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


A Measure of Fairness (part 2)

February 26, 2015

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In A Measure of Fairness, Pollin, Brenner, Wicks-Lim and Luce report their research on two kinds of wage laws: state minimum wage laws, and municipal laws that set a living wage higher than the federal and state minimums.

In 2007, Congress mandated that the federal minimum wage rise to $7.25 an hour by 2009. Twenty-nine states and the District of Columbia have raised their minimum wages higher than that; seven states and D.C. have a minimum of at least $9.00 (see map and data)

Municipal laws that set a wage higher than both the federal and state minimums are usually narrow in scope, applying only to businesses with municipal contracts. San Francisco and Santa Fe are two cities with broader living-wage laws.

The authors identify two different ways of defining a reasonable living wage, one focusing more on benefits and the other on costs:

First, what is a wage rate that is minimally adequate in various communities, in the sense that it enables workers earning that minimum wage and the family members depending on the income produced by this worker to lead lives that are at least minimally secure in a material sense? What wage rate, correspondingly, can allow for a minimally decent level of dignity for such workers and their families?
The second, equally legitimate, question…asks, How high can a minimum wage threshold be set before it creates excessive cost burdens for businesses, such that the “law of unintended consequences” becomes operative?

High on the list of unintended consequences would be job losses if businesses chose to lay off workers or leave a city or state rather than accept higher wage costs.

The authors also identify two ways of studying these issues: prospective research that tries to anticipate the consequences of proposed laws, and retrospective research assessing the actual consequences of existing laws. Except for the last section, the findings described below are from prospective studies.

Benefits to workers and families

Who benefits from wage laws? The answer might seem to be obvious, but some critics have questioned the need for such laws on the grounds that the lowest-wage workers are rarely major breadwinners, but are often younger workers whose wages will probably go up before long anyway. The authors find that the laws primarily benefit the people they are intended to benefit: low-income workers who are “well into their long-term employment trajectories,” with a high proportion of primary breadwinners and other major contributors to family income. In addition, the laws have important ripple effects, tending to raise the wages of workers who are already a little above the legal minimum. For example, the authors estimated that 20% of the people of Arizona would receive some income benefit from a proposed minimum-wage increase, including workers and members of their families.

Several of the research reports are from studies of a proposed city-wide minimum of $10.75 for Santa Monica. It was passed by the city council in 2001 but repealed by the voters in 2002. In order to evaluate its probable effect on incomes, the authors gave careful consideration to poverty thresholds and basic economic needs. First, they drew on research by the National Research Council on more realistic poverty thresholds than those established by the federal government. “The commission’s report…presented eight separate studies using different methodologies for coming up with alternative poverty measures. If we simply calculate the average of these eight alternative poverty lines, this average is 42 percent above the official poverty line.” Considering that the cost of living in the Los Angeles area is about 25% above the national average, they decided to use 160% of the federal poverty line as the poverty threshold for their research.

By that standard, a family consisting of one adult and two children would need an income over $21,475 to escape poverty, which corresponds to a full-time hourly wage of $10.32. A family with two adults and two children would need an income of $27,030, corresponding to a full-time hourly wage of $13.00 with only one adult employed. (All figures were in 1999 dollars, so would have to be somewhat higher today.)

The authors also drew on research by the California Budget Project, which constructed a “basic needs” budget for Los Angeles and other California regions. The CBP described this as “more than a ‘bare bones’ existence, yet covers only basic expenses, allowing little room for ‘extras’ such as college savings or vacations.” By that standard, a family with one adult and two children would need an income of $37,589, or a wage of $18.07 an hour. A family with two adults and two children would need a little less, $31,298, or a wage of $15.05, if one adult stayed home and provided child care. With both adults employed full-time, however, they would need $45,683 because of child care and other costs, but each job would only have to pay $10.98 an hour to generate that income.

To assess the impact of the proposed $10.75 hourly wage, the authors construct two very specific “prototypical family types.” The first is a three-person family whose primary breadwinner earns $8.00 an hour and contributes 70% of the family income. A raise to $10.75 increases the family income from $19,430 to $24,105, an increase of 24.1%. This takes the family from 10% below the adjusted Los Angeles poverty line to 12% above it. It also takes the family from 48% below the CBP “basic needs” budget to only 36% below it.

The second prototypical family is a four-person family with a low-wage worker earning $8.30 an hour and contributing 50% of the family income. A raise to $10.75 increases the family income from $29,880 to $34,290, an increase of 14.8%. (The other adult earner is not assumed to have an hourly rate low enough to be covered by the minimum-wage increase.) This takes the family from 12% above the adjusted Los Angeles poverty line to 29% above it. It also takes the family from 35% below the CBP “basic needs” budget to only 25% below it.

However, some of the increased income from higher wages would be offset by higher taxes and lost tax credits. (It wouldn’t be offset by loss of food stamps or medical benefits, since neither prototypical family was poor enough to qualify for those in the first place.) The authors calculate that the offsets amount to 40% of the income gains for the first family and 27% of the income gains for the second family.

