The Policy Backdrop of Inequality and Its Implications for “Class Warfare”

September 23rd, 2011 at 4:58 pm

Hey, no fair fighting back!!

That’s what I hear when conservatives go on about “class warfare” in response the President’s call for balance in deficit reduction.  It’s particularly grating to hear Rep Paul Ryan use the CW talking point, when the lions’ share of his deficit savings come from cuts to low-income programs and Medicare, with no offsetting revenue.

Lots of posts in recent days have explored the tax side of this equation, essentially emphasizing the Buffett point that many of those who have done the best are paying a smaller share of the income in federal taxes than the middle class.  That’s an important point that links directly to President Obama’s call for shared sacrifice and balanced deficit reduction.  Sorry, Rep. Ryan–it can’t all come out of the spending side.

But, as the figure below reveals, the increase in income inequality—one reliable metric of how different income classes have fared—is very much a pretax phenomenon. The figure shows the changes in income shares from a comprehensive income data set of the Congressional Budget Office, 1979-2007, pretax and aftertax (federal taxes only—I’ve added a table below with the levels for the most recent data year so you can see the underlying shares).

Source: CBO

The fact that the growth in inequality is largely a function of the pretax income distribution doesn’t mean we should make it worse with regressive, supply-side tax cuts—(economist Alan Blinder calls this move “unnecessary roughness”—amplifying pretax inequality with regressive tax cuts).  To the contrary, we need balanced tax measures to generate the revenues to support programs that can help push back on this trend—initiatives like Head Start, child nutrition, educational support.

But it also doesn’t mean we can meaningfully correct the problem with tax policy alone.  We have be mindful of all the policies that effect the pretax distribution—the distribution of labor and capital earnings before any taxes and transfers kick in…that’s where the real inequality action is.

Now, most economists argue that much of the increase in inequality is due to factors like globalization and technological change–factors that are less a matter of policy than of economic evolution.  But of course their impact can be amplified or dampened by policy.  For example, unfair trade practices like China currency management give low-wage competitors an even stronger price advantage.  (Trade agreements are less of a big deal as I see it—the advocates overdo how much they’ll help and visa-versa re the opponents—though the advocates are worse…).

Lack of a strong, long-term public-private strategy in terms of boosting our manufacturing sector, as is standard practice in advanced (Germany) and emerging (China) countries also hurts our manufacturers’ ability to compete internationally.   So policy does matter—considerably–in this space.

Technological change, most recently computerization/IT, is also thought to be a significant factor behind the changes in the graph, though the evidence here is more ambiguous.  (One strain of work, for example, argues that technology has increased labor demand for both high skill and low skill work, while leaving out the middle.)  But to the extent that technology increases employers’ skill demands such that a college education is increasingly necessary to compete, programs that help disadvantaged kids get that opportunity play a role here too.  And cuts to those programs hurt.

Then there’s a bunch of stuff that directly raises or lowers the bargaining clout of middle and working class families—policy changes or missed policy opportunities that have hurt or failed to help them.

–the long-term erosion of the minimum wage

–the absence of legislative protection to balance the organizing playing field for those who want to collectively bargain

–the inattention to labor standards such as wage and hour rules, overtime regs, workplace safety, worker classification (this is where regular employees get misclassified as independent contractors and lose basic labor protections—and guess what?  Progressive reform of this problem is in the President’s new budget plan—very cool…)

–the attack on public sector employment

–the lack of universal health care

–the absence of comprehensive immigration reform

–the flattening trend in education attainment (US attainment, as in share with a college degree, has slowed while that of other advanced economies continues to increase)

One more biggie: full employment.  It’s very much a policy variable and one, in fact, that used to be the law for the Federal Reserve—so-called Humphrey Hawkins Act mandated full employment as a policy goal of the Fed.  As I stress here, the fact that our job market has run with so much slack over the very period when inequality grew so quickly is no coincidence (and visa-versa: when inequality was flat or falling, we were more likely to be at full employment).

And of course, in recession, like now, by dithering on stimulus, we’re disproportionately hurting the wage, incomes, and living standards of the folks who’ve been losing income share over the years shown in the figure above.

In other words, there are a lot of policy measures that have considerable impact on how the benefits of growth are distributed—before taxes even show up on the scene.  When representatives of the wealthy squeal about “class warfare,” they’re not just talking about shielding their treasure from the tax system.  They’re also protecting and endorsing a policy agenda that’s helped tilt growth their way for a long time.

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17 comments in reply to "The Policy Backdrop of Inequality and Its Implications for “Class Warfare”"

  1. Concerned says:

    It is imperative that those with a voice, like Dr. Bernstein, start changing the conversation. I’ll be looking forward to hearing that when I watch his next media appearances. If I may be so bold, the general idea should be that “the only class warfare going on in this country for the last 30+years has been by the more fortunate on those that are less fortunate.”

