The Technology Trap (part 3)

August 11, 2019

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Having described an era in which the middle class expanded and more good jobs were created than destroyed, Frey turns to what he calls the “Great Reversal” in the period since 1980. In recent decades, new technologies have done more to replace workers than enable them, resulting in a shrinking middle class.

The computer revolution

The main difference between the age of automation and the previous era of mechanization is that the automated machine can replace the machine operator. “The great reversal…is in large part a consequence of computers making the skills of machine-tending workers obsolete.”

The most routine forms of work are most easily automated, and that includes some white-collar jobs like mortgage underwriter. Many jobs that paid enough to put their workers into the middle class are routine enough to be reduced to a computer program.

Many other kinds of jobs, however, are harder to automate:

[T]here are many tasks humans are able to perform intuitively but that are hard to automate because we struggle to define rules that describe them. For activities that demand creative thinking, problem solving, judgment, and common sense, we understand the skills only tacitly.

For many of the more creative jobs, computers complement human skills but don’t replace them.

Furthermore, humans have perceptual and manipulative abilities that allow even an unskilled worker to do things that machines have trouble with, such as “distinguishing a pot that is dirty and needs to be cleaned from a pot holding a plant.”

Consider the impact of computer technology on three types of workers:

  1. A highly educated professional uses computer software to become even more productive
  2. A semi-skilled machine operator is replaced by a robot
  3. An unskilled cleaning service worker still has a job, but it’s a low-wage job

That, in a nutshell, is why middle-skill jobs are the ones disappearing, and the middle class has been shrinking. Men have been hit the hardest, since they are most likely to hold the kind of semi-skilled manufacturing jobs that are no longer needed.

Although new technologies have created some entirely new jobs, such as computer programmers, Frey finds that more middle-class jobs have been lost than gained. “Technological change has become more worker replacing in recent years.”

The impact on incomes

Wage inequality has been increasing, and educational qualifications matter more than ever. Inflation-adjusted wages for college educated workers have been rising, especially for women, while wages for workers with high school degrees or less have been falling, especially for men. Frey quotes Erik Brynjolfsson and Andrew McAfee:

There’s never been a better time to be a worker with special skills or the right education, because these people can use technology to create and capture value. However, there’s never been a worse time to be a worker with only ‘ordinary’ skills and abilities to offer, because computers, robots, and other digital technologies are acquiring these skills and abilities at an extraordinary rate.

While the logical thing for future workers to do is acquire as much education as possible, college education is much more expensive–and becoming more so recently–than secondary education.

During this period, wage growth in general has fallen behind productivity growth, and the share of national income going to labor rather than capital has fallen from around 64% to around 58%.

To me, many of these facts seem to cry out for explanations that go beyond the technology itself to the social context in which we are applying it. Since Frey is focused mainly on the American context, he does not discuss how countries like Finland or Sweden are computerizing at least as fast as we are while maintaining more educational opportunity and economic equality. See, for example, Iversen and Soskice’s Democracy and Prosperity, especially post 3.

Social divisions

Displaced workers tend to be concentrated in certain places, especially economically depressed manufacturing cities. These are often far removed from the places where educated people congregate and create new hi-tech enterprises. As Enrico Moretti said in The New Geography of Jobs:

America’s new economic map shows growing differences, not just between people but between communities. A handful of cities with the “right” industries and a solid base of human capital keep attracting good employers and offering high wages, while those at the other extreme, cities with the “wrong” industries and a limited human capital base, are stuck with dead-end jobs and low average wages.

Communities with large job losses also experience declining marriage rates, rising rates of birth outside of marriage, and rising mortality from suicide and substance abuse. The unemployment rate may remain fairly low, either because downwardly mobile workers settle for jobs in low-wage services, or because they drop out of the labor force and stop being counted.

The downwardly mobile are often the politically alienated as well, feeling that neither political party is responsive to their problems. The Democratic Party was once considered the party of labor, but today it represents many constituencies–people of color, women, the LGBTQ community and environmentalists. Frey notes that Rust Belt states teeming with industrial robots tipped the 2016 election to Trump and the Republicans. I would add, however, that rather than appeal to displaced workers as a class, which would be awkward for the party that still favors capital over labor, Trump Republicans often appeal to them as white males, thus gaining their votes without doing much to address their underlying problems. Job losses in manufacturing have hit black workers hard too, but you don’t see Trump holding rallies in their communities!

