Blame the Economy for Widening Inequality – And Washington for Doing Little about It

Blame the Economy for Widening Inequality – And Washington for Doing Little about It

October 3, 2017

America’s widening income inequality has become a subtext across most debates in domestic policy.  GOP plans to repeal and replace Obamacare failed in large part because virtually every expert warned that the changes would end coverage for millions of people with modest incomes and cut taxes for high-income people.  President Donald Trump’s push to cut business taxes will likely meet a similar fate.  He shouldn’t be surprised: The populist revolt that helped elect him has been fueled by popular anger over Washington’s incapacity to do anything about how the economy skews its rewards towards those at the top and away from most everyone else.

Ask the right questions, and the income data reveal a great deal about how this inequality took hold over the last 40 years.  It is given that the American economy and politics both changed dramatically over this period.  But how did each of those forces affect the distribution of incomes? In a new study just issued by the Center for Business and Public Policy at the McDonough School of Business at Georgetown, I used statistical analysis to explore this question.  It turns out that we can track the economy’s role in growing inequality by following the changing distribution of all pre-tax income, and then track the role of politics and the government by following the changing distribution of all post-tax income.

It also turns out that the new populists, or at least their feelings, are justified:  As economic changes have produced widening income inequality, the government has remained largely though not entirely on the sidelines.

To begin, the data show that rising inequality in the United States began in 1977, and the same data series ends with 2014, giving us 37 years of income information on both a pre-tax and post-tax basis.  Over those years, the share of pre-tax national income going to the bottom 50 percent of Americans – that is, not taking account of changes in taxes and government transfers – slumped from 20 percent to 12.5 percent.  This was the doing of a changing economy as globalization and technological advances steadily squeezed the wages and working hours of tens of millions of low, moderate and middle-income Americans.

Over the same years, the share of all pre-tax income going to the top one percent of Americans soared from 10.7 percent to 20.1 percent.  The economic drivers were the same.  In their case, the rapid progress of globalization and new technologies boosted both the returns on capital – think of soaring stock markets – and the compensation of millions of American business executives and professionals.

“Income shares” are economist-speak, so let’s translate them into the average incomes for each group.  The results are sobering.  The average pre-tax income of the bottom 50 percent of Americans, in 2014 dollars, inched up from $15,948 in 1977 to $16,216 in 2014, for a raise of $268 or 1.7 percent over 37 years.  The top one percent lived in a different economy:  Their average pre-tax income in 2014 dollars jumped from $424,631 in 1977 to $1,305,301 in 2014, a raise of $880,670 or more than 207 percent.

To see what the government did about all this, we shift the analysis to the two groups’ income shares and average incomes on a post-tax basis.  The data show, first, that the government took some steps to soften the blow for the bottom 50 percent of the country and were modestly effective.  After taking account of changing tax and spending policies since 1977, the share of all post-tax income going to the bottom half of the country fell from 25.6 percent in 1977 to 19.4 percent in 2014.  So, their income share dropped 24.2 percent on a post-tax basis, compared to 37.5 percent on a pre-tax basis.

The difference tells us what the government actually accomplished:  Washington managed to offset a little over one-third of the adverse impact of globalization and new technologies for the bottom 50 percent of Americans [1 – (24.2 / 37.5) = 0.355].  Their relief came mainly from government steps to expand the earned income tax credit, broaden access to Medicaid, and provide subsidies for health insurance under Obamacare.  Other tax changes made the federal income tax moot for most of this group, but increases in payroll tax rates offset those gains.

Turning to actual incomes, we find that the average post-tax income of the bottom half of the country increased over this period, in 2014 dollars, from $20,390 in 1977 to $24,925 in 2014.  That signifies a raise of $4,535 or 22 percent over 37 years – not much, but better than the 1.7 percent gains in average pre-tax income.

Washington has been more solicitous of the top one percent of the country.  After taking account of changes in tax and spending policies, their share of all post-tax income jumped from 8.6 percent in 1977 to 15.6 percent in 2014.  So, the income share going to the top one percent of Americans increased 81.4 percent on a post-tax basis, compared to 87.8 percent on a pre-tax basis.

Once again, the difference tells us what Washington did: 37 years of tax changes and spending offset about 7 percent of the fast-rising income gains claimed by the top one percent [1 – (81.4 / 87.8) = 0.073].  In more concrete terms, the average post-tax income of the top one percent of Americans increased, in 2014 dollars, from $342,328 in 1977 to $1,012,429 in 2014.  That’s a sweet raise of $670,101 or 196 percent over 37 years.

Over nearly four decades, then, Washington demonstrated moderate concern about the declining position of the bottom half of the country while affirming the rising position of those already at the top.

This record tells us it is time to address the real drivers of widening inequality:  Shift our focus from half-hearted redistribution to serious economic reforms — aggressive anti-trust for all concentrated industries, for example, and universal access to free retraining at community colleges — that can put average Americans in a better positions to capture the rewards of globalization and technological change.



The Three Choices for Tax Reform

September 13, 2017

Trump administration officials and GOP leaders in Congress are still putting together their tax plan. Nevertheless, the early signs point to decisions that could sink the project or produce changes that would jeopardize economic growth.

Congress can approach changing the corporate tax in one of three ways. It can try to simplify the code, it can reform it, or it can cut it back. The GOP’s current approach appears to start with simplification. Simplifying the corporate tax normally means phasing out a package of tax preferences for particular industries or business activities, and using the revenues to bring down the current 35 percent tax rate to 28, 25 or even 20 percent. This model shifts the burden of the tax among industries but not among income groups, since shareholders continue to bear most of the burden. Such simplification can also attract bipartisan support and produce real economic benefits. At a minimum, it lowers tax compliance costs for most businesses; and if it’s done thoughtfully, it can increase economic efficiency. To be sure, any efficiency benefits will be marginal unless the simplifications are fairly broad and sweeping.

