: Tax brackets or tax rates?

RS: Tax rates. It’d have to be over 75 percent on high income. It’s technically raising taxes in terms of rates, but it’s not raising taxes in terms of outcomes. I thought maybe it could be reframed that way and be acceptable.

DV: My question there is the conservative argument against keeping an outcome the same way. Maybe the inequality that has developed over the past 40 years has helped out the people at the bottom of the distribution. Would locking in these outcomes and keeping a set level of inequality hold back growth and hurt people on the lower end?

RS: That would be a concern. I kind of doubt it, but I don’t know how to prove that. Would we grow even faster if we had more billionaires? I kind of doubt that. An example I’d like to give is suppose someone has been a manager of a company and has been very successful. He’s tired of it though. Say someone specializes in corporate turnarounds. You have to fire people and people get angry. It’s a thankless job. You do it and you turn the company around and now you’re in demand and other companies want you too, but now you’re rich from your last job so you’re not going to take on another one unless it makes me a lot richer. Maybe some people like that we would lose and we’d put more mediocre people in. I don’t know whether that is right or not. It might be right, but I also have reasons to doubt that. When you think of Steve Jobs for example, he was apparently a rare talent in running companies. There’s other examples like that. Edwin Land who set up Polaroid. When he retired, it went bankrupt. I have a sense that it’s not—I think we can replace people most of the time as CEOs with someone at a lower salary. It’s just my judgment, but you’re right, we don’t know for sure that there won’t be a cost in this.

DV: Digging into the details of the proposal, the new proposal by Len Burman would not adjust tax rates. It would adjust tax brackets. Can you tell me how that would work? It would replace the inflation index or modify it?

RS: Right now, we have built into the tax code that the brackets are indexed to inflation in such a way that when there’s inflation, the changes in tax brackets lower the take that the government gets. Obviously, it’s costly, because it was pushing more and more people into the higher tax rates unless it was indexed. This is more a framing issue. In behavioral finance, we emphasize framing—especially if you’re trying to sell something to the public. They’ve reluctantly accepted indexation of tax brackets now. But then the question is, how exactly should they be indexed? His idea was to merge that with inequality indexation. Instead of indexing the brackets, calculate how much you would get from indexing the brackets—how much tax revenue lost would be occasioned by that. Take that amount of money and use it across the different tax brackets in a way that is helping target the income distribution. It’s a way of scaling it down so it doesn’t threaten people so much.

Another idea I had was to ask for a bill [where] the insurance would only kick in, if there’s a real inequality disaster—something that most people think is unlikely. Why can’t we at least agree on that? In other words, if we let inequality get much worse, it would only kick in after a certain level of horrible inequality. Why can’t we do that?

DV: I just wanted to go back to the indexing for a second. This would get rid of inflation indexing and take that money that was being lost there and put it towards an expansion of the Earned Income Tax Credit and other lower- and middle-income tax breaks?

RS: It wouldn’t get rid of it unless inequality got worse. If inequality stayed the same, then it would just be the ordinary indexing.

DV: But if it got worse, it would reduce the amount it’s indexed?

RS: It would be punishing the newly rich by putting more of their income taxed at the highest rates.

DV: Would lower tax brackets continue to be indexed to avoid bracket creep?

RS: This would do more than index them, because if you just let inflation indexing happen, they’d be getting less advantageous.

DV: Yeah, I meant it wouldn’t just put all the money towards the EITC and other tax breaks. It would include EITC expansion plus other things.

RS: I suppose. You’d have to call Len Burman to see exactly what he has in mind. But it seems reasonable that we want to prevent bracket creep for low-income people and not put it all on the EITC.

DV: My other question was, as an insurance mechanism, what does this do for reducing inequality? It doesn’t seem to do much.

RS: We could set a target that is better than we have now. I thought I was already producing something so extreme that no one would want to touch it. The thing I keep telling my students right now is we don’t focus enough on big risk. That may be a relatively low probability, but low probability things happen in history.

History is full of surprises. I wrote a book called The New Financial Order and another called Finance and the Good Society. It’s something about how we think about risk and we take provisions for them. That may sound odd. That’s what we do. I really worry that inequality will get worse. People say that technological unemployment has been talked about for over 200 years and it still hasn’t happened. But it could happen, especially with the way technology is moving. I’d just like to have something in place.

DV: How do you think this could be sold politically, given that the goal is to guard against the future slight risk of extreme inequality developing?

RS: Len Burman has always emphasized that the way you’d sell this in Washington is to make it part of a compromise. Let’s say the Republicans want something, but then the Democrats would object that might cause increased inequality and Republicans say “No, it won’t.” OK then can we put in to the law, if it does, then it’ll lead to a tax increase. Maybe then the Republicans will go along with that. They know they have to compromise on some things.

This interview has been edited and condensed.