The economy still grows as technology marches on, although slower than in the previous era and with far less equally distributed benefits. Frey’s concern is that those who are not benefiting will somehow impede the process, by supporting special taxes on robots or tariffs on foreign goods. Frey’s ideas for having technological progress with more widely shared benefits will be the subject of the final post.

Continued


MMT 3: National Income and its Allocation

July 5, 2018

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This is the third in a series of posts about Modern Monetary Theory, based on the text by Mitchell, Wray and Watts. If you have not seen the earlier posts, I recommend that you start at the beginning.

Here we take a closer look at the economy from the income side, considering the various uses of income and how they interconnect.

Gross National Income (GNI)

Because the discussion centers on income received by residents of the United States, the focal point will be Gross National Product and income instead of Gross Domestic Product, as in the previous post. Don’t let the distinction concern you too much, since the two are very nearly the same, both around $20 trillion dollars a year. But to be precise, we need to adjust GDP by adding Foreign Net Income (FNI), including income that Americans earn from investments overseas and excluding income that foreigners earn here. Currently Foreign Net Income is positive, and that makes GNP a little larger than GDP.

GNP = GDP + FNI

Using the components of GDP covered in the previous post (Consumption, Investment, Government Spending and Net Exports), we can also describe GNP this way:

GNP = C + I + G + NX + FNI

The combination of NX and FNI is also known as the Current Account Balance (CAB), which is the difference between money flowing into the country and money flowing out of the country, taking into account both trade and investment income. So it is also true that:

GNP = C + I + G + CAB

In macroeconomics, output equals income, and so Gross National Income equals Gross National Product.

GNI = GNP

These equations describe where the national income comes from, but where does it go?

Allocation of national income

Income can be used in three basic ways: to pay taxes, to consume goods and services, and to save.

GNI = T + C + S, in which:

  • T = Taxes net of transfer payments. That includes all sorts of taxes paid to government, minus any payments from government like Social Security checks or veterans benefits.
  • C = Household spending on goods and services, as before.
  • S = Private sector saving, whether by households or businesses. Businesses account for about three-fourths of it.

Consumer spending uses about 68% of GNI, about the same percentage it contributes to GDP. The next largest use is Saving (19%), followed by Taxes net of transfers (12%).

I have already been using the concept of Disposable Income, which is simply income after taxes and transfers, or GNI – T.

I have also discussed the Marginal Propensity to Consume (MPC or c), which is the portion of each additional dollar of disposable income that is devoted to Consumption. Its counterpart is the Marginal Propensity to Save (MPS or s). Although we are often interested in the average propensities for the economy as a whole, households at different income levels have different propensities. Wealthy households can afford to save more of each additional dollar, while poorer households need to spend more of it.

Leakage and injection

Although Gross National Income = Gross National Product, we have separate formulas for them whose equivalence is not obvious. Let’s see what happens when we try to reconcile the income side (GNI) with the spending or output side (GNP):

GNI = T + C + S

GNP = C + I + G + CAB

Well, C in the first formula is C in the second formula; that much is clear.

Let’s assume that T goes into G, since taxes go to the government.

Then we encounter an apparent discrepancy. We might like to think that all of Saving goes into Investment. But the Investment category in national accounting only includes real assets like plants, equipment and new inventory. Some of saving goes to acquisitions of financial assets (cash accounts, stocks, bonds) that are not financing new acquisitions of real assets. Currently S is about $4 trillion, but I is only about $3.4 trillion

Another difference is that the GNP formula includes the Current Account Balance (CAB), which is currently negative because Americans spend more on imports than foreigners spend on our exports. (Foreign Net Income from investments is positive, but it isn’t large enough to offset Net Exports, which is a big negative.)