The record also shows that serious tax simplification is very hard to achieve. Support from President Obama and congressional GOP leaders wasn’t enough to advance it in 2014, for the simple reason that most companies prefer their tax preferences to a lower tax rate. They’re not wrong economically: The Treasury calculated in 2016 that tax preferences lower the average effective corporate tax rate to 22 percent, and companies in many industries pay substantially less. Why give up those preferences for a 28 or 25 percent rate? A 20 percent rate could solve the problem for most industries, if anyone had a plausible way to pay for it. Of course, financing a deep rate cut was the border adjustment tax promoted by Speaker Paul Ryan, and which the White House and big importers and retailers quickly squashed.

The second option is genuine reform, where Congress changes the structure of the corporate tax. Economically, the most promising reform would give U.S. companies a choice of tax treatments when they invest in equipment. They could deduct the full cost of those investments in the year they make them (“expensing”) while giving up the current deduction for interest on funds borrowed to finance the investments. Or they could stick with the current depreciation system for their investments, including the deduction for interest costs. If enough companies choose the first route, as they likely would, this reform would spur investment and sharply reduce the tax code’s nonsensical bias towards financing business growth with debt rather than equity. Such a structural reform would make sound economic sense. It also seems as unlikely as serious simplification, because it foregoes the pixie dust of marginal tax rate cuts that GOP supply-siders demand.

That leaves the Trump administration and Republican leaders with option three: Cut the corporate tax rate without paying for it. The President seems to favor this approach. He has called repeatedly for slashing the corporate rate to 15 percent, a multi-trillion dollar change, and paying for a small piece of it by limiting a few personal tax deductions for higher-income people. It’s also catnip for GOP supply-siders who continue to proclaim that a deep rate cut will boost economic growth enough to pay for itself. We’ve tried this t several times already, so we now have hard evidence to evaluate those claims. The actual record shows, beyond question, that such turbo-charged dynamic effects do not occur. The most recent example is George W. Bush’s 2001 personal income tax cuts. His “success” enacting them produced huge deficits and ultimately contributed to the financial collapse that closed down his presidency.

A largely-unfunded cut in the corporate tax rate in 2018 would boost corporate profits as well as budget deficits, but it won’t increase business investment, productivity or employment. Prime interest rates in this period have been lower than at any time since the 1950s, so companies have had easy and cheap access to funds for investment for years. At a minimum, this tells us that there’s no real economic basis to expect businesses to use their windfall profits from a big tax cut to expand investment.

Instead, they’re likely to use some of their additional profits to fund stock buy-backs. The rest will flow through as dividends and capital gains, mainly for the top one percent of Americans who hold 49.8 percent of stock in public companies, and the next nine percent who own another 41.2 percent of all shares. Those lucky shareholders will use much of their windfall gains to buy more stock; and coupled with the corporate stock buy-backs, the boost in demand for stocks will pump up the markets. To be sure, those shareholders will also spend some of their unexpected gains, which will modestly stimulate growth. Once that stimulus dissipates, as it will fairly quickly, the ballooning budget deficits will drive up interest rates and slow the economy for everyone else.

The worst scenario is that large, deficit-be-damned cuts in the corporate tax rate could produce a stock market bubble that could take down the economy when it bursts. The good news is that the current Congress would never enact it. The odds of Democrats supporting Donald Trump on a tax plan to make shareholders richer are roughly the same as winning the Powerball; and the certainty of soaring budget deficits should scare off enough conservative Republicans to sink the enterprise.



It’s Still the Economy, Stupid!

July 24, 2017

Republicans know that the terrain for next year’s midterm elections could be treacherous.  Off the record, they bemoan their inability to enact their agenda and mourn President Donald Trump’s unpopularity.  In principle, the GOP still might get its act together and pass a tax reform with new tax breaks for middle class taxpayers.  Events unforeseen and unimagined could offer Trump a platform to renew his poplar appeal.  Even so, they’re ignoring the signs that a sagging economy next year will dominate the 2018 campaigns.

The current expansion is old – it turned eight years old this month – and its fundamentals are weak.  Neither Trump nor Congress has done anything to perk it up.  Only the 1990s expansion lasted longer, and it expired two years after its eighth birthday.  Comparing the two will not cheer Republicans. At a comparable point in the expansion that defined the Clinton era, March 1999, GDP was growing at nearly a 5 percent rate; over the last year, GDP has edged up barely 2 percent.

The most important difference is what was happening then with productivity, and what’s happening now.  In the three years leading up to each expansion’s eighth birthday, productivity had expanded at a 2.4 percent annual rate in the 1990s, compared to 0.7 percent this time.  Without decent productivity gains to lift wages and fuel demand, incomes stall and growth slows.

The main reason we’re not in a recession today is the strong job gains of the last three years, and the current 4.4 percent unemployment rate is comparable to the 4.2 percent rate in March 1999.   Full employment normally presages a slowdown in job creation.  We avoided that in the late 1990s, because the strong productivity growth supported more demand by raising wages.    The best measure of that is personal consumption spending, which increased at a 5.9 percent rate in the year leading up to March 1999.  But our current predicament includes such weak productivity gains that personal consumption spending edged up just 2.6 percent over the last year.

