Category Archives: income inequality

Wealth and Taxation

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As I reported in my last blog post a few days ago, wealth inequality in the United States and the rest of the developed world is growing rapidly and is likely to get much worse in the foreseeable future.   This is happening because income from wealth, i.e. the return on investment, typically grows faster than wages and GDP.  As income inequality also grows, and top wage earners have more and more money to invest, then the gap between investment income and wage income will become even wider.  There is nothing wrong with this and the more money that is reinvested in our economy, the faster it will grow and the more jobs that will be created.
At the same time that huge new wealth is being created we have an archaic tax system in the U.S. which is not only incredibly complicated and inefficient, but also discourages investment because the top individual and corporate rates are so high.  And it doesn’t collect enough tax to pay our bills.  We have huge deficits already and the CBO says that they’ll just keep getting worse.
Making government operate more efficiently with less spending is highly desirable but will only go so far.  Every government program has a constituency of supporters who complain when their own program is targeted for cuts.  And the biggest and most expensive, the entitlement programs of Social Security and Medicare, have the largest constituency of all, over 50 million retirees at the present time and growing rapidly as the baby boomers retire at the rate of 10,000 per day.
This huge crunch can only be resolved by fundamental tax reform.  Several different ways have been proposed to do this:

  • Reform the current income tax system by broadening the base, lowering rates and eliminating deductions and loopholes to pay for it.  The problem with this approach is that no one wants to give up their own deductions (for mortgage interest, charitable contributions, employer provided healthcare, state and municipal taxes, etc.)
  • Introduce a consumption tax such as the Graetz Plan which I described in my January 7, 2014 post.  It would establish a 14% Value Added Tax on consumption, supplemented by a lower but still progressive tax on incomes over $100,000.  It would avoid being regressive on low wage workers by using an Earned Income Tax Credit to offset the Payroll Tax.
  • Introduce a wealth tax.

Sorry, I’m over my (self-imposed) word limit already.  I’ll describe a possible wealth tax in my next post!

Wealth Inequality I. What Is It?

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The subject of income inequality has generated much interest and concern in recent months.  Now we will also be hearing a lot about wealth inequality, based on the highly credible new work, “Capital in the Twenty-First Century” by the French economist, Thomas Piketty.  The New York Time’s Eduardo Porter, summarizes the basic message in his recent column “A Relentless Widening of Disparity in Wealth”, which is clearly displayed in the two charts below.
CaptureThe value of private capital as a percentage of national income worldwide has been growing steadily since about 1950 and Mr. Piketty predicts that this trend will continue indefinitely.  The trend is equally true, not only in the U.S., but also in other developed countries as is illustrated in the chart.  It happens because the income from wealth, i.e. return on investment, typically grows faster than wages and GDP.
As Mr. Porter says, “It means future inequality in the United States will be driven by two forces.  First of all, a growing share of national income will go to the owners of capital.  Of the remaining labor income, a growing share will also go to the top executives and highly compensated stars at the pinnacle of the earnings scale.”
This trend has now been in effect ever since 1870, with the exception of the period between World War I and World War II, when a massive amount of wealth was destroyed.  The forces of globalization and growth of technology are contributing to both types of inequality, especially in the developed world (see my post of January 23), and these forces will almost surely continue unabated.  So the wealth and income inequality gaps are just going to keep getting worse.
How much inequality can exist in a democracy?  The number of losers (the low income, the poor, and even the struggling middle class) will gradually get bigger and bigger and will become more and more frustrated and express their discontent at the ballot box.  This threatens the future of capitalism and free enterprise, the economic principles on which our way of life is founded.
Something has to be done!  Stay tuned for my next post!

Where Have All the Raises Gone?

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In yesterday’s New York Times an editorial asks the question “Where Have All the Raises Gone?”, pointing out that wages for college graduates have been stagnant since 2001 (see the chart below.)  A report referred to in the NYT editorial suggests that as the information technology revolution has matured, employer demand for cognitive skills has waned and so some college graduates have had to take lower paying jobs, displacing less educated lower skilled workers in the process.  This makes sense and, of course, new hiring has slowed down even more as a result of the recession.
CaptureThe question then becomes, what, if anything can government do to counteract and overcome this trend?   According to the NYT, “what’s needed to raise pay are policies like a higher minimum wage, trade pacts that foster high labor and regulatory standards, and more support for union organizing.”
Of course there is another point of view and it is expressed very well in yesterday’s Wall Street Journal by Mortimer Zuckerman, the Chairman and Editor-in-chief of U.S. News and World Report, “Fight Inequality With Better Paying Jobs”. Mr. Zuckerman declares that “income inequality isn’t so much the problem as income inadequacy.  A more robust economy, stoked by growth-oriented policies from Washington, would help produce the jobs and opportunities that millions of Americans need to climb the economic ladder.”  He suggests that what is needed is:

  • Lower corporate tax rates so that American multinational companies will bring their foreign earnings back home.
  • Get healthcare costs under control (Obama Care doesn’t do this).
  • Cut back on unnecessary regulations to encourage more business investment.
  • Train more skilled workers.  The National Federation of Independent Businesses reports that 38% of its members have job openings they can’t fill.
  • Restore H1-B visa levels to the higher levels of earlier years – 195,000 per year compared to only 65,000 today.  Skilled immigrants start many new businesses and this is the biggest source of new job creation.

