My last post pointed out that there appears to be an inverse correlation between tax rates and economic growth in developed countries. In particular:
Tax levels in the U.S. have stayed relatively constant since 1965 while they have grown significantly in other O.E.C.D. countries.
GDP, on the contrary, has been growing faster in the U.S. than it has in these same countries.
Median wages, while growing more slowly in the U.S., are still much higher than in the other major O.E.C.D. countries.
A new report from the Brookings Institute analyzes the factors which have contributed to relatively slow wage growth in the U.S.
Labor productivity has been growing faster than hourly compensation since the mid-1970s.
Benefits have grown much faster than wages in recent years.
Labor’s share of income, compared to capital’s share, has been dropping in recent years.
Wage gains have been greater in the higher wage quintiles.
Domestic manufacturing output has increased even as manufacturing employment has decreased.
Entrepreneurship (i.e. new business formation) has declined in recent years even though it may now be starting to pick up.
Labor market slack has declined since the Great Recession though some still remains (measured as the share of the work force that works part time for economic reasons).
Recent labor productivity growth has been especially slow, restraining wage growth.
Conclusion. As everyone knows, slow wage growth is a highly contentious issue in the U.S. In addition to being a fundamental measure of a society’s wellbeing, it played a central role in the outcome of the 2016 Presidential election.
What can and should be done to speed up wage growth in the U.S.? Stay tuned!
It is widely deplored that wages for both middle- and lower-income workers are stagnant and have not even recovered from where they were before the beginning of the Great Recession. The latest issue of The Economist explores this problem, “When what comes down doesn’t go up.” The Economist sees several factors at work:
As the unemployment rate continues to drop, many new jobs are paying less than the old jobs that were lost.
In Germany “mini jobs,” paying under $440 per month, are skyrocketing. In Britain “zero hours” contracts, with no commitment to a fixed number of hours, are becoming more common.
In 2013 Kelly Services, which provides temporary workers, was the second largest employer in the U.S. with a staff of 750,000. 2.9 million temps account for 2% of all jobs in the U.S.
As The Economist points out, if low pay does in fact lock in, inflation will stay low even as the unemployment rate continues to fall. The Federal Reserve will then be likely to keep interest rates low indefinitely as well. But this means there will be far less incentive for Congress and the President to cut back on huge deficit spending because debt is almost “free money” when interest rates are low. Long term, massive debt, is a huge threat to our security and prosperity.
Breaking out of this pernicious low wage trap will require a bold effort by Congress and the President to boost economic growth. By far the best way to do this is with broad-based tax reform at both the individual and corporate levels. As I have discussed in previous posts, what is needed is lower tax rates paid for by closing loopholes and deductions. Hopefully, the new Congress is headed in this direction!
With a new Congress just elected, this is a good time to reflect about what changes should be made in public policy. Our biggest economic problem is to speed up growth in order to provide more and better paying jobs. In addition, a faster growing economy would bring in more tax revenue which would help pay our bills and reduce the deficit. A column in today’s New York Times, “The Great Wage Slowdown, Looming over Politics,” by David Leonhardt, proposes a cut in the marginal tax rate for the middle class as a way of boosting their incomes. As can be seen in the above chart, median household income has been flat since the year 2000, and even lower since the 2008 recession. Mr. Leonhardt goes on to say that any tax cut for the middle class should be balanced by a tax increase for the wealthy.
It so happens that I proposed such a plan several months ago as a way of boosting the economy and reducing inequality at the same time. The idea is to enact broad-based tax reform whereby tax rates are lowered for all, offset by shrinking tax deductions. The 64% of taxpayers who do not itemize deductions will receive a big tax cut. But these are the very middle-class wage earners with stagnant incomes. So they will likely spend their tax savings, thereby giving the economy a big boost.
Individual tax deductions total about $1 trillion per year.
Let’s suppose that these deductions are cut in half to $500 billion per year.
Let’s further suppose that half of this amount, or $250 billion per year, is cut from the taxes of the 64% who do not itemize deductions.
If these 64% spend just 2/3 of their new income (instead of saving it or paying off debt), this will total $170 billion which is 1% of GDP.
This would increase the rate of growth of GDP from the 2.2% average, since the end of the Great Recession, to 3.2%. This represents an enormous boost to the economy and would return average GDP growth to about its 3.3% average since 1947.
Mr. Leonhardt suggests that presidential contenders in 2016 would greatly benefit from proposing a tax rate cut for the middle class. Here’s a specific plan they can use!
