Protecting the Brandeis Ratio?

by Reihan Salam

Ian Ayres and Aaron Edlin have a proposal in the New York Times:

What we call the Brandeis Ratio — the ratio of the average income of the nation’s richest 1 percent to the median household income — has skyrocketed since Ronald Reagan took office. In 1980 the average 1-percenter made 12.5 times the median income, but in 2006 (the latest year for which data is available) the average income of our richest 1 percent was a whopping 36 times greater than that of the median household.

The authors aim to make the current Brandeis ratio an upper bound:

Congress should reform our tax law to put the brakes on further inequality. Specifically, we propose an automatic extra tax on the income of the top 1 percent of earners — a tax that would limit the after-tax incomes of this club to 36 times the median household income.

Importantly, our Brandeis tax does not target excessive income per se; it only caps inequality. Billionaires could double their current income without the tax kicking in — as long as the median income also doubles. The sky is the limit for the rich as long as the “rising tide lifts all boats.” Indeed, the tax gives job creators an extra reason to make sure that corporate wealth does in fact trickle down.

Here’s how the tax would work. Once a year, the Internal Revenue Service would calculate the Brandeis ratio of the previous year. If the average 1-percenter made more than 36 times the income of the median American household, then the I.R.S. would create a new tax bracket for the highest 1 percent of income and calculate a marginal income tax rate for that bracket sufficient to reduce the after-tax Brandeis ratio to 36.

This new tax, if triggered, would apply only to income in excess of the poorest 1-percenter — currently about $330,000 per year. Our Brandeis tax is conservative in that it doesn’t attempt to reverse the gains of the wealthy in the last 30 years. It is not a “claw back” tax. It merely assures that things don’t get worse. [Emphasis added]

Interestingly, the authors are entirely indifferent as to what is to be done with the resulting revenue. Assuming superstar dynamics remain in place, the composition of the median household continues to change as individuals delay marriage and labor force participation declines, etc., it seems plausible that pressure on the ratio will grow, yet this will create a revenue windfall for the federal government.

The proposal calls for managing the after-tax Brandeis ratio. This could be shorthand for post-tax and post-transfer, in which case the federal government could simply provide a large cash payment to households at the median. Think about how this would change the political dynamic in U.S. society. Champions of the inequality tax would also be champions of large cash payments to households up to and including young middle-class individuals. Incentives to earn might be undermined for those in the highest bracket. Yet what would happen to incentives to earn for those at the median and below?

One is reminded of Monica Prasad’s argument regarding carbon taxes:

The very thought of new tax revenue has a way of changing the priorities of the most hard-headed politicians — even Genghis Khan learned to be peaceful, the story goes, when he saw how much more rewarding it was to tax peasants than to kill them. But if we want lower emissions, the goal of a carbon tax is to prompt producers to change their behavior, not to allow them to continue polluting while handing over cash to the government.

How do you get them to change? First, you prevent policy makers from turning the tax into a cash cow. Carbon tax discussions always seem to devolve into gleeful suggestions for ways to spend the revenue. Reduce the income tax? Give the money to low-income consumers? Use it to pay for health care? Everyone seems to forget that the amount of revenue is directly tied to the amount of pollution that is still going on.

Denmark avoids the temptation to maximize the tax revenue by giving the proceeds back to industry, earmarking much of it to subsidize environmental innovation. 

This introduces an interesting possibility. Instead of simply handing over income that exceeds the Brandeis ratio to the federal government, perhaps we can, like the Danes, earmark the resulting revenue to a fund devoted to mitigating poverty through a wide variety of innovative strategies. Some donors would devote resources to, say, marriage promotion and family formation while others would devote resources to early childhood interventions.

Under this scenario, one can imagine that some of the very wealthy will work strenuously to earn more so that they can (a) win the esteem of their peers and (b) maximize their impact by maximizing their donation to the fund, which will be run by an NGO that will rank the top contributors. (The political philosophers Joseph Carens has written on a related theme.) 

This idea isn’t that much more attractive than the vision advanced by Ayres and Edlin. It does, however, bring the role of government into the foreground. Unconditional transfers are a good way to mitigate inequality in one moment. It is not clear, however, that they are the best of facilitating durable intergenerational progress, given that some families will devote the transfers to consumption while others will invest in human capital, etc. Moreover, the government might choose to devote new tax revenue to, say, military adventurism, lunar mining colonies, and other ventures that aren’t directly salient to inequality. It is possible that Ayes and Edlin could identify the best and smartest ways to fight inequality over the long term, but it seems a safer bet to rely on a decentralized, trial-and-error process, a crude approximation of which is the aforementioned anti-poverty fund.