In other words there are lots of things the federal government can do to boost the economy.  As Mr. Zuckerman says, “The political system is failing us.  Washington doesn’t seem to be listening as our political parties are focused more on ideological conflict than the good of the country.”

Poverty, Inequality and the Minimum Wage II. Cities Are Expensive!

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Poverty and inequality are getting worse in the United States.  The question is what to do about it.  One proposal is to raise the minimum wage from its current value of $7.25 per hour to $10.10 per hour.  The Congressional Budget Office has studied the tradeoffs in doing this.  Approximately 16 million people, at the bottom end of the wage scale, would see their incomes go up.  But 500,000 people would see their incomes go down because they’d lose their jobs!  Does the positive outweigh the negative?  It’s not clear!
CaptureBut here is another aspect of the problem.  The Brookings Institution has just published a new study “All Cities Are Not Created Unequal”, pointing out that the 50 largest cities in the U.S. have higher rates of inequality than does the country as a whole.  Brookings looks at the so-called 95/20 ratio between the 95th percentile of wage earners compared to the 20th percentile.  The national average for this ratio is 9.1 with the 95th percentile earning (in 2012) $191,770 and the 20th percentile earning $20,968.  But many large cities such as San Francisco (16.6), Boston (15.3) and New York City (13.2) have much higher ratios.  The midsized city of Omaha has a ratio of 8.2 which is below the national average.
In other words the problems of poverty and inequality are much worse in some parts of the country than in others.  This suggests that at least part of the solution to addressing this problem should come at the state and local level.  It makes sense for California, Massachusetts and New York, for example, or at least San Francisco, Boston and New York City, to establish their own higher minimum wages.
This is not to say that a higher minimum wage at the national level is not also needed (more coming).  But the whole country cannot be expected to bail out a few major cities where the problem is much worse than elsewhere.

Poverty, Inequality and the Minimum Wage

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Poverty and income inequality are getting increasingly worse in the United States and need to be seriously addressed by our political system.  In my last post on February 16, I presented data from the Heritage Foundation which shows that the War on Poverty has been quite successful in eliminating destitute poverty in the U.S.  What this means is that most low-income families have the basic necessities of enough food to eat (96%), a refrigerator (99%), a telephone (96%), air conditioning (81%), a car (74%), etc.  Of course, these “amenities” are provided at a great cost to society of about $1 trillion per year in social transfer payments.
CaptureCan we do a better job in helping the poor in the near term?  The conservative writer and political activist, Ron Unz, thinks we can.  He has just written a perceptive blog post “The Conservative Case for a Higher Minimum Wage”, proposing a national minimum wage of $12 per hour.  His reasoning is as follows.  Low wage jobs are primarily in the non-tradable service sector and so these jobs are hard to outsource and also hard to automate.  Therefore the unemployment effects of such a minimum wage increase would be minimal.  Mr. Unz estimates that, Walmart could accommodate a $12 per hour minimum wage with a one-time price hike of just 1.1%.  The grocery prices of home-grown agricultural products would rise by less than 2%.
A $12 per hour wage for a full time 40 hour per week worker would mean an annual salary of $25,000 per year or $50,000 per year for a couple.  At this income level, the family would be paying more in taxes and receiving fewer government benefits.  This would turn many net tax recipients into net taxpayers and thereby raise their stakes in the American way of life as well as lowering the deficit.
I emphasize that this is a program to alleviate poverty in the U.S.  It will not do anything to help the middle class worker whose wages have been stagnant ever since the recession started six years ago.  This is a much harder problem which will require politically charged changes in U.S. economic policy.
Stay tuned!

