Vice Versa: Inequality and Our Economic Problems

BY John Miller | November/December 2013


This article is from Dollars & Sense: Real World Economics, available at http://www.dollarsandsense.org/archives/2013/1113miller.html


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This article is from the November/December 2013 issue of Dollars & Sense magazine.

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... President Obama and his supporters have been talking about “an economy that grows from the middle out.” ...

The key causal factor of the middle-out view is that a wider income distribution slows economic growth by lowering consumption demand. The data for the recovery since mid-2009 do not support this view.

Moreover, data do not support the view that tax cuts in the past 30 years are responsible for the widening income distribution.

—John B. Taylor, “The Weak Recovery Explains Rising Inequality, Not Vice Versa,” Wall Street Journal, Sept. 9, 2013.

Vice versa back at you, John Taylor. Rising inequality is not just bad for us, but is the root cause of today’s economic problems. A Stanford economist and Senior Fellow at the conservative Hoover Institute, Taylor readily admits that inequality is on the rise. But he never spells out the degree to which the widening gulf between the best off and the rest of us has concentrated economic gains nearly exclusively among the super rich. Had he done so, he would have found it far harder to dismiss the roles that pro-rich economic policies and worsening inequality have played in causing today’s economic maladies.

The most recent data, drawn from a variety of highly credible sources, show what the concentration of income “more at the upper end,” as Taylor puts it, has meant in practice. As of 2012, the richest 1% of families, all with incomes above $394,000, receive more than one-fifth of the income of the nation, some 22.5%, according the latest data compiled by economists Emmanuel Saez and Thomas Piketty. That’s nearly equal to their 23.5% share of income in 2007, before the onset of the Great Recession, and their 24% share during the late 1920s, on the eve of the Great Depression—the two highest concentrations of income since 1913. And, as Saez and Piketty document, a stunning 95% of what income gains there have been during the current recovery (from 2009 to 2012) have gone to richest 1%.

Not surprisingly, by 2012 only the income of the top 5% had returned to its pre-recession level in 2007, as the latest figures from the Bureau of the Census confirm. The inflation-adjusted income of the median family, on the other hand, was still 8.3% below its pre-recession level, and no higher than in 1989, nearly a generation earlier.

College Grads and the Super-Rich

What accounts for today’s staggering inequality? Taylor claims that changes in the private economy have driven up the wages of the well-educated and have left those with fewer years of education behind.

The distance between the economic position of workers with college degrees and those without has, indeed, widened considerably over the last three decades. In 1979, the “college premium” was 1.41. That is, the median wage of a college graduate was 41% greater than that of a worker with only a high-school diploma. By 2007, the college premium had reached 1.75. In addition, since the onset of the Great Recession in December 2007, the number of jobs held by college graduates has increased, while the number of jobs held by those without a college degree has fallen.

But that is hardly enough evidence to support Taylor’s claim. First off, nearly all of the increase in the college premium occurred before the last decade, but inequality has continued to worsen. In addition, the inequality among wage earners, especially between the top wage earners and the rest of the workforce, a large and increasing number of whom hold a college degree, is far greater than the college premium data suggest. For instance, looking at the ranking of wage and salary earners between 1979 and 2007, the wages and salaries of the top 1% rose by 156%, while those of the bottom 90% went up by just 17%. At the end of that period, the ratio of the wages and salaries of the top 1% to those of the bottom 90% stood at over 20-to-1, more than double the 9.7-to-1 ratio in 1979.

When investment income is added to wage and salary income, the economic gulf between the elites and the vast majority becomes even greater and increases even more quickly than the wage gap alone. Over the same 1979-to-2007 period, the ratio of total income of the top 1% to that of the bottom 90% tripled from 14-to-1 to 42-to-1. And even among the richest 1% income became considerably more concentrated. In 1979, the ratio of income of the top one-tenth of 1% to that of the top 1% was 3.4-to-1 in 1979 but reached to 5.2-to-1 by 2007.

These vast differences cannot be attributed solely, or even primarily, to differences in years of education among wage earners.

Pro-Rich Tax Cuts and Inequality

Taylor also emphatically disagrees with the “middle-out view” that the pro-rich tax cuts and economic policies that began in the early 1980s are the cause of the ever-widening gulf between the haves and the have-nots. But the very evidence he uses to support his position suggests otherwise.