It’s the same story with business investment, the other domestic source of new demand. In the year preceding the eighth birthday of the 1990s expansion, fixed business investment rose 8.5 percent; over the past year, it grew 4.2 percent or half that rate.

All of these measures presage a slowdown in the U.S. economy next year – GDP gains of 1.5 percent in 2018 is a fair guess — and we could slip into a recession if some adverse event provides the trigger.

Last October, I cautioned Hillary Clinton that she would face these same conditions if she won, but that three initiatives could breathe new life into this old expansion.  The first order of business is a dose of demand stimulus, preferably through large infrastructure investments paid for down the line.  Trump promised the same thing; but he and the GOP Congress moved quickly beyond it.

The second initiative would focus on energizing productivity growth.  My own recommendations last October started with measures to help average Americans upgrade their skills, by giving them free access to training courses at local community colleges.  The Trump and GOP budget proposals would cut the inadequate training programs already in place.

The third initiative is a companion piece to promote higher productivity: Jumpstart business investment in new technologies and equipment.  That will be harder for Trump than it would have been for Secretary Clinton, because it requires setting aside the supply-siders’ faith in the power of cutting marginal corporate tax rates.  Instead, we should focus for now on lowering businesses’ upfront costs to purchase the new technologies and equipment that make skilled workers even more productive.

The measure would offer businesses a choice: deduct the full cost of those new purchases in the year they buy them – it’s called “expensing” – or stick with the current system where businesses depreciate the cost and deduct the interest on funds borrowed to cover it. Expensing is a feature of the Trump and GOP tax proposals, but both plans offer more sweeping and much more expensive changes that appear headed for the same fate as Trumpcare.

The election of Trump and the GOP Congress buoyed business confidence precisely because investors believed they would follow through quickly with an infrastructure stimulus and business tax reforms.  Neither seems likely today; and even if one or the other somehow passes in some form late this year, it will probably be too little and too late to revive growth and wages by November 2018.  If neither happens, it will take more than tweets to explain to voters why Republican control of both branches of government has failed to improve their lives.



Trump’s Tax Plan is Aimed at the 2018 and 2020 Elections, Not U.S. Competitiveness

April 26, 2017

President Trump wants to cut the tax rate for all American businesses to 15 percent, and damn the deficit. If you believe him, any damage from higher deficits will be minor compared to the benefits for US competitiveness, economic efficiency, and tax fairness. The truth is, those claims are nonsense; and the real agenda here is the 2018 and 2020 elections. Without substantial new stimulus, the GOP will likely face voters in 2018 with a very weak economy – and tax cuts, especially for business, are the only form of stimulus most Republicans will tolerate. Moreover, if everything falls into place, just right, deep tax cuts for businesses could spur enough additional capital spending to help Trump survive the 2020 election.

Let’s review the economic case for major tax relief for American companies. It’s undeniable that the current corporate tax is inefficient – but does it actually make U.S. businesses less competitive? The truth fact is, there’s no evidence of any such effects. In fact, the post-tax returns on business investments are higher in the United States than in any advanced country except Australia, and the productivity of U.S. businesses is also higher here than in any advanced country except Norway and Luxembourg.

The critics are right that the 35 percent marginal tax rate on corporate profits is higher than in most countries. But as the data on comparative post-tax returns suggest, that marginal tax rate has less impact on investment and jobs than the “effective tax rate,” which is the actual percentage of net profits that businesses pay. On that score, the GAO reports that U.S. businesses pay an average effective tax rate of just 14 percent, which tells us that U.S. businesses get to use special provisions that protect 60 percent of their profits from tax (14 percent = 40 percent of 35 percent).

Tax experts are certainly correct that a corporate tax plan that closed special provisions and used the additional revenues to lower the 35 percent tax rate would make the overall economy a little more efficient. But lowering the rate alone while leaving most of those provisions in place would have almost no impact on the economy’s efficiency – and the political point of Trump’s plan depends on not paying to lower the tax rate.

Finally, would a 15 percent tax rate on hundreds of billions of dollars in business profits help most Americans, as the White House insists, since 52 percent of us own stock in U.S. corporations directly or through mutual funds? The data show that most shareholders would gain very little, because with 91 percent of all U.S. stock held by the top 10 percent, most shareholders own very little stock.

Moreover, the proposed 15 percent tax rate would cover not only public corporations but also all privately-held businesses whose profits are currently taxed at the personal tax rate of their owners. So, Trump’s plan would slash taxes not only for public corporations from Goldman Sachs to McDonald’s, but also for every partnership of doctors or lawyers, every hedge fund and private equity fund, and every huge family business from Koch Industries and Bechtel, to the Trump Organization..

There is no doubt that the President’s tax plan would provide enormous windfalls for the richest people in the country. Beyond that, it may or may not sustain growth through the next two elections, since even the best conservative economists commonly overstate the benefits of cutting tax rates. But the truth is, there aren’t many other options that a Republican Congress would accept.

 



Donald Trump and Paul Ryan’s Plan to Put Foreign Investors First

March 29, 2017

The “Border Adjustment Tax” (BAT) endorsed recently by President Trump is his administration’s first foray into international economics. It is an inauspicious start.

BAT advocates like House Speaker Paul Ryan promise it will cut the trade deficit by making U.S. exports cheaper abroad and foreign imports more expensive here. The truth is, a BAT won’t much affect U.S. exports or imports, and it certainly won’t create jobs. It would produce a large stream of new federal revenues, and it could trigger retaliatory tariffs on some U.S. exports. A BAT also would enrich a great many foreign investors and companies, and leave a lot of American investors and large companies poorer. All told, it’s the kind of “bad deal” that Mr. Trump once railed against.