Inequality, Productivity and Compensation

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The Brookings Institution social economist, William Galston, has an interesting column in yesterday’s Wall Street Journal, “The U.S. Needs a New Social Contract”, deploring the fact that worker compensation (i.e. wages + benefits) has not kept up with gains in worker productivity since the 1970s.  Here is a chart published by the Economic Policy Institute showing the divergence between productivity and compensation for a “typical” ( i.e. in the middle) worker beginning in the 1970s:
CaptureThe Heritage Foundation’s James Sherk has addressed this same question in a recent report “Productivity and Compensation: Growing Together” and shows that the “average” compensation of an American worker does track productivity very closely as shown in the chart below:
Capture1What is the explanation for this apparent discrepancy?  In fact, it is the difference between the average earnings of U.S. workers and the earnings of the median or middle worker.  The very high earnings of the top 10% and the even higher earnings of the top 1% raise average worker compensation way above the income level of the median worker.  In other words it is the result of the skewed and unequal distribution of incomes which is heavily weighted toward those at the top of the scale.  The typical or median worker is falling behind and is not benefitting from the steady rise in the overall productivity of the American economy.  This is what income inequality is all about.
The question is what to do about it.  Faster economic growth will create more opportunity by creating more jobs and better paying jobs.  Raising high school graduation rates as well as creating high quality technical training programs will also help.
Mr. Galston insists that this is not enough.  Too many workers will continue to lag farther and farther behind.  We could raise the Earned Income Tax Credit for low income workers but this would be very expensive in our currently tight fiscal situation which is likely to continue indefinitely.
Do we need a new social contract?  If so, what form will it take?  How will we pay for it?  These are indeed very difficult questions to answer!

The Economic Outlook: 2014 – 2024 II. How Can We Grow Faster?

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Last week I summarized the latest economic report from the Congressional Budget Office which very clearly describes both the slow rate of growth of our economy since the end of the recession, the enormous buildup of our national debt in the past five years and also the likelihood that it will continue getting worse for the foreseeable future unless big changes are made.
CaptureAbout a week ago the two economists Edward Prescott and Lee Ohanian had an Op Ed in the Wall Street Journal, “U.S. Productivity Growth Has Taken a Dive”, pointing out that the productivity of U.S. workers has grown at an average annual rate of only 1.1% since 2011, much lower than the average annual rate of about 2.5% since 1948 (see the above chart).  They also point out that the rate of new business creation is 28% below where it was in the 1980s (see the chart just below).  Growth of worker productivity and growth of new business formation are the two main forces which drive economic growth.
Capture1“Why is the startup rate so low?  The answer lies in Washington and the policies implemented in the wake of the 2008 financial crisis that were, ironically, intended to grow and stabilize the economy.” Mr. Prescott and Mr. Ohanian continue that it is the “explosion in federal regulation, intervention and subsidies (which) has retarded productivity growth by protecting incumbents at the expense of more efficient producers, including startups.”
It is easy to be pessimistic about the prospects for change in the government policies which are retarding economic growth.  Unfortunately, many political and social leaders have the point of view that it is income inequality which is “the defining issue of our time.”
The best response to this pervasive attitude is to shift the conversation towards equality of opportunity rather than dwelling on income inequality.  By far the best way to increase opportunity for those who desire it and are willing to work for it is to grow the economy faster in order to create more and better jobs. If we are able to do this, we’ll all be much better off.

Does Free Trade Increase Inequality?

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Several days ago, David Bonior, a former Congressman from Michigan, wrote in the New York Times about “Obama’s Free-Trade Conundrum”. “The President cannot both open markets and close the wage gap.”  There is an “academic consensus that trade flows contribute to between 10 and 40 percent of inequality increases.”  This happens because “there is downward pressure on middle-class wages as manufacturing workers are forced to compete with imports made by poorly paid workers from abroad.”
CaptureBut there is another point of view, provided, for example, by the report “NAFTA at 20: Overview and Trade Effects”, prepared by the Congressional Research Service about a year ago.  “U.S. trade with its NAFTA partners has more than tripled since the agreement took effect (in 1993).  (Canada and Mexico) accounted for 32% of U.S. exports in 2012.  40% of the content of U.S. imports from Mexico and 25% of U.S. exports from Canada are of U.S. origin.  In comparison, U.S. imports from China are said to have only 4% U.S. content.”  In other words, NAFTA at least has been a huge success.
Being able to trade with others is the foundation of private enterprise.  Foreign trade is simply an extension of domestic trade.  To limit trading opportunities with other countries would be a huge barrier to economic growth and therefore to future prosperity as well.
But at the same time we do want a more equal society as well as well as a more prosperous one.  The key to resolving this “conundrum”, as Mr. Bonior puts it, is to address “opportunity inequality” as well as “income inequality.”
It is estimated that each billion dollars in U.S. exports provides employment for about 5000 workers.  Nebraska, for example, exported $12.6 billion worth of goods and services in 2012 which translates into 63,000 jobs.
More jobs and better jobs are what create economic opportunity.  One way to create more jobs and better jobs is to promote foreign trade by removing as many trade barriers as possible.  Hopefully Congress and the President can work together to get this done!