    The dialogue must change.

  2. urban legend says:

    And I think it’s time to restore the understanding that the first priority of Humphrey-Hawkins was full-employment — at reasonable wages no less. It’s the short title of the bill, the dominant theme of the long name of the act, and the first-mentioned goal in the statutory language with the most words devoted to it. “Reasonable price stability” — something quite a bit less than a ringing call — is mentioned third and looks clearly to be considered subservient to the first goal.

    So where did this notion of the “dual mandate,” with fighting inflation given equal or often superior billing to full employment? It’s a distortion of the statute, and sounds suspiciously like the product of a sophisticated finance industry P.R. effort. Two simple words, very shrewd. No erosion of those debt obligations, hell no, we can’t have that no matter how high unemployment goes. Don’t worry, we’ve got the Fed in our hip pocket.

    • D. C. Sessions says:

      The thing is, we mostly have had full employment. If, that is, you define “full employment” as the level of employment just short of pushing up wages.

      That’s what happens when you leave the terms undefined: somebody figures out how to define them to suit themselves — or, in this case, to suit the suits.

  3. urban legend says:

    I would also add as a contributing factor general acceptance of the false notion that the primary duty of management is to enhance shareholder value, combined with conflict-of-interest compensation plans, especially stock options and quickly vesting stock awards, that “align” management interests with enhancing shareholder value. Hence, management obsession with day-to-day movements in stock prices, instead of the health of the corporate entity which is their primary fiduciary obligation.

    Of course, low marginal rates at the top and capital gains rates — and treatment of certain forms of compensation as capital gains — have also contributed heavily to outrageous executive compensation — better described as theft of corporate assets sanctioned by equally conflicted boards of directors.

  4. William Timberman says:

    “It’s particularly grating to hear Rep Paul Ryan use the CW talking point, when the LOINS’ share of his deficit savings come from cuts to low-income programs and Medicare, with no offsetting revenue.”

    Absolutely priceless. Inspired typo of the decade, beyond a doubt.

  5. Geoffrey Freedman says:

    Economists are starting to pay more attention to the observed relationship between wage and wealth inequality and financial instability.

    For example if you chart bank failures in the U.S. to wealth and income inequality, the curves are remarkably similar. Bank failures were remarkably high in 1929 and 2008 relatively speaking), and these points historically are apexes of income and wealth inequality. The time period in between, which is relatively speaking more egalitarien in wealth and income distribution, are much more stable in this regard.

    Correlation does not necessarily imply causation, but it certainly warrents further investigation.

    I also suspect that globalization exacerbates the spread of wealth and income inequality.

    I also think its not coincidental that the exploding economies in India and China are occuring at a time when their middle classes are growing.

  6. tom says:

    Your reasons for the distortion in pre tax income distribution are good ones.

    I think you are missing an effect of tax rates on pre tax distribution, however. When you have high tax rates on excessive income, it provides a strong disincentive to the wealthy and powerful to not take excessive amounts of money as income. One should be careful; $250000 is a high income, but it is not high enough for the high tax rates that would be an effective disincentive. We needed more brackets at the high end, perhaps 1, 2, 5, 10, 20 million.

    Ideally, we would have tax rates that are a function of income distribution.

  7. perplexed says:

    This overwhelming focus on income inequality in isolation is obscuring its contribution to the much more serious and damaging problem of wealth concentration (Gini .84 and growing). Allowing such a huge proportion of “our” after-tax national to income to go into the “savings” accounts of the incredibly wealthy few is killing the “golden goose.”

    Maybe we should forget about income taxes altogether and switch to a combination of wealth and VAT’s. If nothing else it would keep our focus on the two most important factors: revenue and wealth concentration. With all this talk about “fairness,” maybe we should also be talking about the “output gap” tax and who is paying that as well.

  8. Jim Edwards says:

    As I’ve said before, I live and work in India as a games developer. I’m always struck by this notion that technology is some bugaboo to the middle class as if only everyone would learn to program wages would be all right. But the money is not going to programmers. It’s going to MBAs and hedge fund managers, and the same crowd who could have given James Fisk or Jay Gould a run for their money back in the robber baron days.

    I compete for online bids against people from all over the world and the truth is we cannot out bid a group from Germany or one from the US. They cannot out bid us either. Indian game developers make much less than the US equivalent, but they produce much less as well. I’ve been here over 5 years and have seen this to be the case everywhere I’ve gone. Just as with developers in the US, when you get a great developer you do whatever it takes to keep them. Eventually their salary rises to roughly the percentage of work they do regardless of location.

    Where there is an unfair advantage in India is the cost of non developer costs. My rent is almost free. I pay less than $10 a month for unlimited cell calls anywhere in India. I get a dedicated T1 line with static IPs for less than $30 per month. Employee lunches are $1 per person.