Mr. Trump and Speaker Ryan never mentioned a BAT until recently, and the reason they like it now is that it’s a cash cow to pay for their sharp cuts in corporate taxes. The Trump-Ryan BAT would give U.S. producers a 20 percent rebate on the wholesale price of any goods or services they export – 20 percent, because that’s the GOP’s preferred corporate tax rate – and impose a 20 percent tax on foreign goods and services imported here from abroad. It would raise trillions of dollars, because we import about $500 billion more per-year than we export.

For conservatives at least, all those revenues should be a red flag. In a populist period, a subsequent President and Congress may well decide to raise corporate taxes — and when they do, the BAT’s fat revenue stream could well go to fund progressive causes.

Mr. Trump still has no Council of Economic Advisers, so maybe he believes that a BAT will spur U.S. exports and create jobs. Even Peter Navarro should to be able to tell him why that won’t happen. At first, a BAT would strengthen demand for U.S. exports and weaken demand for foreign imports here. But those shifts in demand would quickly strengthen the dollar and weaken foreign currencies, perhaps enough to offset the BAT’s initial impact on import and export prices. In theory, the currency movements triggered by the changes in prices brought about by the BAT should restore pre-BAT prices for both imports and exports, so the only change would be a lot of new revenues from taxing net imports.

In practice, the BAT’s impact on the dollar and U.S. trade is a roll of the dice. As Federal Reserve chair Janet Yellen noted recently, no one knows how closely the currency changes will mirror the BAT’s direct effects on prices. If they overshoot, U.S. consumers will pay more for imports; if they undershoot, U.S. export prices won’t fall much. On top of that, no one knows how much of the BAT tax U.S. importers will pass along to American consumers, and how much of the BAT rebates U.S. exporters will pass along to their foreign customers. Finally, painful retaliation might follow, since China and others won’t take kindly to paying a 20 percent tariff on their exports to the United States, and China’s competitors won’t like the BAT’s substantial devaluation in the yuan-dollar exchange rate.

One effect is certain: The BAT will harm U.S. investors and reward foreign investors as the currency changes reduce the dollar value of U.S.-owned assets abroad and increase the foreign-currency value of foreign-owned assets here. The Bureau of Economic Analysis tells us that in the second quarter of 2016, Americans held foreign stocks, corporate and government bonds, and derivatives worth $12.9 trillion; and foreign-owned financial assets in the United States totaled $20.3 trillion.

If we assume the Trump-Ryan BAT leads to a 20 percent increase in the value of the dollar and a corresponding 20 percent decline in the trade-weighted value of foreign currencies, it would reduce the value of U.S.-held financial investments abroad by nearly $2.5 trillion and increase the value of foreign-owned financial investments here by more than $4 trillion. What kind of deal is that, Mr. President?

The trillion-dollar losers will include U.S. investors in European or Asian mutual funds; U.S. companies with profitable foreign subsidiaries, from Microsoft and Facebook to Coca Cola and Pfizer; and U.S. banks that lend to foreign companies. The trillion-dollar winners will include foreign investors with U.S. mutual funds; foreign companies with major American subsidiaries, from Toyota and Anheuser Busch to Unilever and Phillips; and foreign banks who lend to U.S. companies.

Perhaps the best motto for the Trump-Ryan BAT is “Put Foreign Investors First.”

Robert J. Shapiro, chairman of the economic and security advisory firm Sonecon, was Under Secretary of Commerce for Economic Affairs in the Clinton administration. In the 2016 campaign, he advised Hillary Clinton.

 



What Hillary’s Campaign Missed

November 15, 2016

Last week’s election should be dubbed the revenge of the neglected. The outcome would have been different if Hillary’s strategists had taken to heart James Carville’s famous quip in 1992, “It’s the economy, stupid.” I remember it well, because I pulled together Bill Clinton’s economic program for the 1992 campaign. Of course, today’s economic problems are different from those of a quarter-century ago. But the political manifestation is virtually the same – tens of millions of Americans justifiably dissatisfied with their economic conditions and prospects.

As regular readers of this blog know, I’ve spent several years tracking what’s happened to the incomes of Americans of different ages, races and ethnicities, educational levels and gender, as they grew older. The Brookings Institution published the first results in 2015 covering the period 1980 to 2012. I sent that report to Hillary and Bill Clinton and as many of those who worked for them as I knew. The results refuted the left’s claims that incomes of average Americans have stagnated for two generations – across every category, median household incomes rose at healthy rates, year after year, through the presidencies of both Bill Clinton and Ronald Reagan.

But the results also showed tectonic income changes from 2001 to 2012 as this steady income progress ended. Hillary was particularly struck by the study’s darkest finding: The median income of households headed by people without college degrees — which covers nearly two-thirds of all U.S. households – fell as their household heads aged from 2001 to 2012.  This unprecedented development, of tens of millions of families losing income as they aged from their thirties to their forties, or from their forties to their fifties, held across race, ethnicity and gender, and for all age groups except millennials.

For example, the real median income of households headed by high school graduates ages 35-to- 39 in 2001 fell from $54,862 in 2001 to $49,800 in 2012. (All income data here are in 2012 dollars.) So, these Gen Xers earned $5,062 less at ages 46-to- 50 in 2012 than they did when they were 35-to- 39 years old in 2001. Their counterparts a decade earlier – households headed by high school graduates ages 35-to- 39 in 1991 – saw their real median incomes rise from $51,645 in 1991 to $63,614 in 2000, for gains of nearly $12,000 (about 20 percent) as they aged from their later-thirties to their later-forties.