So some of the national income in GNI isn’t showing up in national spending in GNP. The gap is about $1 trillion, attributable to the excess of Saving over Investment and the negative Current Account Balance. The text calls these “leakages” from GNP. In order for GNI to equal GNP anyway, there must be some offsetting “injection” of spending. That is, there must be some other form of spending going into national product and income, but not coming from national income. And of course there is; it’s the deficit spending by government.

What makes everything balance is that government spending exceeds taxation. G is greater than T by an amount equal to the missing $1 trillion. Most of that is the federal deficit, although G and T take into account spending and taxes at all levels of government. The sovereign government uses its unique position as the issuer of currency to create money when it spends, and that increases national output and income. The deficit spending helps drive the economy, accounting for about 5% of GDP and GNP.

The consequences of trying to balance the federal budget should now be even clearer. It would require some combination of spending cuts, which would reduce national output and income, and tax increases, which would reduce disposable income. Either way, consumption would be negatively impacted to a degree governed by the marginal propensity to consume. The negative impact would be compounded by the consumption multiplier discussed previously. After the multiplier effects ran their course, the economy would find a new equilibrium, but at a lower level of national output and income.

As long as hundreds of billions of national income are going into financial assets but not investments in real assets, and additional billions are going to buy imports instead of American products, the country relies on deficit spending by government to sustain national output and income. The alternative is recession. And in fact, the authors report that balanced federal budgets have usually been followed by periods of recession.

Paradoxes of thrift and spending

Most people consider thrift a virtue. In his classic The Organization Man, William H. Whyte described it as one of the three traditional values of the “Protestant Ethic.” (The other two were hard work and self-reliance.) But in the aggregate, too much saving can be a problem. Not all saving is matched by investment, and what isn’t is a drag on current GNP. Keynesian economists call that the “paradox of thrift.”

If all households would start being thriftier at the same time, consumption would drop, forcing businesses to scale back production and employment. Saving would increase, but not all of the increase would go into the acquisition of productive assets. In fact, investment would likely go down, since businesses see less profit in investing in new plants and equipment when consumer demand is falling. A lot of the new saving would go to buy financial assets, especially safe ones like cash accounts and bonds. The bottom line is that households would ultimately be punished for their thrift by a decline in their own incomes as the economy contracted.

On the other side of the ledger we have what we might call the “paradox of excess spending” (my term). What might be considered a vice on the individual level actually helps sustain or increase output and income on the aggregate level. The sovereign government is the entity with the power to make that happen.

Why tax?

If deficit spending is so good for the economy, then “why not just eliminate taxes altogether?” the authors ask.

One reason is that the power to tax is the main thing standing behind the currency. If people didn’t need to pay their taxes in dollars, the demand for dollars might fall, weakening its exchange value on currency markets and its purchasing power.

Another reason is that the public and private sectors are somewhat in competition, especially when the economy runs at higher capacity. If taxes go too low, private consumption goes too high, commanding too many resources, especially labor. If all the most qualified workers are comfortably employed in the private sector, government agencies have trouble finding talented people. Taxes divert spending from private to public uses, enabling society to create public goods and services. “Taxes create real resource space in which the government can spend to fulfill its socio-economic mandate. Taxes reduce the non-government sector’s purchasing power and hence its ability to command real resources.”

A related reason is that by reducing private-sector spending, taxes also help control inflation. Disposable income is now about 88% of Gross National Income. If taxes would move closer to zero, disposable income would move closer to 100%. The increase in aggregate demand could put a big strain on supply, pushing prices up.

The conclusion is that deficit spending is economically useful, but so are taxes.

Income redistribution

An additional effect that government has on income is to redistribute it. One way it does that is through mildly progressive taxation, taxing high incomes at higher rates than low incomes. The other way it does it is by spending more on low-income households through such transfer programs as Medicare, unemployment insurance, veterans benefits, food stamps and family assistance.

