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.



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.