Baby boomer households headed by high school graduates who were 45-to- 49 years old in 2001 suffered even larger income losses than the Gen Xers: From 2001 to 2012, their real median income slumped from $63,534 to $51,002, falling $12,532 or some 20 percent as they aged from their later-forties to their later-fifties.

Households headed by college graduates didn’t lose income as they aged over the following 11 years, but only barely so. The median income of those households headed by people ages 35-to- 39 in 2001 inched up from $97,470 in 2001 to $100,771 in 2007, and then fell back to $98,845 in 2012, when they were 45-to- 49 years old. Compare that to the 1990s, when households headed by college graduates ages 35-to- 39 in 1991 saw their median income rise from $81,742 in 1991 to $106,454 in 2000, gains of $24,712 or about 30 percent I calculated that about half of all working-age households lost substantial ground as they aged through that decade, and another quarter of Americans treaded water. This was an economic turn the United States has never seen before. It gave meaning to Donald Trump and Bernie Sanders’ claims that the economy is rigged, and it bred the broad anger that ignited their campaigns.

Hillary’s campaign didn’t ignore these developments. But her strategists, intent on reprising President’s Obama winning coalition, focused instead on the special problems of young, minority, and female voters. The campaign offered the Hispanic community a new path to citizenship for undocumented workers, and promised pay equity for women. It called for larger Earned Income Tax Credit checks for working-poor families, and debt relief for recent college graduates. All of these initiatives have merit. But none of them directly addressed or even acknowledged the structural forces squeezing out income gains for much of the country.

Hillary pressed me to explain the long income slump. I told her the truth: These income problems did not bubble up from the trade deals of the 1990s and the offshoring of manufacturing jobs, which happened mainly in the 1970s and 1980s. The fault lay mainly in forces much harder to demonize, namely technological advances and the way globalization and the Internet affect how companies price their goods and services.

Americans love the entertainment and social networks fostered by information technologies and the Internet. But these technologies also restructured the operations of virtually every office, factory and storefront. As that happened, anyone without the skills and confidence to work effectively in an IT-dense workplace saw his or her “labor value” erode and wages fall. College graduates avoided the worst of the income slump, because virtually everyone who earned a bachelor’s degree in the last 15 years is IT literate.

The other major culprits for the recent income squeeze are the Internet and, yes, globalization. Again, manufacturing job losses are not the heart of it. Rather, the Internet and globalization both intensify pricing competition, and businesses facing those strong competitive pressures often find themselves unable to pass along any rising costs in higher prices. So, as energy and employer healthcare costs rose sharply, especially from 2000 to 2008, many U.S. companies were forced to cut other costs. The data show that those cuts started with jobs and wages.

All of these downward forces took hold throughout the 2002-2007 expansion, and the financial crisis and deep recession that followed only amplified them.

The data also show that conditions shifted again in 2013, when energy prices collapsed, Obamacare started to slow employer healthcare premium increases and, with wages and salaries depressed, hiring became an attractive proposition again for companies. The latest data show that incomes have been rising since 2013 across virtually every group. For my friend Hillary, it was too little, too late: A few years of modest income progress have not offset a decade of painful losses.

But Trump’s success as president will depend on sustaining those income gains for four more years. As I’ve said here before, the economy needs a good dose of stimulus, and Trump’s deficit-defying tax cuts should jump-start growth in late-2017 and 2018. But his tax plans are so excessive economically, they could set the Federal Reserve on a course of multiple interest rate increases that slow growth by 2019. Beyond that, the economic challenge that Hillary also would have faced is that income progress ultimately requires healthy productivity gains, but productivity growth have slowed dramatically for few years now. If Trump and the GOP Congress fail to nudge up productivity, they could face their own populist revolt in 2020.



Halloween Special: How Hillary Can Handle Scary Interest Rate Hikes

October 31, 2016

Looking past this weekend’s kerfuffle over Huma Abedin’s emails, Hillary Clinton’s success in her first term as President will depend in large part on whether the incomes of most Americans keep rising. As readers of this blog know, my studies tracking people’s incomes, year to year as they aged, found that the median household incomes of millennials, Gen Xers and boomers all grew at healthy rates in 2013, 2014 and 2015. Moreover, this income progress reached across gender, race and ethnicity, and educational levels. That’s why consumer confidence and President Obama’s approval ratings are now so high.

The catch is that for most households, these gains came after a decade of income losses from 2001 to 2012. Hillary’s first challenge is to avoid a recession that could overwhelm most people’s recent gains — and her opportunity is to provide four more years of income progress that could well make most Americans optimistic again.

The challenge could start between Hillary’s election and inauguration, in December when the Federal Reserve’s Open Market Committee (FOMC) next votes on raising short-term interest rates. At the FOMC’s last meeting in September, its members voted seven to three not to raise those rates; but most Fed watchers expect the Committee to reverse this stance in December. Based on the Fed’s history, that decision will be followed by a long succession of additional interest rate hikes over the next three years. If that happens, growth and income gains could stall or worse as the costs for businesses to invest, and for consumers to buy a home, a car or a major appliance, all rise.

Traditionally, the Fed raises interest rates when the economy threatens to overheat and pump up inflation. But this time, there is little evidence of such a scenario. Inflation has risen at an annual rate of less than two percent for 51 consecutive months, and growth this year has been modest.  Moreover, based on long-term interest rates, U.S. and global investors expect low weak inflation to persist for years.