Costs to business

Most legally mandated wage increases are not dramatic, and their impact is limited by the number of workers whose wages are already at or near the new minimum. Typical of the research reported here is the authors’ finding that a Santa Fe living-wage ordinance would increase average costs relative to business revenue by about 1%. The impact is often two or three times greater for businesses with more low-wage workers, especially in the food service and hotel industries.

Affected businesses can handle the added labor cost in many different ways. Perhaps the most obvious is to raise prices. Although that poses some risk of lost business, the damage is limited if the price increases are small, competitors are also raising their prices, consumers are interested in quality more than price, and possibly that consumers prefer to patronize businesses that treat their employees well, as some research indicates. In addition, some businesses, especially retail businesses operating in poor neighborhoods, may gain business because better-paid workers have more money to spend.

Another way that businesses absorb higher labor costs is through increased productivity. Higher wages tend to reduce turnover, which reduces the costs incurred in recruiting, selecting, hiring and training new workers. Based on their research in Santa Fe, the authors suggest that 40% of the cost of higher wages can be recovered in higher productivity.

Businesses can also absorb higher labor costs by redistributing income within the firm. This can be done in a rather subtle fashion, simply by letting low-wage workers have a larger share of productivity gains, while holding higher incomes steadier. Perhaps that is only fair, considering that the country has been doing the opposite for some time: “The fact that the minimum wage has been falling in inflation-adjusted collars while productivity has been rising means that profit opportunities have soared while low-wage workers have gotten nothing from the country’s productivity bounty.” If paying a higher wage forces a business to accept slightly lower profits, the damage to its competitive position is limited by the fact that its competitors may be facing the same problem.

Two more drastic responses to increased costs are to lay off workers or relocate to another city or state. The businesses most likely to relocate are those with a customer base that is not tied to a specific location, and with a substantial increase in labor costs. But many of the businesses that rely on low-income labor also have strong ties to a particular place, such as many restaurants and hotels.

The authors’ summary of their New Orleans research is typical of their conclusions:

Our results suggest that the New Orleans firms should be able to absorb most, if not all, of the increased costs of the proposed minimum wage ordinance through some combination of price and productivity increases or redistribution within the firm. This result flows most basically from the main finding of our survey research–that minimum wage cost increases will amount to about 0.9 percent of operating budgets for average firms in New Orleans and no more than 2.2 percent of operating budgets for the city’s restaurant industry, which is the industry with the highest cost increase.  This also suggests that the incentive for covered firms to lay off low-wage employees or relocate outside the New Orleans city limits should be correspondingly weak.

 Retrospective studies

In a few cases, the researchers were able to evaluate the effects of wage increases that had already been in effect for some time. Mark Brenner and Stephanie Luce studied the effects of wage ordinances in Boston, Hartford and New Haven covering businesses with city contracts. Critics had predicted that fewer companies would bid on city contracts, and the reduction in competition would result in higher costs for the city. In fact, there wasn’t much difference: The number of bidders went down in New Haven, but went up in Hartford and stayed the same in Boston. Businesses did not lay off workers, but adjusted to the higher wages mainly by accepting lower profit margins.

Brenner, Wicks-Lim and Pollin did a study comparing states with and without minimum-wage laws higher than the federal minimum. They found no adverse effects of higher minimum wages on employment.

Wicks-Lim and Pollin studied the effects of Santa Fe’s citywide minimum wage on job opportunities for low-wage workers. Aaron Yelowitz had reported that unemployment rose once other factors were statistically controlled. Wicks-Lim and Pollin found that employment actually held steady, but that the rate of unemployment was higher than expected only because more people came into the labor market looking for work. They came “precisely because there were more jobs and better jobs in Santa Fe than elsewhere.” Pollin also reminds us that the United States used to have a higher minimum wage (in inflation-adjusted dollars) in the 1960s than it has today, with no apparent damage to employment or productivity.

In general, this book supports the conclusion that raising wages for low-income workers brings at least modest benefits to workers, while imposing modest costs on employers and consumers. For workers, the benefits are partly offset by higher taxes and reduced benefits for the poor. For employers, the costs are partly offset by price increases, higher productivity, and redistribution of compensation among different levels of workers. Living-wage initiatives are one effective way of addressing extreme income inequality and poverty. They are not a cure-all, however, and other measures like progressive taxation and direct public assistance remain important as well.


A Living Wage (Glickman, part 2)

February 11, 2015

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The previous post discussed how Lawrence Glickman links the demand for a living wage to the historical transformation of the US economy. As independently owned and managed farms and businesses became less common, American workers had to rethink their hostility to working for wages. Increasingly they pinned their hopes for freedom and independence on better wages instead of on control over their own labor. The labor movement called for a high American standard of consumption supported by a living wage, at least for white males.

An idea whose time had come

By the end of the nineteenth century, this idea was gaining support beyond the labor movement itself. “Religious reformers were the first group outside of the labor movement to call for a living wage, beginning with Pope Leo XIII’s encyclical of 1891.” The Pope declared it a “dictate of nature more imperious and more ancient than any bargain between man and man.” In 1906, the Catholic priest and social activist John Ryan, published A Living Wage, which also made a distinction between prevailing market wages and ethical wages based on natural moral law. Prevailing wages were partly determined by the relative power of capital and labor, so were unlikely to reflect the true value of workers or their work. [On a personal note, my father told me that when he studied economics at a Catholic college in the 1930s, his ethics professor argued for the moral responsibility of employers to pay a living wage.]