For the aggregate effects, I will refer to the study by Thomas Piketty, Emmanuel Saez and Gabriel Zucman for the Washington Center for Equitable Growth. The researchers divided the U.S. population into three broad income groups, and then compared their shares of national income before and after taxes and transfers. Here’s what they found for 2014:

  • Top tenth: 47.0% of income before taxes and transfers, 39.0% after
  • Next two-fifths: 40.5% of income before taxes and transfers, 41.6% after
  • Bottom half: 12.5% of income before taxes and transfers, 19.4% after

Overall, 8% of the national income was reallocated downward from the top tenth of the population, with 1% going to the next two-fifths and 7% going to the bottom half. That reallocation had a big impact on those who received it, boosting the average income of the lower half of the population by 54%. Since the top tenth already had so much, what they gave up only amounted to 17% of their income.

Redistribution from the haves to the have-nots tends to boost consumption and aggregate demand. Lower-income households have a higher propensity to consume; they consume most of any additional dollars they receive. “This arises because lower-income families find it harder to purchase enough goods and services to maintain basic survival given their income levels.” Wealthier families have a higher propensity to save. They “not only consume more in absolute terms, but also have more free income after they have purchased all the basic essentials.”

Continued


The Distribution of National Income (part 3)

February 23, 2017

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I admit that my last two posts have been pretty heavy on the facts and figures. But now we can use the conclusions to shed some light on the political polarization of the country.

Two main conclusions of Piketty, Saez, and Zucman’s analysis stand out. First, the distribution of pre-tax income is now more uneven than at any time since the 1920s. The top tenth of the population is getting almost half the national income, while the entire bottom half of the population is getting only one-eighth of it. Second, taxation and government spending are only mildly progressive and redistributive. Redistribution reduces the top tenth’s share from 47% to 39%, while increasing the bottom half’s share from 12.5% to 19.4%.

The politics of redistribution

To start assessing the political implications of these conclusions, let’s do a mental experiment. Imagine that each of the broad income groups described in the report took a position on government taxes and spending based solely on their narrow economic self-interest. We would expect people in the top tenth of the distribution to oppose the government’s redistributive role, since they pay more of its costs and qualify for fewer of its benefits. The lower-half of the population should be more supportive, since they receive more in benefits than they pay in taxes.

However, the political stance of the remaining two-fifths–those with incomes in the upper half but not in the top tenth–is likely to be more ambivalent. Their pre- and post-tax shares of national income are about the same (40.5% vs. 41.6%). What they receive in benefits offsets what they pay in taxes. Bear in mind that post-tax income in this analysis includes all forms of government benefits–monetary transfers, in-kind transfers, and general spending for the public good. If they focus on the benefits, they may support government spending; but if they focus on the costs, they may support tax cuts. (Or they can support a lot of both, and put up with deficits and more national debt.)

Since the major political parties disagree so much on taxes and spending, we would expect higher-income people to prefer the Republican Party and lower-income people to prefer the Democratic Party. This is true up to a point. Income is a fair predictor of party affiliation and voting, and the effect of income on voting has actually increased as the gap between rich and poor has widened. Gelman, Kenworthy and Su reported, “For the nation as a whole…there is a broad similarity between the trends in income inequality and the rich-poor gap in partisan voting. Each declined after the 1940s and then rose beginning in the 1970s or 1980s” (Social Science Quarterly, December 2010).

Gallup surveys have found that Democrats are much more likely than Republicans to believe that the present distribution of wealth is unfair, and that higher-income groups should pay more taxes.

The role of beliefs

Narrow self-interest is not the only basis on which people vote, however, even on questions of economics. Beliefs about how the economy works or should work are important, as well as beliefs about the impact of public policy on the general prosperity. Politics in a democracy is partly a struggle for the hearts and minds of the people, especially the hearts and minds of the middle class. They may align themselves with either the rich or the poor, depending on whose interests they think best represent the general good.

The upper-tenth have a disproportionate share of the money, but only a minority of the votes. To have their way politically–and they’ve been doing a pretty good job of that lately–they need good arguments against high taxes on the rich and high spending for the less fortunate.

One of those arguments is the appeal to meritocracy. Higher-income people can defend the very unequal pre-tax income distribution as a reflection of people’s real contribution to society. The successful deserve what they get; the unsuccessful deserve less; and the trouble with redistribution is that it punishes achievement and rewards failure. A related argument is that the rich are the job creators who use their incomes and wealth to invest in economic growth for the benefit of all.