There seems to be a general consensus on the reality of increasing income inequality in the U.S. and even some agreement on its two main causes: globalization and the rapid spread of technology. The slow growth of the economy since the end of the recession has made the inequality problem that much worse. Not surprisingly, slow economic growth in the past five years has led to stagnant wages for many workers. My last post addressed this problem. The above chart from the New York Times shows that incomes for top wage earners have been rising in recent years while they have been stagnant for middle- and lower-income workers.
But there is more to it than this. In yesterday’s Wall Street Journal, Mark Warshawsky and Andrew Biggs point out that, “Income Inequality and Rising Health-Care Costs,” in the years 1999 – 2006, total pay and benefits for low income workers rose by 41% while wages rose by only 28%, barely outpacing inflation. For workers making $250,000 or more total compensation rose by a lesser 36% while wages grew by a greater 35%. This apparent anomaly is explained by the fact that health insurance costs are relatively flat across all income categories, thus comprising a much larger percentage of the total pay package of low-income workers than for high-income workers. In fact, the Kaiser Foundation has shown that low-wage workers tend to pay higher health insurance premiums, as well as receiving lower insurance benefits, than higher paid workers (see the above chart).
Overall, what this means is that employer provided healthcare is taking a huge chunk out of the earnings of low-income workers which makes income inequality much worse than it would be otherwise. Of course, the cost of healthcare is a huge burden for the entire U.S. economy, currently eating up 17.3% of GDP, twice as much as for any other developed country.
For both of these reasons it is an urgent matter for the U.S. to get healthcare costs under control. Avik Roy of the Manhattan Institute has an excellent plan to do just this as I have discussed in several recent posts.
The latest news on the American economy is mixed. The unemployment rate fell to 5.9% in September but the labor force also fell by 97,000 last month. The labor participation is now down to 62.7%, a level last seen in 1978. On the plus side 248,000 new jobs were created but the share of the population employed stayed at 59%, less than its 59.4% level at the end of the recession in June 2009. In other words, job growth is definitely picking up but not fast enough. How about income inequality? One simple way of describing and understanding the degree of income inequality in the U.S. is to look at median household income and how it changes over time. The above chart from the WSJ shows how the median U.S. household income fell from an all-time high of $56,895 in 1999 to $51,939 in 2013. However it also climbed back up to $56,436 in 2007 before dropping precipitously until 2012. The Global Strategy Group discovered in a recent survey that registered voters overwhelmingly rate economic growth as a higher priority than economic fairness. This means that any policy designed to speed up economic growth is likely to receive favorable support by the electorate.
In a recent post I describe a plan for broad-based tax reform specifically designed to speed up economic growth. It would involve an across-the-board cut in tax rates totaling about $500 billion per year, but completely paid for by closing loopholes and deductions which primarily benefit the wealthy. The 64% of taxpayers who do not itemize deductions would receive a tax cut. And they would likely spend this extra money in their pockets because they are precisely the middle- and lower-income wage earners with falling incomes.
An income tax redistribution like this would greatly reduce inequality but in a way which is designed to give the economy a big boost!
The Harvard Business School has just conducted its third alumni survey on U.S. competitiveness and finds “An Economy Doing Half Its Job.” “Our report on the findings focuses on a troubling divergence in the American economy: large and midsize firms have rallied strongly from the Great Recession, and highly skilled individuals are prospering. But middle- and working-class citizens are struggling, as are small businesses. We argue that such a divergence is unsustainable.” Highlights of the survey are:
Survey respondents were pessimistic on balance, although less so than in previous surveys. By a ratio of three to two, those who foresaw a decline in U.S. competitiveness in the next three years outnumbered those who predicted an improvement. Respondents were much more hopeful about the future competitive success of America’s firms than they were about the future pay of America’s workers.
Respondents saw weaknesses in those aspects of the U.S. business environment that drive the prospects of middle- and working-class citizens, for instance, the education system, the quality of workplace skills, and the effectiveness of the political system.
Alumni working in small businesses had more negative views of virtually every aspect of the U.S. business environment. This finding echoes growing evidence from other sources that small businesses are disadvantaged in America.
The authors of the report “see a need for business leaders to move toward strategic, collaborative efforts that make the average American productive enough to command higher wages even in competitive global labor markets. Without such actions, the U.S. economy will continue to do only half its job, with many citizens struggling.” What’s interesting about this report is that it describes the problems of the American economy in a straightforward and practical way with no apparent ideological slant. Of course, addressing these issues requires political action with all of its messy, partisan overtones. Nevertheless perhaps all parties can at least agree on what the basic problem is.