    An employee here makes about 1/5th the salary and lives just as well as in the US. When I look at my life here and my life in the US, I wonder where all my money goes in the US. It’s simple. The rentiers. If you look at who that top 1% is, it’s the rentiers. Who gambled away the finacial security of the US? The rentiers. And who does not want a weak dollar or inflation reduced debt regardless of the impact on the US economy? The rentiers.

  9. Michael says:

    The conservative project for America will be complete when the first Chinese factory moves here to take advantage of low wages and lax environmental standards.

  10. jfb2252 says:

    Prof. Elizabeth H. Bradley (Yale) has a recent publication showing that most OECD countries spend about the same on (social services + health care) but the ratio in all the others is about 2:1 social:health where for US the ratio is under 1:1. The higher the spending on health, the worse the health outcome. Spending on social services, e.g. housing, employment training, unemployment benefits, etc., appeared to have greater health benefit than direct spending. This suggests that the discretionary spending cuts will hurt overall US health in spite of the ACA, giving its opponents another club to beat it with.

  11. Padraic says:

    1. Much of the lucky 1 percent are in the financial industry. Money has increasingly flowed to the profits and compensation of financiers.
    2. Corporations are run now for the benefit of management . Stockholders not so much. While management has payed itself handsomely for the past decade the investors have in aggregate made next to nothing. If we have more of this trend for another decade it will not make sense to invest in American stocks

    • reflectionephemeral says:

      This is the important point here. About 40% of our economic growth comes in the financial industry. As Paul Volker has put it, the only financial innovation that’s contributed to growth in the past thirty years is the ATM.

      And the Kaufmann Foundation found that the nonproductive but lucrative financial sector is sucking up talented folks who might otherwise do worthwhile things like start businesses or invent new technologies.

      Longstanding restrictions on activities of firms were repealed or ignored– places like Sweden & Texas, which had strong banking & home lending regulations, respectively– were spared much of the worst of the financial crisis.

      Let banking be boring again.

  12. Phillip Wynn says:

    Damn you! Damn you! You keep using these fact things, and graph thingees that illustrate that reality thing. Are you some kind of communist?

  13. perplexed says:

    -“But it also doesn’t mean we can meaningfully correct the problem with tax policy alone.”

    We can if we get over our aversion to and lack of discussion of wealth and inheritance taxes. Its not self correcting. If you use the wrong tax policy for 30 years in a row it doesn’t somehow reverse itself; it just continues to get worse. But if we just focus on income taxes (and crowd any discussion of wealth taxes)it would take many, many years (probably would take the long run), to correct the damage from so many years of wrong-headed tax policies. We aren’t even discussing marginal rates that would do much to slow the progress of wealth concentration, let alone reverse it. This focus on income taxes just enables the “drift” politics that prevents the government from taking any real corrective action. The fact that wealth and income are already so concentrated is doing more to slow the progress of wealth concentration than government tax policies are.

    The republicans have succeeded in neutering the government’s ability to address wealth and income concentration problems through tax policy. The problem this creates is that there is no other way to correct it that we know of and so we’re left with laissez-faire; the anarchists have succeeded. As we continue to talk, the wealth concentration marches on.

    We need to do more to get the public to understand what a .84 Gini coefficient for wealth really means, how close it is to .99, and how damaging it is to the country’s prospects for getting out of this crises and being competitive in the future. All of this largely pointless discussion about who pays what % of total income taxes does nothing but obscure the real issues; its what the republicans and the rentiers they represent want. We need to start driving the agenda. Let’s force the media to Google Gini coefficient for wealth and make them discuss the implications of it on air. What happens when we get to .90? What can we do to change it? (If nothing else it will be fun to watch & entertainment is what they’re really about anyway isn’t it?)

  14. Ben Leet says:

    Lawrence Mishel recently reported on wealth gains since 1983, and they match your graph on income gains. The top 5% received 81.7% of gains. The lower 60% of households showed a loss in wealth. See — You might add that the shift in post-tax income since 1979. The post-tax share to the top 1% was 7.5%, and has grown to 17.1% — this from Tax Policy Center — —-
    And to change the topic, in China the manufacturing worker receives $1.36 an hour vs. the U.S. manufacturing worker wage of $34 an hour, or $2,800 a year vs. $70,000 a year. (Monthly Labor Review, D. of Labor, 3.2011) It is past time for protectionism and a new trade paradigm. As you say, we need to remedy the imbalance of income distribution, and structurally change to the economy especially in manufacturing. Reducing the financial system debt to 10% of GDP as it was in 1970, instead of 123% of GDP in 2007 would also rebalance a wobbly economy.

  15. confused says:

    If high unemployment leads to higher wage inequality, why is wage inequality much lower in Europe where unemployment is higher ? I am not sure that the argument would still hold after a careful international comparison…