Support for these views is widespread. Gallup has reported that when Americans are given a choice between taking steps “to distribute wealth more evenly” or “to improve overall economic conditions and the jobs situation,” people of all political affiliations and income levels prefer the latter by a wide margin.

That helps explain the working-class conservatism reported, for example, by J. D. Vance in Hillbilly Elegy. Although many low-income whites have more to gain from government spending than they have to lose from taxation, they cling to an ideology of self-reliance and hostility to government “handouts”. Reliance on government carries with it a stigma that I see as partly a racial stigma. Slavery, segregation and discrimination impeded black achievement and fostered government dependence, contributing to a stereotype of black laziness. Whites could maintain their sense of superiority by dissociating themselves from such dependency. That meant dissociating themselves from Big Government and liberal politics, especially after the Democratic Party embraced the civil rights movement in the 1960s.

Progressives need to change the national conversation about economic inequality, so that it is no longer about industrious job creators at the top, undeserving slackers at the bottom, and families in the middle who should be grateful to the rich for whatever wages they are offered. They need to challenge the dubious assumption that private wealth is always invested for the public good, while government spending is nothing but a drag on the economy. Considering our low rate of economic growth, our lagging productivity, and our wage stagnation, it isn’t obvious that concentrating more and more financial capital at the top has been such a winning strategy. Meanwhile, we cannot seem to find the money to make vital investments in our human capital, so that young people can get educations without accumulating a mountain of debt. People should not have to apologize for getting help to develop their human potential, especially when that enhances their capacity to contribute to society.

Voters shouldn’t have to choose between policies that create jobs and those that alleviate inequality. In a properly functioning democracy, they ought to go hand in hand, as they did during the postwar economic boom.

Progressive beliefs have the potential to spread to all class levels, just as conservative beliefs have. Already there are many higher-income individuals, such as Warren Buffet and George Soros, who advocate for more egalitarian policies.

Trump: populist or plutocrat?

Where does President Trump fit into the politics of redistribution? As a billionaire, he stands near the top of the economic pyramid. Like many other rich men, he sees his success as a sign of his superior merit, no matter what Trump University students or other detractors say in their lawsuits. Indeed, he declares himself to be uniquely suited to save the US economy.

Trump has filled his cabinet mainly with other rich folks who are not noted for their egalitarian views. Mother Jones reported that his cabinet selections have an average net worth of $357 million. The richest 1% of American households have an average net worth of only (did I say “only”?) $18.7 million.

Why is Trump so popular? I think primarily because he presents himself as the ultimate job creator, who will boost economic growth by bringing back lost American jobs. He will use the unorthodox strategy of getting other countries to give us more favorable terms of trade, so that our manufacturing industries prosper, presumably at someone else’s expense. All Americans will benefit, especially downwardly mobile workers, when he puts America first and makes America great again.

We are supposed to be so impressed by these promises that we overlook his tendency to favor the privileged over the rest of society. Strip away his economic nationalism, and what’s left is the usual Republican tax breaks for the rich and benefit cuts for the poor. We don’t have the detailed plans yet, but all indications point to a tax reform bill that will give the biggest reductions to the top brackets, and an Obamacare replacement that will make health insurance less affordable for the poor. Although Trump appealed to enough Democrats and independents to eke out an electoral college victory, the core of his support is among  Republicans.

The Trump administration has a real potential to exacerbate income inequality and political polarization. Maybe he can grow the economic pie so much that people don’t care how unequally it is divided, but I wouldn’t bet on it.

 


The Distribution of National Income (part 2)

February 21, 2017

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We have been looking at a report on the distribution of national income from the Washington Center for Equitable Growth, authored by Thomas Piketty, Emmanuel Saez and Gabriel Zucman. What makes it special is its attempt to account for all forms of income, not just those most often reported in surveys and tax returns. Based on this more complete accounting, the authors conclude that between 1980 and 2014, the top tenth of the adult population increased their share of the pre-tax national income from 34.2% to 47.0%. The share going to the next two-fifths of the population declined from 45.9% to 40.5%, and the share going to the bottom half of the population declined from 19.9% to 12.5%. During this period, economic growth was sluggish compared to the postwar era (1946-1980), but average real income more than doubled for the top tenth, while remaining essentially unchanged for the bottom half.