My last post “Raising America’s Pay” addresses a new report from the Economic Policy Institute, “Raising America’s Pay: Why It’s Our Central Economic Policy Challenge”. Its starting point is the now generally accepted view that wages for the typical American worker have been flat ever since the early 1970s even though labor productivity has continued to rise steadily.
The EPI authors recognize that globalization and the growth of technology have contributed to wage stagnation even though they blame malign policy decisions as well. I do agree with them that the resulting increase in economic inequality is detrimental to America. I also agree with them that the way to address inequality is for wages to go up. The best way to accomplish this is to lower unemployment by increasing economic growth. This will happen when large numbers of consumers start spending more money, thereby increasing demand. Does this sound like a vicious circle? It need not be! The above chart from the Wall Street Journal shows that the net worth of U.S. households has now more than recovered from the Great Recession. The problem is that most of this new wealth has gone to the people with the highest incomes who are more likely to save it. What we need to do is “redistribute” (gasp!) some of this vast sum of new wealth back to middle and lower income people who would be much more likely to spend it.
There is a straightforward way to do this. Broad based tax reform! Lower everyone’s tax rates paid for by closing loopholes and shrinking deductions which primarily benefit the wealthy. This will be a pure gain in income for the two thirds of Americans, about 80 million, who pay income taxes but do not itemize deductions, most of whom are in the lower and middle income brackets. These people are likely to spend most of their new income, thus giving the economy the big boost that it needs!
Our leaders in Washington should be able to figure this out!
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.” But 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!
My previous post, “Fundamental Tax Reform Is the Key to Solving Our Economic and Fiscal Problems II. The Graetz Plan”, describes a tax reform plan which establishes a 14% national consumption (VAT) tax, exempts families earning under $100,000 from paying any income tax and also reduces the Corporate Income Tax to 15%. All of this is done in a revenue neutral manner while also preserving all of the progressivity of our current income tax system. A recent Op Ed column in the New York Times, by the economist Lawrence Kotlikoff, “Abolish the Corporate Income Tax”, makes the case that such a proposal “might sound like a gift to the rich, but it would actually help workers. … Apple’s tax return says it all: The company, according to one calculation, paid only 8% of its worldwide profits in United States corporate income taxes, thanks to piling up most of its profits and locating far too many of its operations overseas.”
Our corporate income tax rate, at 35%, is one of the highest in the world and this is what encourages American multinational companies to move their business to other countries. Whether we abolish the corporate income tax entirely, or just reduce it to 15%, is less important than recognizing the need to overcome popular prejudice about big business and make fundamental changes in our tax structure.
Solving our country’s many problems, from rising inequality at home to projecting adequate strength around the world, requires that the U.S. have a strong economy. An annual growth rate of 2% of GDP is not nearly good enough to end our current economic stagnation. To accomplish this will require overcoming the strong headwinds of increasing global competition and the replacement of people with machines. We will need innovative thinking and initiative to break out of the old ways of doing things which are holding us back.
Are the American people “exceptional” enough to accomplish this challenging task?
The economist Joseph Stiglitz has an Op Ed column in today’s New York Times, “In No One We Trust”, blaming the financial crisis on the banking industry. “In the years leading up to the crisis our traditional bankers changed drastically, aggressively branching out into other activities, including those historically associated with investment banking. Trust went out the window. … When 1 percent of the population takes home more than 22 percent of the country’s income – and 95 percent of the increase in income in the post-crisis recovery – some pretty basic things are at stake. … Reasonable people can look at this absurd distribution and be pretty certain that the game is rigged. … I suspect that there is only one way to really get trust back. We need to pass strong regulations, embodying norms of good behavior, and appoint bold regulators to enforce them.” Mr. Stiglitz is partially correct. Although the housing bubble, caused by poor government policy – loose money, subprime mortgages, and lax regulation – was the primary cause of the financial crisis, nevertheless, poorly regulated banking practices made the crisis much worse. But this is all being fixed with Dodd-Frank, a just recently implemented Volker Rule, and a soon coming wind-down of Fannie Mae and Freddie Mac. Mr. Stiglitz concludes, “Without trust, there can be no harmony, nor can there be a strong economy. Inequality is degrading our trust. For our own sake, and for the sake of future generations, it is time to start rebuilding it. But how do we reduce the inequality in order to restore the trust which is necessary for a strong economy? Mr. Stiglitz doesn’t say! What we need is faster economic growth in order to create more new jobs. The last four years have demonstrated that the Federal Reserve can’t accomplish this with quantitative easing. It needs to be done by private business and entrepreneurship. Tax reform and the easing of regulations on new businesses is what we need. It’s too bad that ideological blinders prevent so many people from understanding this basic truth!