The only evidence that inflation hawks can cite is the recent strength of job creation. From January 2013 to September 2016, U.S. businesses added an average of 204,000 net new jobs per month. That’s nearly the pace last seen under Bill Clinton, when business created an average of 219,000 net new jobs per month from January 1993 to December 2000. Worrying about inflation may make sense once we reach full employment, since when that happens, competition for workers pushes up wages that are passed on in higher prices.

But the United States is not at full employment today, or close to it. Large numbers of people continue to work part time and not by choice, and labor force participation by prime age Americans remains abnormally low.

 The Fed’s only real argument for raising interest rates is strategic — higher rates create the room for the Fed to cut them in the next downturn. But even with 2.9 percent growth in the third quarter, the economy has expanded at a rate of less than two percent this year, and fixed investment has declined four quarters in a row. In this economic environment, a succession of rising interest rates over the next two years could trigger that downturn. And as the Bank of England has noted, if an economy begins to decline while short-term rates remain near zero, central bankers can still use quantitative easing to stimulate demand.

 It’s worth noting that near-zero interest rates carry risks of their own. With yields on government bonds so low, large investors have shifted to riskier investments with higher yields. That’s why commercial real estate is rising, why there’s a bubble in art markets, why prices for agricultural land and junk bonds are historically high, and why the price-to-earnings ratio for U.S. stocks is now 30 percent above its historical average.

These risky investments could pose a threat to the economy and people’s incomes, if a substantial jump in interest rates triggers a large decline in the U.S. stock, real estate and junk bond markets. Moreover, much like the run-up to the 2008-2009 crisis, the big financial institutions may not have paid enough attention to the risks in their high-yield investments. To be safe, Hillary should call on the Treasury and the Fed to audit those institutions through a new round of “stress tests,” and then ensure that any major institution with a shaky portfolio takes steps quickly to reduce its exposure.

If, as now expected, the Fed goes ahead and raises interest rates, the economic fate of most Americans will rest in the new President’s hands. Hillary’s best response will lie in fiscal policy.  Her first budget should call for more spending on infrastructure, new grants to the states to begin their transition to free tuition at public institutions, bigger Obamacare subsidies to offset the fast-rising premiums expected in 2017, and expanded support for research and development. On the tax side, new incentives for business plant and equipment also are in order. Hillary should cast all of these measures as an investment agenda for long-term growth, and not wave the red flag of “stimulus” in the faces of congressional Republicans.

Her first budget also should include measures to directly support income progress by working people, including the increase in the minimum wage, pay equity guarantees, and the expansion of the earned income tax credit. Finally, she can pay for all of these measures, as promised, by ending carried interest, closing corporate loopholes, and raising taxes on wealthy households.  She can also ensure that these tax changes don’t slow a fragile economy by phasing them in starting a year or two down the road.

The Federal Reserve is a very powerful force in the American economy. But so is the President — and a determined President Hillary Clinton can protect the incomes of Americans even if the Fed prematurely raises interest rates.



Obama’s Expansion Is Finally Paying Off 

October 13, 2016

There’s no debate that the tough economic times of the last decade have helped frame the 2016 elections. In fact, many Americans are so accustomed to seeing the world through their experience of tough times, that it’s hard to recognize when conditions have changed.

Yet, here’s one sign that times are different: American businesses have created almost 9.2 million net new jobs since January 2013, recalling the job creation rates of the 1980s and 1990s. More important, our analysis of the latest Census Bureau data shows that over the three year period from 2013 through 2015, the incomes of most American households grew again, and at rates that matched or exceeded the average for the 1980s and 1990s.

Last month, the Census Bureau reported that the aggregate median income for all U.S. households grew 5.2 percent in 2015, the first such increase since 2007. But as regular readers of this blog know, we apply a statistical approach that digs much deeper into the data. This approach allows us to capture the income experience of typical households of various kinds, by tracking their incomes as they age.

To see if and when economic conditions did truly change, we started by tracking the income path of millennial households, headed by people ages 25 to 29 in 2009, from 2009 to 2015.  Over those same years, we also tracked the income path of Generation X households, headed by those ages 35 to 39 in 2009; and the income path of late boomer households headed by those ages 45 to 49 in 2009.

This analysis found, as expected, that times were tough for most Americans from 2009 through 2012. For example, the median income of the Gen X households was flat over those years, and the late boomer households absorbed income losses averaging 1.1 percent per year.  The only households with rising incomes from 2009 to 2012 were the millennials, and their gains were a fraction of those achieved by households of comparable ages in the 1980s and 1990s. (Table 1, below)

Our analysis also showed that most people’s income paths shifted starting in 2013. Compared to the preceding three years, the income gains by the Gen X households went from zero to 2.9 percent per year; and the late boomer households, whose median income fell 1.1 percent per year from 2009 to 2012, saw gains of 1.4 percent per year from 2013 through 2015. Finally, the median income of the millennial households jumped from 2.7 percent per year to 4.6 percent per year. Also, it’s worth noting that the largest income gains for all three age cohorts came in 2015.

Table 1.  Average Annual Household Income Gains by Age Cohort,
As They Aged from 2009 to 2015

chart1

This analysis also shows that most Americans, finally, are better off than when President Obama took office. The median income of millennial households, in 2015 dollars, rose from $50,875 in 2009 to $63,010 in 2015, as they aged from 25 to 29 years-old, to 30 to 35. Similarly, the median income of Generation X household who were 35 to 39 in 2009 grew from $66,287 in 2009 to $72,028 in 2015. Even the late boomers who were 45 to 49 in 2009 managed small gains, edging up from $70,706 in 2009 to $71,300 in 2015.