These figures are only for pre-tax income, however. They leave open the question of what role taxes and government spending play in the distribution of national income. Does post-tax income tell a different story?

Post-tax income

By considering the distribution of the entire national income, the report challenges the way we normally think about after-tax income. In our everyday experience, it’s what’s left after the taxes are taken out. That makes it always less than gross income. But in the national income accounting, total post-tax income and pre-tax income are the same! That’s because the national income does not go down just because some of it is taxed. The tax dollars are spent directly or indirectly on someone’s behalf, and so they can be counted as somebody’s income. Post-tax income is not a reduction in national income, but just a redistribution of national income.

The calculation of post-tax income from pre-tax income requires two steps: the subtraction of taxes paid, and the addition of government benefits received. Taxes include all levels (federal, state, local) and all types (income, sales, payroll, property). Government benefits include both monetary transfers (earned income tax credit, cash assistance payments, food stamps) and in-kind transfers (mainly health benefits through Medicare and Medicaid). Some cash income is already included in pretax income, such as Social Security payments.

The trickiest type of government benefit to account for is “collective consumption expenditures.” This is government spending on behalf of society in general. One might apportion it equally, on the assumption that each citizen gets the same benefit from it. But the researchers distribute it in proportion to other income, reasoning that higher-income people usually get more benefits from general public spending. For example, wealthier people are more likely to live in communities where the taxes support higher spending per student in the public schools. They are also more likely to be shareholders who benefit from the profits earned by defense contractors. The authors acknowledge that “our treatment of public goods could easily be improved as we learn more about who benefits from them.”

What if the government spends more than it receives in tax revenue? Then the deficit has to be allocated to individuals too, as a kind of negative benefit. Otherwise, total benefits received would be larger than total taxes paid, making post-tax income larger than total national income, upsetting the logic of the entire analysis.

The distribution of taxes and benefits

In general, the distribution of taxes and benefits is mildly progressive, but not markedly so. With all forms of taxation considered, higher incomes are a little more heavily taxed. The effective tax rates are 33.9% for the top tenth of adults, 28.6% for the next two-fifths, and 24.4% for the bottom half. The effective tax rate for the adult population as a whole is 30.5%.

Each group’s share of all taxes paid depends on how much income they have to begin with, as well as the rate at which it is taxed. In 2014, the top tenth got 47.0% of the pre-tax income and paid 52.2% of the taxes (hardly an unreasonable burden in my humble opinion). The next two-fifths got 40.5% of the income and paid 38% of the taxes. The bottom half of the population got 12.5% of the income and paid 10% of the taxes.

On the government benefits side, the top tenth got the smallest share–26.0%–which is lower than their share of income and taxes, but still much higher than their share of population. Although they didn’t qualify for means-tested assistance programs like Medicaid and food stamps, they got a lot of the general benefits of government spending. The next two-fifths, however, got the largest share–41.6%–roughly proportional to their share of the population. What they pay in taxes they get back in benefits such as good schools. The lower half of the population got 32.6% of the benefits, which is much more than their tax burden but much less than their 50% share of the population.

The redistribution of national income

The result of government taxation and spending is that a modest portion of national income is redistributed, primarily from the top tenth of the population to the bottom half.  A simple comparison of pre- and post-tax income shows this clearly.

Because the top tenth paid more in taxes than they received in benefits, their post-tax share of national income was 8 percentage points lower than their pre-tax share in 2014 (39.0% vs. 47.0%).

For the next two-fifths of the population, pre- and post-tax income came out about the same. They started out with 40.5% of the pre-tax income, paid 38% of the taxes, got 41.6% of the government benefits, and wound up with 41.6% of the after-tax national income. All the figures are roughly proportional to their 40% population size, so this group didn’t win or lose much from income redistribution.

