Inequality and Budget Deficits: Why is Only the Latter an Emergency?

November 23rd, 2012 at 12:01 pm

I just read two sweeping reports on the state of income inequality in the US (the second link focuses on state-level inequality) and other advanced economies.  Perhaps it’s because I’ve been so ensconced in fiscal cliff discussions, but I was struck by how much more alarmed policy makers are by the budget deficit than by the inequality situation.  There are reasons for that tilt—some good, some bad—but based on magnitudes of the problem, it’s far from clear that our current sole policy focus is warranted.


The first link above finds the indispensable inequality researchers Piketty and Saez reflecting on the long income inequality time series data they and others have developed for the advanced economies.  Their key findings are:

–the decline in income concentration in the US over the great recession was due to cyclical capital losses, not a structural change in the underlying factors driving the trend.  This can be seen quite clearly by a) taking capital gains out of the income data, revealing a steady upward trend, or b) by noting the increase in inequality (share of income going to the top 10% of households) in 2010, a return to trend.

–The fact that different countries hit by the same globalization and technology advances show different inequality trends suggests an important role for political economy—policies that affect the distribution of market incomes—in these outcomes.  In France and Germany, for example, the top 10% holds about 35% of national income; in the US, it’s about 50% (see figure below).  “Pure technology stories based solely upon supply and demand of skills can hardly explain such diverging patterns,” write the authors, who argue that tax policies are a “promising candidate.”

–As I’ve suggested in various posts, the authors agree that higher inequality may be associated with the debt bubble and bust from which we’re still recovering, though they’re not sure as to what’s causation and what’s correlation (they take solace in the Minsky-esque conclusion that “modern financial are very fragile and can probably crash by themselves—even without rising inequality”).  Me, I think in an economy where a) inequality steers growth away from the broad middle, b) credit is cheap, under-regulated, and securitized such that there’s distance between originator and final borrower, and c)  as the boom progresses, risk become underpriced—well, that’s a recipe for the shampoo cycle (bubble, bust, repeat) with inequality at the core of the model.

The second paper—from researchers at EPI and CBPP—is also part of a valuable series (“Pulling Apart,” or PA) that tracks income inequality by states over time.  Some findings that caught my eye:

–The story above re credit taking the place of paychecks is partially motivated by real declines in average incomes, as the wedge of inequality diverts growth to the top of the scale.  That dynamic is evident in the PA data—see, for example:

On average, incomes fell by close to 6 percent among the bottom fifth of households between the late 1990s and the mid-2000s, while rising by 8.6 percent among the top fifth. Incomes grew even faster — 14 percent — among the top 5 percent of households.

In every state plus the District of Columbia, incomes grew faster among the top fifth of households than the bottom fifth. Nationally, the richest fifth of households enjoyed larger average income gains in dollar terms each year ($2,550, after adjusting for inflation) than the poorest fifth experienced during the entire three decades ($1,330).

By looking at rising inequality through the lens of state data, the authors offer up state-level policy ideas that will help, like raising and indexing state minimum wages, more progressive state taxes (e.g., by reducing reliance on sales taxes versus income or property taxes), and better coordinated safety net and health care programs.  This last bit is particularly timely given the implementation of the Affordable Care Act.  The states that accept and implement the Medicaid expansion and move aggressively to set up the health care exchanges will be providing a great service for their citizens on the wrong side of the Gini coefficient.

So, what does all of this have to do with the fiscal cliff and budget deficit?  Since the early 1980s, deficits have averaged around -3% of GDP with a pretty big variance, -5% in the mid-80s, +2.4% (surplus) in 2000, as high as -10% during the great recession, and about -7% and falling now.

On the inequality side, since the early 1980s, according to Piketty and Saez, we’ve transferred 15% of national income from the bottom 90% of households to the top 10%.

Which of those is the bigger economic deal?  If you ask any DC policy maker what’s the most important challenge facing the nation, they’ll tell you it’s the budget deficit.  Yet a compelling argument can be made that a shift of such magnitude in national income from the bottom 90% to the top 10%, and the commensurate problems it presents—the growing gap between growth and the living standards of the middle class and poor—is, in fact, at least equally, if not far more, worthy of their attention.

The deficit and the debt are highly sensitive to growth.  Even in the fiscally irresponsible and not-great-growth GW Bush years, the deficit to GDP fell to about 1% in 2007.  If we manage to get a balanced plan in place that includes some new revenues, once the economy begins to grow again, the near term deficit will diminish.  After that, it’s all a question of slowing health care spending, and that’s an existential question not just for the budget but for the whole economy, meaning we have to crack that nut no matter what.

