How American Wars Lead to Increased Income Inequality

With the United States having been in a state of war(s) since 2001, a study by Rosella Cappella Zielinski at the Watson Institute of International and Public Affairs at Brown University is particularly pertinent, especially in this time of growing federal deficit spending.  In this report, she also examines the connection between social inequality and how wars are paid for by Washington.

Dr. Zielinski begins by looking at how governments pay for wars:

1.) through an increase in general public debt (i.e. deficit financing).

2.) through war bonds.

3.) Central bank money printing.

4.) through an increase in direct taxation (i.e. income, property and corporate taxes).

This is particularly critical given the concern about the growing level of sovereign debt in the United States.

Dr. Zielinski then estimates the costs of wars fought by the United States starting with the War of 1812 in both current year dollars (prices in effect at the time of each war) and in inflation adjusted dollars (using fiscal 2011 prices).  Here is a graphic showing how each of the last ten wars fought by the United States were financed by Washington:

It is quite apparent that America's wars between the War of 1812 and the First World War were financed using domestic borrowing (in red) with war debt being dominated by loans purchased from wealthy elites and banking syndicates.  One of the main reasons that taxation did not play a significant role in America's early wars was the fact that Washington only had the ability to raise funds with customs and excise taxes (with a temporary period of income taxation between 1861 and 1871); the imposition of a permanent income tax took place in 1913 when the 16th Amendment to the Constitution was ratified.    Taxation became increasing important for funding wars starting with the Second World War and continuing through to the Korean War which was 100 percent funded by increased taxes.  Like its earlier wars, Washington funded the Vietnam War mainly through domestic borrowing.  In sharp contrast, the Gulf War and the post-9/11 wars began with tax cuts; in these wars, external financing including allied grants and foreign borrowing were increasingly important.

Let's look again at how Washington can/has funded its war efforts:

1.) Debt -

a.) Domestic Debt - money which is lent to the government by its citizens and institutions with the guarantee that it will be paid back over time.  Purchasing war-related debt is voluntary and can take place in two forms; as a war bond campaign and through the issuance of general debt which may or may not be marketed to the public.

b.) External Debt - war funds are raised through the issuance of securities which are marketed on foreign markets or through the use of interstate loans or grants.

2.) Printing additional money.

3.) Taxation -

a.) Direct Taxation - includes income, property, corporate and excess-profits taxes with no option to opt out.

b.) Indirect Taxation - includes sales, value-added, excise and customs taxes with the option to opt out (i.e. these taxes can be avoided by consumers when they decline to consume taxable items).

Now that we have a background on how Washington has funded its wars over the past two centuries, let's look at how war financing relates to wealth distribution.  Wealth redistribution is classified in two ways:

Progressive - wealth is transferred from individuals in higher income brackets to those in lower income brackets which leads to greater social equality.

Regressive - wealth is transferred from individuals in lower tax brackets to those in higher income brackets which leads to greater social inequality.

Now, let's look at the relationship between wealth transferral and the methods of paying for wars as outlined above.  Let's start by looking at two means of financing a war that will lead to progressive redistribution of wealth and lowered income inequality:

1.) When governments issue war bonds and targets them towards lower income brackets by issuing the bonds in relatively low denominations, the interest which is accrued on the bonds over their life promotes the accumulation of wealth in low income households, resulting in progressive wealth redistribution.  

2.) When governments levy direct war taxes, particularly on those in higher income brackets, progressive redistribution of wealth takes place from higher income to lower income households.  In this case, the cost of the war is not a burden to those in lower income brackets. 

Now, let's look at two means of financing a war that will lead to regressive redistribution of wealth and raised income inequality:

1.) When governments issue war bonds that are not intentionally marketed to lower income households (i.e. issue them in only large denominations or market them through larger specialized investment firms that only wealthy households can access).  Those households that can afford to buy bonds will recoup their investment along with accrued interest, however, the cost of servicing the debt through increased taxes falls on all households, including those that cannot afford to purchase bonds which ultimately transfers wealth from lower income households to higher income households.

2.) When governments levy indirect war taxes, those households that are unable to opt out of purchases are forced to pay higher prices for goods and services whose costs have been inflated by war-related tax increases since manufacturers and sellers pass along indirect taxes to consumers.  In this case, indirect taxes result in a transfer in wealth from lower to higher income households.  Additionally, wartime scarcity can result in higher prices which is more problematic for lower income households.  

As well, wars that are financed by the printing of money promote income inequality because the increased supply of money in the economy leads to higher levels of inflation.  Wars that are financed by external debt may or may not increase domestic income inequality because American wealth is transferred to individuals and financial institutions that lie outside the American economy.

Let's look at the most recent and ongoing War on Terror and how it has impacted American wealth equality.  The War on Terror is paid for with domestic debt (60 percent) and foreign debt (40 percent).  The war began with a tax cut under the Jobs and Growth Tax Relief Reconciliation Act of 2003 with tax cuts continuing into the Obama Administration.  Unlike most U.S. conflicts, tax rates continued to decline throughout the war.  Here's a quote from the paper on the impact of the War on Terror on income inequality:

"The effect of post-9/11 war finance, including continuous tax cuts and domestic borrowing, on wealth redistribution will likely entail a transfer of wealth from low- and middle-income individuals to wealthy individuals. This regressive redistribution will be mitigated by the fact that due to general economic weakness, the increased military spending and resulting deficits did not result in wartime inflation."

Let's close with this graphic showing the relationship between war finance, inequality and the share of wealth held by the wealthiest one percent of Americans:

As you can see, the era after the Vietnam War resulted in increased income inequality, thanks to tax cuts, deficit war financing (outside of war bond issuance) and war-related inflationary effects.  The period since 2001 has also seen an increase in income inequality thanks to tax cuts and deficit war financing with the only saving grace being a period of relatively low inflation.  Dr. Zielinski predicts that, unless Washington shifts from a program of funding wars by deficit financing to funding wars through direct taxation, wars being fought by the United States will continue to contribute to America's growing income inequality.