The bottom half of the population gained more in benefits than they paid in taxes, so their post-tax share of national income was 6.9 points greater than their pre-tax share (19.4% vs. 12.5%). That difference consists mainly of non-cash benefits. That’s because their meager pretax incomes–averaging $16,200–were taxed at 24.4%, and that more than offset any cash benefits they received. The net benefits they got were primarily from health insurance programs.

To summarize, in 2014 the US transferred 8% of the national income by taxing the top tenth of the population, with 7 points of that going to the bottom half and 1 point to the other two-fifths. The transfer reduced the top tenth’s sizeable after-tax income by 17%. But the transferred income loomed much larger in the lives of the people at the bottom who received it in one form or another. Since they had so much less to begin with, it boosted their income by 54%. In dollar terms, it meant an increase in average income from $16,200 to $25,000, a significant improvement, but still leaving them far behind everyone else.

Redistribution and the trend toward inequality

Has the redistribution of income through taxes and government spending helped to offset the trend toward greater inequality? One would expect that as the rich got richer, they would be forced into higher tax brackets, increasing the tax revenue available for redistribution. One might also expect that as incomes at the bottom stagnated, political pressure would build to increase spending to augment them.

The point about tax revenue has some truth to it. Between 1980 and 2014, the top tenth increased their share of pre-tax national income from 34.2% to 47.0%, but some of that gain was offset by taxes. Still, their after-tax share of national income went from 29.5% to 39.0%. The increase in post-tax income was about three-quarters of the increase in pre-tax income. In other words, they got to keep three-fourths of their gains.

For the other nine-tenths of the population, tax offsets worked to reduce losses instead of gains. For the bottom half, the decline in their share of post-tax income was 85% as large as the decline in their share of pre-tax income. For the two-fifths of the population in between, the decline in their share of post-tax income was only  59% as large as the decline in their share of pre-tax income. To put it another way, the government absorbed 15% of the losses for the bottom half and 41% of the losses for the two-fifths in the upper middle of the distribution.

What the country did not do in those years was increase the overall rate of taxation or make the tax rates more progressive. The average tax rate considering all taxes went down slightly from 30.8% to 30.5%. Moreover, the effective rate of taxation went down for the upper half of the population (due mainly to income tax cuts), but went up for the lower half (due mainly to increases in payroll taxes). That’s why the government absorbed more losses for the upper-middle class than for the bottom half. Redistribution from top to bottom could still go up a little, because the rich had more money that could be taxed. But non-progressive tax policies left most of the increase in inequality untouched.

As for the second point, about political pressure to increase spending on the poor, that was outweighed by pressure to cut tax rates for the middle and upper classes. Between 1980 and 2014, the percentage of national income going to finance government benefits for the bottom half remained stuck around 10%, while benefits for the upper half remained around 20%. The upper middle class played a crucial political role here. With their own share of the national income shrinking, a majority of them sided with the rich in supporting low taxes, rather than with the poor in supporting policies to reduce inequality. I will have more to say about the political implications of the income distribution in my next post.

Continued


The Distribution of National Income

February 20, 2017

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The Washington Center for Equitable Growth has issued a new, very informative report on income inequality. Its authors, Thomas Piketty, Emmanuel Saez, and Gabriel Zucman, are trying to improve on the way economists have measured inequality in the past:

One major problem is the disconnect between maceoeconomics and the study of economic inequality. Macroeconomics relies on national accounts data to study the growth of national income while the study of inequality relies on individual or household income, survey and tax data. Ideally all three sets of data should be consistent, but they are not. The total flow of income reported by households in survey or tax data adds up to barely 60 percent of the national income recorded in the national accounts, with this gap increasing over the past several decades.

Why is there such a discrepancy between the national income accounting and the personal reporting? The main reason is that when people report their income on a survey or a tax return, they are thinking of income actually received in cash. But some forms of national income accrue to individuals whether they see cash from them or not. Employers contribute to workers’ pension plans or subsidize their health insurance. Corporations make money on behalf of shareholders that they retain for investment rather than distribute as dividends. This report aims to apportion the entire national income among individuals. It tries to account for all forms of compensation for workers and all returns on capital assets, whether taken in cash or not.