Inequality, on the other hand, can and likely will keep growing, as Piketty and Saez’s data suggest, unless policy measures intervene.  I’ve discussed such measures in lots of past posts—see here, e.g., re full employment and the role of economic slack in growing inequality.  Piketty and Saez’s arguments for higher tax rates on those at the top of the income scale are clearly worth keeping in mind during our current fiscal negotiations.  And the PA team’s ideas about state measures would help too.

But it’s hard to imagine much progress on this front if policy makers continue to obsess so exclusively on budget deficits instead of the income deficits experienced by the poor and middle class.  Of course, many deficit scolds are motivated by anti-tax, anti-social insurance, and anti-government ideology, so they’ve got a vested interest in the status quo.  And to be clear, I’m not suggesting we ignore the budget deficit.  I’m just saying that here as elsewhere, a bit more balance is in order.

Source: Piketty and Saez, 2012, link above.

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5 comments in reply to "Inequality and Budget Deficits: Why is Only the Latter an Emergency?"

  1. Tom in MN says:

    And compare the disaster waiting at the end of each problem. Krugman has been arguing that the debt disaster is not even that bad. Bond rates rise, the Fed responds by printing money and the Dollar falls boosting exports. No Greek problem, we can never default, we just print more money. The resulting inflation is even good for those with mortgages.

    Inequality, on the other hand, well that ultimately leads to class warfare, literally. Social instability, riots, everyone looses. And those with the most have the most to loose. What do the rich get for their tax dollars? They get a stable country that is a good place to live and make lots of money.

    I know which one I’m more worried about.

  2. Mike says:

    I think something is a little off when deficit “hawks” frame the debt issue as the most pressing long-term concern our country has ever seen (OH THE CHILDREN!), when climate change gets nary a mention. I live on Long Island in New York and we were (as you may know) hit hard by Hurricane Sandy. Last year we were hit hard by Hurricane Irene. These are storms that would have happened previously once a lifetime or generation, but now seem to be occurring much more frequently. It would be nice to see that spoken about a bit more by Washingtonians rather than the seriousness of cutting the social safety net for seniors.

    Also, a little frustrated about the narrowness of the talk about inequality, which seems to only encompass debate about the Bush tax cuts for the wealthy and a few transfer programs (though the ACA is obviously very important). Trade deals tilted against the working/middle classes, gov’t support of Wall Street and pharmaceutical monopolies (though we are ostensibly trying to deal with the former), and the low-inflation bias of the Fed all contribute to inequality in one way or another, but they are rarely on the political agenda.

    I’m aware that change comes piecemeal, but I think one of the biggest problems is what you mentioned in a previous post. Washingtonians may have good intentions (at least some of them), but the fact that many live a comfortable life means that the urgency on an issue like inequality just isn’t really there. I know that there are exceptions, and some members of Congress do some really good work, but it just seems like the same things are always on the agenda, and that isn’t a good recipe for change to the “unequal” status quo.

  3. pjr says:

    I understand that France recently was considering a law that would limit CEO pay to 20 times the average worker’s pay, and that the ratio in the US has grown tenfold since the 1960s to about 300-to-1. I don’t like France’s idea, but I am convinced that the US tax code of the 1960s strongly discouraged high executive pay in favor of a business spending on the business, to include its workers (many of whom were in a union of some type). That tax code also helped to keep deficits low, and the economy was very strong despite an extremely high dependency ratio along with low workforce participation rates by women. Our leaders in Washington need to know that they have been doubling-down on terribly misguided policies that serve only the wealthiest Americans while the country as a whole stagnates.

  4. urban legend says:

    How can you write an entire post dedicated to dealing with forces generating rampant inequality and not even mention to the loss of the ability of middle and lower-middle class workers to combine forces and participate in the setting of their terms of employment? Not even to argue against its importance, even though the forced decline of unionism just happens to coincide almost perfectly with the growth of inequality? .

    That seems to me like one of the defining characteristics of neo-liberalism: it’s perfectly comfortable with top-down political policy activity, but not so much with the messy process of worker participation in the enterprise. Something like a turn-off by dirty fingernails or something?

    Perhaps one might consider that in most of the European countries with less inequality, unions are a much stronger force. Where arguably that’s not the case, e.g., France, there’s a long tradition of uprisings like national strikes to necessitate some self-discipline by elites.

  5. DHFabian says:

    The US chose social policies that increase poverty, and keeps people firmly trapped at the bottom. With each economic downturn, the number of permanently poor increases. Clinton took a machete to the safety net while embracing policies that increase joblessness. Many are a single job loss from losing everything, with no way back up. How do you get a job without a home address, phone, bus fare? The rungs were cut off the proverbial ladder out of poverty. Historically, when the richest few gained too much power, the poor and middle classes united to push back, to the benefit of both. This time, the poor and middle were deeply pitted against each other, so there can be no effective push-back.