December 21, 2012

The fiscal cliff is fast approaching, and with tax cuts for affluent Americans set to expire, many of our nation’s richest citizens could face a significant tax hike.

From the perspective of President Obama and many Democrats, the way to decrease our deficit is to significantly increase the tax rate for high earners, so many of their proposed solutions call for tax changes based on income.

But are they focusing on the wrong thing? Is income really the best basis for deciding on tax hikes?

Recently, some economists have come forward to suggest that the key to fixing our country’s long-term economic woes is to start taxing wealth, not income. In the United States, the distribution of overall wealth–this includes an individual’s investments, savings and other assets–is highly imbalanced: The top 1% of Americans possess nearly 50% of total wealth in our country.

But are economists unfairly targeting the rich? Probably not. It turns out that wealth inequality adversely affects economic growth, and harms our country’s chances for success, according to research conducted by the International Monetary Fund, which focuses on securing financial stability around the globe.

We’ll take a closer look at how wealth inequality can hurt us all economically, and how our nation would change if we focused more on solving the inequality gap.

The Real State of Wealth Inequality in the U.S.

Simply put, wealth inequality is exactly what it sounds like: an unequal distribution of assets among a group of people. Even in a country in which the recent election was dominated by the concept of the 99% vs. the 1%, few Americans really understand the scope of wealth inequality in the U.S.

A recent survey conducted by Michael I. Norton and Dan Ariely—professors at Harvard Business School and Duke University, respectively—showed that most Americans greatly underestimate the state of inequality in the United States. The majority of respondents estimated that the wealthiest 20% of Americans owned only 59% of total wealth in this country.

The reality is starker: Recent data has shown that the top quintile owns as much as 84% of total wealth. In the below graph, taken from Norton and Ariely’s paper, you can see just how little wealth is owned by the four lower quintiles.

When asked how they’d want wealth distribution to look in an ideal scenario, the majority of respondents recommended that the top 20% own only 32%–that’s much closer to the distribution of wealth seen in Sweden.