Did inequality help cause the financial crisis?

States within the United States compete with each other on tax, in an effort to attract mobile capital. This competition is harmful, and in particular it exacerbates inequality, by forcing tax rates on mobile capital to fall, while not having the same effect on (relatively immobile) labour. Recently, the Institute on Taxation and Economic Policy (ITEP) in Washington, DC, analysed the outcomes of this race to the bottom, in a distributional analysis of tax systems in the U.S. states. An ITEP summary of the report notes:

Nationwide, the poorest twenty percent of Americans paid on average10.9 percent of their incomes in state and local taxes in 2007. By contrast, middle-income taxpayers paid on average 9.4 percent of their incomes toward those taxes, and the wealthiest one percent of taxpayers paid just 5.2 percent of their incomes, on average, in state and local taxes.

State and local taxes are regressive, countering efforts made at the Federal level to institute progressive (that is, the poor pay a lower share of their income) taxation.

In the context of inequality, another report from Raymond H. Brescia of Albany Law School explores some links between inequality and the financial crisis. First, he notes the stunning rise in inequality in the U.S., akin to what preceded the Great Depression (see graph.) Then he asks:

"There are several possible explanations for the potential connection between rising income inequality and the great strains on the economy it causes. Did rising income for certain sectors lead to an ability to use that income to influence policymaking in such a way that favored those sectors? Did such income inequality pressure politicians to promote policies that favored easy access to credit as a way to mollify lower income constituents who might otherwise grow frustrated with their own stagnating wages in the face of such inequality? These are the types of explanations that some have offered to try to explain the link between income inequality and the Great Recession. In this work, I both analyze these explanations, but also offer a third: that both income inequality and racial inequality created greater social distance and this social distance, in turn, led to greater predatory conduct. That predatory conduct turned a mortgage market into an economic killing field.

The results of his research?

• the greater the income inequality in a state, on average, the greater the delinquency rate in that state.
  
• The greater the generalized trust in a state, the lower that state’s delinquency rate.
  
• The higher the social capital in a state, and the higher the level of volunteerism in a state, the lower its delinquency rate.
  
• The higher the median income in a state, the higher the delinquency rate in that state.
• An index of a series of indicators — income inequality within a state, the size of the African-American population in a state and the median income of the African-American population in that state — reveals a strong correlation between these indicators and delinquency rates. This correlation suggests not that low-income African-Americans are to blame for the foreclosure crisis, but, rather, that middle-class African-Americans were targeted for, and steered towards, loans on unfair terms, precipitating the foreclosures that are now concentrated disproportionately in communities of color.

And the conclusion? Among other things:

"If we are to believe that a lack of trustworthiness and an excess of predatory conduct helped feed the subprime mortgage bonfire, it is essential to restore checks and balances to the financial system that restrain such conduct, and incentivize trustworthy behavior in mortgage lending and other financial practices. We also need to reduce social distance, both economic and racial."

And that would fit comfortably enough with the conclusions of the Spirit Level, one of the most widely discussed (and impressive) pieces of research on inequality in history. Tax is obviously a big part of the inequality story, and in this respect, the latest ITEP report offers four useful pointers for U.S. states to follow.