We can also compare this record with other recent presidents, using my analysis published by the Brookings Institution last year. In that report, I tracked the income progress by comparable age cohorts during the presidencies of Ronald Reagan, George H.W. Bush, Bill Clinton, and George W. Bush — that is, gains in median income by households headed by people ages 25 to 29, 35 to 39, and 45 to 49 in the first year of each of those president’s terms. Since no president should be held responsible for the economy’s performance in his first year in office, we tracked the income gains of each age cohort from year two of each presidency through year one of his successor’s term.

Using this framework, it’s clear that most American households made more income progress under Obama than households of comparable ages under George W. Bush or his father, George H.W. Bush. (See Table 2, below.)  Moreover, the income gains of 2013 through 2015, like the job growth of the same years, suggest that the U.S. economy is still capable of producing a robust expansion, at least for a few years. The data show, in Table 2 below, that incomes grew at a faster annual rate over the last three years than they did on average over the eight years of Reagan’s presidency for all three age cohorts, and faster than they did on average over the eight years of Clinton’s presidency for two of the three age cohorts.

Table 2.  Average Annual Median Income Gains by Households Headed by People Ages 25 to 29, 35 to 39 and 45 to 49 as They Age through Each Presidency

chart2

 Of course, it’s not truly a fair comparison politically, since Clinton and Reagan delivered strong income gains over their entire terms, while Obama has done so for only three years. But especially after the meager income progress of the 2002–2007 expansion, the data show that the U.S. economy can still deliver robust income growth for almost everyone.

So, the challenge facing the next president is to sustain this recent income progress, in large part by reversing our recent record of faltering productivity.



On Economic Growth, Hillary Delivers and Trump Pretends

September 26, 2016

To prepare for tonight’s debate, I decided to think through Donald Trump’s promise to deliver 4% annual economic growth. First off, if this is Trump’s goal, then his program is as much a fraud as his foundation or university. If anything, his proposals would slow our already modest growth. To be sure, no one has a silver bullet to raise the economy’s underlying growth rate. But that doesn’t mean we’re helpless, and Hillary Clinton’s program will almost certainly raise that growth rate.

Four percent growth is not unprecedented. Under JFK and LBJ, the economy grew an average of 5.2% per year; and Bill Clinton produced 3.8 % average growth over eight years, including five years of 4% growth or more. But they were exceptions: Ronald Reagan and Jimmy Carter each managed 3.4% average annual growth; George H. W. Bush and Barack Obama each achieved 2% annual growth, and George W. Bush eked out just 1.6% annual growth. Moreover, the Federal Reserve forecasts that the U.S. economy will continue to grow an average of 2% annually for the next decade. This forecast and the record under Obama and Bush II all suggest that strong headwinds are hampering America’s economic growth.

By the arithmetic, economic growth measures how much more goods and services the economy has produced in one year, compared to the preceding year. That tells us that two key factors for higher growth are how many more people have jobs producing goods and services, and how productive, on average, everyone is producing those goods and services. By the arithmetic, strong growth rests substantially on increasing the number of people with jobs and the productivity of the entire workforce.

One reason for the disappointing growth of the last 15 years is that the number of net new workers each year slowed sharply. For that, blame the decline in U.S. fertility rates that began 20 years ago, rising rates of retirement by aging baby boomers, the slowdown in immigration sparked by the Great Recession, and steady erosion in the labor participation rate (LPR). All told, the Bureau of Labor Statistics reports that the U.S. workforce is now growing .5% per year, down from 1.25% per year under Bill Clinton.

So, which candidate has proposed anything that would expand the number of Americans working? Both agree on spending more on infrastructure, but that will have modest effects on long-term growth. Beyond that, one striking feature of Trump’s immigration, healthcare and other proposals is their secondary effect of shrinking the number of people working in the U.S. economy.

 To begin, Trump’s signature pledge to deport 8 to 11 million immigrants would reduce the workforce directly, for those caught and deported; and indirectly, by forcing millions to take cover outside the mainstream economy. Similarly, his promise to repeal Obamacare would increase the time that millions of Americans have to spend out of work for health reasons.

Nor should anyone believe that his $4.4 trillion to $5.7 trillion in tax cuts will somehow induce more people to work — that particular supply-side hokum is refuted by the rising labor participation rate (LPR) after Bill Clinton raised taxes, and the falling LPR after Bush II cut taxes.

By happy contrast, much of Hillary Clinton’s program would have secondary effects that increase the number of people in the labor force and working. Her path to legalization for immigrants will allow an additional eight million adult immigrants to participate fully and openly across the economy. Her plans to broadly expand access to child care and provide universal pre-K education would enable millions of parents to reenter the workforce or move from part-time to full-time jobs.

Moving along, her pledge to achieve universal healthcare coverage, once fulfilled, will lessen the number of people forced to stay home or even give up their jobs for health reasons. Her commitment to pay equity, once met, will encourage more women to enter the workforce or to increase their hours at work, as should her pledge to expand employment for 53 million American adults with disabilities. Finally, Hillary’s plans for expanding access to higher education will raise the labor participation rate, because that rate tends to rise with education.

The arithmetic of growth also depends on how fast productivity increases – and progress in productivity, which grew 2.8% per year in the later 1990s, has collapsed: From 2011 to 2015, productivity increased just 6% per year; and over the first half of this year, productivity actually fell at a rate of .6% per-year.