For purposes of analysis and discussion, the researchers divided the US population into three broad groups, the top tenth, the next two-fifths, and the bottom half. The unit of analysis was the adult individual 20 or older. Most of the analysis split marital income equally between spouses, for example assigning each of them $40,000 if one earned $50,000 and the other $30,000. That makes sense if couples are sharing their purchasing power. The authors also did a separate analysis of gender inequality using individual earnings. There they found that overall, men had 1.75 times as much work income as women, without controlling for hours worked or types of jobs. That ratio has been falling steadily since the 1960s, when it was over 3.00.

Pre-tax income

To appreciate the degree of income inequality the researchers found, consider the familiar analogy of dividing a pie. Imagine that you bake a large pie for a party of ten, dividing it into ten equal slices. But the first guest to dig in takes five slices! The next four guests take one slice each, leaving only one slice to be divided among the remaining five diners. In percentage terms, one-tenth of the people got 50% of the pie, the next two-fifths got 40%, and the remaining half got only 10%.

The real numbers for 2014 (the last year reported) are not far from that. The top tenth got 47.0% of the national income; the next two-fifths got 40.5%, and the bottom half got 12.5%. The average (mean) income for the groups was $304,000 per person for the top 10%, $65,400 for the next 40%, and $16,200 for the bottom 50%. (If some of the numbers sound large, remember that income is being defined very inclusively.)

One advantage of these particular dividing points is that they clearly distinguish between one group whose share of national income is roughly proportional to its size (the two-fifths) and two groups whose share is either disproportionately large (the top tenth) or small (the bottom half).

In addition to the enormous differences in shares, the three groups differed in how much of their income they derived from returns on capital as opposed to their own labor. The top tenth got 43.0% of their income from capital, compared to 17.9% for the next two-fifths and 5.1% for the bottom half. Ironically, in a country that prides itself on its work ethic, the most meager rewards go to those who have to rely the most on their labor.

Trends in inequality

In order to study trends over time, the researchers compared two 34-year periods, 1946-1980 and 1980-2014. The first period includes the postwar economic boom. The second period begins with the year Ronald Reagan was elected president, although I don’t know how much that affected its selection as a dividing point. The authors do suggest that changes in public policy were at least partly responsible for the increase in inequality that has occurred since 1980.

The period after World War II was a time of rapid economic growth and broad-based increases in income. Pre-tax income (adjusted for inflation) increased 79% for the top tenth, 105% for the next two-fifths, and 102% for the bottom half over those 34 years. Because the increase was less for the top tenth than the other groups, the distribution became a little more egalitarian. The share of national income going to the top tenth declined from 37.2% to 34.2%.

The period since 1980 has been a time of both slower economic growth and very unevenly distributed gains. Pre-tax income increased 121% for the top tenth, 42% for the next two-fifths, and only 1% (!) for the bottom half. The rich got richer and the poor got left behind. As a result, the distribution of national income became noticeably less egalitarian. The share of the top tenth rose from 34.2% to 47.0%, but the share of the lower half dropped from 19.9% to 12.5%. That top share is similar to what rich people were getting back in the 1920s, before the Great Depression. Over the course of the past century, income inequality has gone down but then gone back up. At the highest levels of income, the return to inequality has been even more dramatic. Average income for the top 1% increased only 47% during the postwar era, lagging well behind general economic growth; but it rose 205% after 1980, far exceeding general growth. For the top 0.01%, where the average income is over $28 million, the increase has been 454%.

Although global trends such as outsourcing and automation have produced gains for capital at the expense of workers, the authors point out that not all countries have experienced the same extremes of inequality as the United States has. Although economic growth has been slower in France, the lower half of the French population has shared in the national growth as the American lower half has not. As a result, “While the bottom 50 percent of incomes were 11 percent lower in France than in the United States in 1980, they are now 16 percent higher.” America’s self-image as a unique land of opportunity is no longer secure.

Income redistribution?

Pre-tax income does not tell the whole story, however. The taxation of income provides some potential for redistribution, as those with higher incomes are taxed in order to provide some benefits to those with lower incomes. In my next post, I will discuss the report’s comparison of pre- and post-tax income to see how taxes and government benefits are distributed, and what effect they have on income inequality.

Continued