States began passing minimum-wage laws in 1912, and the platform of the Democratic Party began calling for a federal minimum wage in 1916. From organized labor’s point of view, the minimum wage was exactly that, only the lowest point on the “spectrum of conceivable living wages,” but it was a start.

Opposition to higher wages was still intense in the early 1900s. The opposing arguments were partly economic, based on the idea that the wage set by the market represented the real value of labor. But this easily became a moral argument: since the worker’s labor was only worth what the market said it was worth, any demand for more was an immoral attempt to get something for nothing. Another argument was that any interference with the labor market violated the principle of freedom of contracts. A market wage represented an agreement between two free parties, but a legally mandated minimum deprived employers of their right to bargain freely with workers. It was this last argument that most impressed the Supreme Court when it declared minimum-wage laws unconstitutional in 1923. [It probably didn’t occur to justices to worry about whether the individual worker really had much freedom to bargain with a powerful employer.]

By the 1930s, support for a living wage became stronger, as economists, politicians and the general public came to associate low wages with economic depression. President Roosevelt stated it bluntly in 1938: “We suffer primarily from a failure of consumer demand because of lack of buying power.” With the productive capacity of the nation expanding, not to raise wages made it impossible for workers to buy enough goods to keep the factories humming and the labor force employed.

I don’t recall Glickman telling this part of the story, but the Supreme Court reversed itself in 1937 and upheld a state minimum-wage law. Interestingly, this happened because a certain Justice named Roberts departed from his usual practice of voting with the four most conservatives justices (perhaps setting a precedent for the Affordable Care Act!). This decision marked the end of an era in which the Court had generally resisted government efforts to regulate industry.

In 1938, Congress passed the Fair Labor Standards Act, which set a national minimum wage and a standard work week of forty hours beyond which overtime must be paid. Perhaps just as important, although not discussed by Glickman, the National Labor Relations Act of 1935 gave workers the right to organize and bargain collectively. A combination of union organizing and government support helped millions of workers achieve a higher standard of living and move into the middle class.

An idea whose time has gone?

Because Glickman is concerned primarily with the rise of the living wage as an idea, he ends his story in the early twentieth century with its partial implementation. He does not address the question of why the struggle for higher wages became so much harder in the latter part of the century, or why the very term “living wage” went out of fashion. I’ll just mention a few of the many developments that impeded or even reversed the progress that workers had been making:

  1. Runaway inflation not only eroded the buying power of wages, but it also reduced popular support for wage increases, since high wages could be blamed for inflation.
  2. Globalization undermined the argument for a distinctly “American standard” of wages. Employers could justify low wages in order to keep their companies globally competitive, or replace well-paid US workers with lower-paid foreign workers.
  3. New technologies reduced the demand for unskilled labor and the market price of that labor.
  4. Globalization and automation led to job losses in the highly unionized manufacturing sector, while employment in the less unionized service sector expanded. The decline of unions reduced the workers’ political clout too, since the labor-friendly Democratic Party had relied heavily on unions for its grass-roots organizing.
  5. The decline of the patriarchal, male-breadwinner family undermined the argument for a “family wage.” In theory, wages could be lower if families were accustomed to relying on multiple earners, but households with only one earner lost ground.
  6. The struggle for higher wages focused increasingly on racial minorities and women, who had been largely excluded from high wages in the past. Many white males felt threatened, however, and became more interested in holding on to what they had than advancing the cause of labor in general. They abandoned their traditional Democratic allegiance and voted Republican in large numbers, especially in the South, helping insure that public policy would tilt toward business and away from labor. The labor movement eventually paid a price for once thinking of the living wage as only a white man’s wage.

A new interest?

The recent attention focused on economic inequality suggests that the issue of just wages may once again move center stage. At the low end of the income scale, increases in the minimum wage have failed to keep up with inflation. In today’s dollars, the original minimum of about $4 an hour increased to over $10 in the 1960s before falling back to $7.25 since then. Meanwhile, incomes in the middle have largely stagnated while incomes at the top have increased dramatically (especially after-tax incomes because of large tax cuts for the wealthy).

Thomas Piketty observes that in the US recently, “income from labor is about as unequally distributed as has ever been observed anywhere,” with the top tenth of workers receiving 35% of the total and bottom half of workers only 25%. Income from investments is even more uneven, since the share of wealth controlled by the richest tenth has risen to over 70% in recent decades. The distribution of total income is a combination of the distributions of both labor income and investment income. The share of total income going to the top tenth fluctuated in the range of 30-35% between 1950 and 1980, but has gone up to 45-50% since 2000. So 15% of the national income has been transferred to the top tenth from everybody else. (See my discussion of Piketty’s Capital in the Twenty-First Century, especially part 3.)

In our new Gilded Age, with the rich living in increasing luxury while so many others can barely scrape by at all, the stage may be set for a new national discussion of a living wage.