Idea for Tackling Inequality Number 27,653: Stop Subsidizing It

It’s rare that a week goes by in Washington without some major conference on inequality. This usually involves some prominent people, who get six or even seven figure paychecks, speculating on why inequality has grown and what we can do about it. These exercises illustrate the basic problem.

Most of the discussion assumes that inequality is something that happened. By contrast, the more obvious story is that inequality is something that was done; it was the result of policies that had the effect of redistributing income upward.

It isn’t hard to identify these policies. A trade policy that is intended to put U.S. manufacturing workers in direct competition with low-paid workers in countries like Mexico and China has the predicted and actual effect of lowering their wages. It also lowers the wages of non-college educated workers more generally, as displaced manufacturing workers crowd into other sectors of the economy.

By contrast, recent trade agreements have done little or nothing to put highly educated professionals like doctors and lawyers in competition with their counterparts in the developing world. The same argument for gains from trade that economists used to justify deals like NAFTA would apply to proposals to make it easier for foreign professionals to train to U.S. standards and work in the United States. The lower pay to doctors and lawyers would save us tens of billions a year on health care costs and legal fees.

But economists get really confused when they’re asked about free trade in professional services. They apparently only studied policies that lower the wages of less-educated workers.

The same story applies to the Federal Reserve Board and its plans to raise interest rates this year. The point of raising interest rates is to slow the economy and keep people from getting jobs. This deliberate weakening of the labor market not only hurts the people who are unable to get jobs, it also hurts all of those who are already working by reducing their bargaining power.

Workers find it much more difficult to get pay increases when there is high unemployment. In fact, the low unemployment years of the late 1990s were the only time in the last four decades in which workers at the middle and bottom of the wage distribution enjoyed sustained real wage growth.

But if we can’t get the government to stop these policies that drive down wages and lead to more inequality, maybe we can at least get the government to stop subsidizing the high salaries of the people who have pointless conferences on reducing inequality. These people generally get paychecks well in the hundreds of thousands of dollars. They are subsidized by taxpayers because they work at tax-exempt institutions such as foundations, universities, and think tanks.

As a result of their tax-exempt status, wealthy people can write off their donations to these organizations against their income tax. With a 40 percent top marginal tax bracket, taxpayers are effectively paying 40 cents of each dollar of these salaries.

This suggests an obvious public policy for people concerned about inequality: cap the pay of anyone working at non-profit organization at something like $400,000 a year (twice the pay of a cabinet secretary). We generally are able to get very competent people to work as the Secretary of State or Attorney General. If a foundation or university can’t attract competent people even when offering twice as much money, perhaps it is not the sort of organization the taxpayers should be subsidizing.

Note that this is not capping pay at these organizations. If Bill Gates wants to pay someone $2 million or $3 million a year to run his foundation, he is welcome to do so. He just won’t be able to get the taxpayers to subsidize his foundation.

Another nice aspect of this policy is that it can be implemented at the state level. Changing the federal tax code would require an act of Congress, but most states offer special tax treatment to non-profits as well. There is no reason that states couldn’t make this special treatment contingent on universities, foundations, and other non-profits adhering to the twice a cabinet member’s pay ceiling. That carries less punch than losing federal tax exempt status, but it would still be a nice kick to non-profits that insist on bloated pay at the top.

Reducing the top salaries at non-profits will not reverse the rise in inequality of the last three decades. But it may spare us the spectacle of highly paid people, subsidized with our tax dollars, pondering the problem of inequality.

Originally posted at CEPR.Net.