Yesterday’s New York Times has a very interesting article, “U.S. Middle Class No Longer World’s Richest”, demonstrating that from 1980 -2010 the median wage in many other developed nations has grown faster than in the U.S. The chart below does show that the U.S. median wage is still growing but just not as fast as elsewhere. The authors suggest three reasons to explain what is happening:
Educational attainment in the U.S. is growing more slowly than in the rest of the industrialized world.
A larger portion of business profits in the U.S. is going to top executives meaning less for middle and low income workers.
There is a higher degree of income redistribution (through taxation) in Canada and Western Europe than in the U.S.
The data presented in this article is more elaborate but nevertheless consistent with what other studies are showing. We are still on top but we need to make some major changes in order to stay there. For example:
Most states have adopted the national Common Core curriculum for K – 12 schools. In today’s highly competitive global environment, this will enable a more rigorous evaluation of educational attainment between the states and should, therefore, improve overall academic achievement.
The best way to raise salaries for middle and low-income workers is to boost economic output overall. Fundamental tax reform, with lower tax rates for everyone, offset by closing loopholes and lowering deductions for the wealthy, will put more money in the hands of the people most likely to spend it. This will increase demand and make the economy grow faster.
As a highly visible way of addressing economic inequality in the U.S., institute a relatively small, i.e. 1% or 2%, wealth tax on the assets of individuals with a net worth exceeding $10 million. This would raise up to $200 billion per year which could be used for an extensive infrastructure renewal program, creating lots of jobs and further boosting the economy, with a lot left over to devote to shrinking our massive federal deficits.
A program like this encourages everyone to work hard and reach their highest potential, including accumulating as much wealth as they are able to. But the people at the very top, i.e. the superrich, will be required to give back a little bit more in order to benefit the entire country.
This morning’s Wall Street Journal has a book review by the New York fund manager, Daniel Shuchman, “Thomas Piketty Revives Karl Marx for the 21st Century” of Thomas Piketty’s new book “Capitalism in the Twenty-First Century.” As I recently discussed, Piketty makes the simple observation that income from wealth, i.e. investment income, grows faster than income from wages or GDP. He then provides a large quantity of data showing how this has played out since the end of WWII. He plausibly predicts that the value of private capital as a percentage of national income will continue to grow indefinitely into the future. This much is straightforward. The question is how we should react to a steadily increasing and very large concentration of wealth in the hands of a small percentage of people. Mr. Piketty’s own idea is, for example, to establish an 80% tax rate on incomes starting at “$500,000 or $1,000,000” in order “to put an end to such incomes.” Mr. Shuchman attempts to discredit Mr. Piketty by focusing in on such socialistic views for dealing with the problem rather than discussing the intrinsic merit of Piketty’s basic thesis about the buildup of great wealth in the first place.
My own view is that Mr. Piketty has clearly identified a weakness of capitalism and that it behooves supporters of free markets and private initiative to address this problem in a constructive way, for example, as follows.
We need fundamental broad-based tax reform, i.e. lower tax rates in exchange for closing loop-holes and lowering deductions, in order to boost the economy and create more jobs. As part of a major tax overhaul, we could also establish a relatively small wealth tax, of about 1% or 2%, on assets over $10,000,000, which would raise as much as $200 billion per year. This much money could be used to begin a large scale program of infrastructure renewal as well as leaving a lot left over to make significant payments on reducing our annual deficit.
Such an overall plan would address both income inequality and wealth inequality in a highly visible manner while simultaneously helping our economy.
The French economist Thomas Piketty is creating a huge stir with the publication in English of his new book “Capital in the 21st Century.” Mr. Piketty develops a very simple idea, with reams and reams of data. Namely that income from wealth, i.e. investment income, typically grows faster than income from wages and GDP. This means that the value of private capital is growing steadily as a percentage of national income. This trend has been occurring ever since 1950, at the end of WWII, and is likely to continue indefinitely absent new mega shocks to the global economy such as another world war. In other words, wealth inequality is rapidly increasing just as is income inequality. Today’s New York Times has an interesting article “Taking on Adam Smith (and Karl Marx)” discussing Mr. Piketty’s background and how it has influenced his research. “No revolutionary, Mr. Piketty says that inequality by itself is acceptable to the extent it spurs individual initiative and the generation of wealth. But extreme economic inequality, he contends, will have a deep and deleterious impact on democratic values,” says the reporter.
Now that income inequality and wealth inequality are clearly well documented, the question is how our democratic society will respond through the political process. First of all, we need to agree to take the problem seriously. Equality of opportunity and economic mobility still exist but it is getting harder and harder to move up the income ladder. What our country badly needs right now is an economic program that will get our economy growing faster in order to create more jobs as well as bringing in more tax revenue to pay for government.
One way to accomplish this is with
Broad-based tax reform to lower rates in order to put more money in the hands of people who will spend it on basic necessities as well as business expansion. Lower rates can be paid for by closing loopholes and deductions which primarily affect the wealthy.
A low percentage (1% or 2%) tax on wealth (i.e. financial assets) with a fairly high personal exemption of perhaps $10 million in order to only include the most wealthy. This would raise about $200 billion per year which could be used to fund a wide scale infrastructure renovation program which would provide employment to millions of people.