Three factors are mainly responsible. First, business investment in equipment and other technologies has slumped. In addition, the gap between the skills many workers have and the skills they need has widened. Finally, it appears that the development and use of new technologies, processes, and ways of organizing and running businesses — in a word, innovation — has slowed.

Here, too, Trump offers nothing.  His huge tax cuts would balloon federal deficits, and so raise the cost for business borrowing to invest in new equipment and technologies. Trump also offers nothing to help workers improve their skills, and nothing to stimulate innovation and the broad use of new technologies.

By contrast again, Hillary’s agenda would actively promote progress in productivity. Her plans for tuition-free access to higher education will expand the skills of millions of young people, and her blueprint to reduce budget deficits will ensure that federal borrowing does not raise the cost for business borrowing to invest. Hillary also supports innovation by calling for expanded federal investments in basic R&D and promoting more public-private collaborations to commercialize that R&D. And since innovations often come from young enterprises, her program to expand bank lending for such companies is also well suited to promote innovation.

On economic growth, as on many other issues that will shape America over the next decade, Hillary delivers while Trump blusters.

 

 



The Economic Outlook for the Election and Beyond, and How Who Wins Could Change It

September 7, 2016

With nine weeks to go, the economic conditions for the election are set — modest growth, low inflation, and continuing job gains. A few Wall Street forecasters rate the odds of a 2016 recession at one-in-three; but unless a major shock wrenches the economy off its present course, bet with Janet Yellen and Ben Bernanke on the economic expansion continuing into next year.

The tougher question is what economic conditions will confront the new president and the rest of us in 2017 and 2018? Since the fourth quarter of 2015, the economy has grown at an annual rate of less than one percent, and business investment has declined at a three percent annual pace.

Consumer spending and home sales could lift growth and investment next year, if the healthy income growth of the last three years continues. But much of those income gains come from the unusually strong job growth of those years; and with unemployment now below five percent, job creation almost certainly will moderate soon.

If jobs gains lessen next year, healthy income gains will depend on a turnaround in the economy’s disappointing productivity record. A modern economy cannot stay strong indefinitely without strong productivity growth to fuel incomes, demand, profits, and investment. Its recent record explains our slow growth: Productivity gains averaged just .6 percent per year from 2011 to 2015, and even those small gains turned negative in the first half of 2016.

This represents a major change: Productivity increased at an average rate of 2.8 percent per year through Bill Clinton’s second term and remained strong at 2.6 percent per year from 2001 to the financial collapse in 2008. Moreover, it recovered quickly in 2009 and 2010, reaching 3.2 percent per year. Unless productivity recovers again in 2017, wages and incomes could stall and the economy could stagnate in the next President’s first or second year in office.

Yet, the economic debate this year has mainly focused on overall growth rather than productivity. Most economists — Ben Bernanke, Paul Krugman, Larry Summers and Kenneth Rogoff, among others — pin the slowdown in GDP growth on higher savings and the associated weaker spending. So, most economists have called for renewed fiscal stimulus here and for much of the world. They’re right; but the outlook for incomes and investment would be more encouraging if the fiscal stimulus focuses on recent meager, or even negative, productivity gains — and their impact on growth.

Americans are in luck — assuming the pollsters are right that Hillary Rodham Clinton will vanquish Donald Trump. While Clinton has not offered an explicit program to boost productivity, her economic and social policy proposals include the three essential elements of such a program. First, improve overall market conditions for all industries; second, promote innovation through the development and broad use of new technologies, materials, and ways of doing business; and third, give workers access to the skills they need to operate effectively in a more innovative economy.

The big play to improve the efficiency of all U.S. industries and businesses is Clinton’s commitment to expand public investments in infrastructure by $275 billion over five years. Unsurprisingly for Hillary, her program covers every conceivable form of infrastructure. There are new investments not only for roads, bridges, public transit, rail freight, airports, seaports, waterways, dams, and wastewater systems.

Her proposals also cover 21st century infrastructure networks, including a smart electric grid, advanced oil and gas pipeline systems, and universal access to 5G broadband and Next Generation wireless. Since virtually every enterprise and employee depends on these systems every day, her proposals should enable most firms and workers to carry out their business more efficiently.

As stimulus, these infrastructure improvements amount to $55 billion per year, or just three-tenths of one percent of GDP. Fortunately, Clinton’s program includes other measures that also should bolster productivity. To promote innovation, she pledges to scale up federal investments in basic research and development through the NSF, the NIH, the Energy Department and DARPA, across areas from high performance computing and green energy, to machine learning and genomics.

Always a pragmatist, Clinton also has plans to promote the commercialization of advances in R&D through grants for private accelerators and reforms to expand access to capital by the young businesses that play a prominent role in innovation.

Finally, Clinton has a serious program to help Americans upgrade their skills. Computer science training would be available for all high school students, and foreign-born students who complete a U.S. masters or Ph.D. degree in a STEM field would automatically receive green cards to stay and work in the United States.

However, the cornerstone is tuition-free access to public colleges and universities for all young people from families earning $125,000 or less, and tuition-free access to community colleges for anyone. To complete her productivity agenda, Clinton should expand her community college program and give all working adults the real ability to improve their skills, through no-cost access to two training courses per year at community colleges.

From the other side, Trump offers virtually nothing. He says that he, too, would increase federal spending on infrastructure. But his tax promises would balloon federal deficits by upwards of $700 billion per year, leaving no room to upgrade infrastructure, much less promote basic R&D or expand access to higher education and worker training.

His massive deficits also would crowd out business investments in new technologies and new enterprises. Trump’s program, in short, would virtually guarantee that the American economy stagnates, or worse.