Such a wealth tax would be a highly visible means of addressing economic inequality in a way which would greatly benefit to the economy at the same time.
The Yale Economist and Nobel Prize winner, Robert Shiller, has an article in today’s New York Times, “Better Insurance Against Inequality”, proposing that “taxes should be indexed to income inequality so that they automatically become more progressive – meaning that the marginal tax rate for the highest income people will rise – if income equality becomes much worse.” We do know, of course, that income inequality is steadily increasing in the U.S. It is in fact essentially folklore that the top 1% of Americans is collecting a larger and larger share of the national income. Furthermore the French economist, Thomas Piketty, has recently shown that there is also “a relentless widening of disparity in wealth”.
Our democratic political system will surely respond in some way to this increasing gap between the rich and the poor. It is important to our future wellbeing to respond in a constructive manner. Today’s top tax rate of 39.6% is already very high and Mr. Shiller admits that the top rate would have to rise well over 75% in his plan.
Our biggest economic problem today is a stagnant economy. We badly need faster economic growth, in order to put people back to work and to bring in more revenue to shrink the deficit. Today what we need is lower tax rates, to put more money in the hands of people who will spend it, including potential entrepreneurs who will invest it in new businesses. Raising tax rates to address rising income inequality is therefore self-defeating as an economic strategy.
Rather let’s tax people’s financial assets after they have earned their money. A 1% wealth tax with a relatively high $10,000,000 personal exemption would bring in approximately $200 billion per year. $200 billion per year would enable us to pay down our deficit at a much faster rate as well as having a lot left over to begin an extensive infrastructure renewal program (for example)!
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: The 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: What 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!
In the latest issue of Barron’s, Frederick Rowe, the managing partner of Greenbrier Partners Capital Management, asks in “More Than a Sugar High?” , “Can you imagine a country that is managed in an economically rational manner, creating the wealth that’s necessary to take proper care of the citizens who get left behind? … What if our economic recovery is more than a sugar high? What if there is more here than insanely stimulative monetary policy from the Federal Reserve? What if the U.S. has already begun to steer an economic course to a period of unprecedented and genuine prosperity, achievement, and problem solving?”
Here are eight factors which Mr. Rowe gives to point us in the right direction:
North American Energy Independence (already on the horizon).
Sensible Immigration Reform: encouraging our most enterprising and hard-working people to become citizens rather than chasing them away.
Repatriation of Corporate Income: if a company domiciled in the U.S. makes money in Argentina and wants to invest it in the U.S. we double-tax the daylights out of it. It would be hard to imagine a more counterproductive tax policy.
Changing Directors and Their Thinking: the once unthinkable mindset of corporate directors acting on behalf of long-term owners (rather than the CEOs with whom they play golf) is actually gaining traction.
Lowering Corporate Taxes: the tax-writing committees in Congress are working on this.
Increasing Technological Leadership: the most dynamic technology companies in the world are domiciled in the U.S. Technology, in the short run, displaces workers. But eventually workers catch up because new technology creates new kinds of jobs that were never imagined before.
Americanization of the World: more than three billion people around the world will soon be able to afford to live much more like the 300 million Americans do. So companies which make it big here have an automatic global opportunity.
Obamacare: Even this bureaucratic catastrophe provides a large opportunity for economic opportunity. Think of Jimmy Carter’s failures which led to Ronald Reagan’s successes.
“Let your imagination run and consider all the things that can be accomplished by an energy-independent, cash-generating, cash-repatriating country that is a hotbed of technological innovation.”
I can’t possibly say it any better than this!
Many political commentators have been complaining recently about the financial difficulties of the American middle class. For example, a recent report from Bill Moyers and Company, “By the Numbers: The Incredibly Shrinking American Middle Class”, has a chart showing that the median middle class salary, adjusted for inflation, is now no better than it was in 1989 and not much higher than in 1979: But there is another point of view, very well described by the two economists, Donald Boudreaux and Mark Perry, in the Wall Street Journal just about a year ago, “The Myth of a Stagnant Middle Class”. They make several pertinent points:
The Consumer Price Index overestimates inflation by underestimating the value of improvements in product quality and variety.
Wage figures ignore the rise over the past few decades in the portion of worker pay taken as (nontaxable) fringe benefits. Health benefits, pensions, paid leave, etc. now amount to almost 31% of total compensation according to the Bureau of Labor Statistics.
The average hourly wage has been held down by the great increase of women and immigrants into the workforce over the past three decades. Because the economy was (before the Great Recession) so strong, it created millions of jobs for the influx of often lesser skilled workers into the workforce.
Messrs. Boudreaux and Perry point out several other improvements in the quality of life which Americans enjoy:
Life expectancy has increased to 79 years for an American born today, five years longer than in 1980. And the gap in life expectancy between whites and blacks has narrowed.
Spending by households on the basics of food, housing, utilities, etc. has shrunk from 53% of income in 1950, to 44% in 1970 to 32% today.
Although income inequality is rising when measured in dollars, it is falling when measured in terms of our ability to consume. For another example, air travel is now as common as was bus travel in an earlier era. And another: the latest electronic products are available to even middle class teenagers.
Conclusion: We should stop complaining about inequality and thank our lucky stars for the free enterprise system which has been so successful in improving our quality of life.