Taylor’s argument rests on data published by the Congressional Budget Office (CBO) showing that “the distribution of market income before taxes widened in the 1980s and ’90s by about as much as the distribution of income after taxes.” But that hardly makes his case. Rather, the fact that after-tax income and before-tax income are widening at about the same rate offers powerful testimony to how pro-rich tax cuts have wiped out whatever government taxing policies had done in the past to mitigate the effects of widening economic differences in the private sector. “Market income inequality rose almost continually over the period [from 1979 to 2009],” write CBO tax analysts Ed Harris and Frank Sammartino. “Taxes and transfers did not offset market inequality.”

Federal taxes are considerably less progressive than in the past and no match for three decades of widening inequality. In 1979, the richest 1% paid an effective federal tax rate of 35%—handing over a little over one-third of their total income in federal taxes. By 2009, the effective tax rate of the top 1% had fallen to 28.9%, according to the CBO. And when a less progressive federal tax code was combined with a regressive state and local tax code, taxes could no longer combat widening inequality.

Inequality and Economic Growth

Finally, there are also several reasons to reject Taylor’s claim that inequality is not the cause of the weak recovery and sluggish economic growth since the official end of the Great Recession in June 2009.

Taylor’s argument is that inequality has not retarded spending because today’s saving rate of 5.4% is not especially high by historical standards. That’s true. But after the 1980s, the saving rate dropped steadily as consumption, boosted by a stock market boom, rose during the 1990s and, fueled by a housing bubble, rose still more during the last decade. Today’s savings rate is considerably higher than the 3% savings rate that prevailed in the middle of the last decade.

While spending by the rich, if high enough, could hypothetically power economic growth, several prominent economists are convinced that the redistribution of income toward the upper end has diminished spending and stood in the way of more rapid economic growth. Alan Krueger, current chair of the Council of Economic Advisors, thinks the drag on spending from this upwards redistribution “could be substantial.” He estimates that, by 2007, increased income inequality put an additional $1.1 trillion a year into the hands of the top 1%, who spend only about one-half of additional income. Had that $1.1 trillion remained in the hands of the bottom 99%, who have a general savings rate of about 10%, Krueger calculates that total consumption spending would have been 5% higher.

On top of its retarding effect on consumer spending, the concentration of income enhanced the political power of the super rich. Political scientists Adam Bonica, Nolan McCarty, Keith Poole, and Howard Rosenthal report that the share of individual campaign contributions made by the richest 0.01% rose from about 15% in 1980 to 40% in 2012.

And the political outcomes of the last three decades have surely conformed to the political interests of the most well-to-do—from the deregulation of the financial sector to pro-rich taxes to constraints on federal spending since the end of the Great Recession. Government spending and investment have been falling since 2010. Cuts in discretionary spending have reduced economic growth by 0.7 percentage points since 2010 and raised the unemployment rate by 0.8 percentage points, according to a recent report prepared for the conservative Peter G. Peterson Foundation. Taylor claims that three decades of rising inequality are explained by market forces. The lesson here, as Joseph Stiglitz has argued, is that “market forces don’t exist in a vacuum—we shape them.” In the last three decades, the very policies Taylor is determined to absolve have, in fact, shaped market forces in a way that has brought us ever-widening economic inequality, economic crisis, and now unrelenting economic stagnation.

is professor of economics at Wheaton College and a member of the Dollars & Sense collective.

: Lawrence Mishel and Josh Bivens, “Occupy Wall Streeters Are Right About Skewed Economic Rewards in the United States,” Economic Policy Institute Briefing Paper, Oct. 26, 2011; Congressional Budget Office, “The Distribution of Household Income and Federal Taxes, 2008 and 2009,” July 2012; Adam Bonica, Nolan McCarty, Keith T. Poole, and Howard Rosenthal, “Why Hasn’t Democracy Slowed Rising Inequality?” Journal of Economic Perspectives, Summer 2013; Emmanuel Saez, “Striking it Richer,” University of California-Berkeley, Sept. 3, 2013; Ed Harris and Frank Sammartino, “Trends in the Distribution of Household Income, 1979-2009,” Congressional Budget Office, Aug. 6, 2012; Jonathan James, “The College Wage Premium,” Economic Commentary, Aug. 8, 2012; Carmen DeNavas-Walt, Bernadette D. Proctor, Jessica C. Smith, Income, Poverty, and Health Insurance Coverage in the United States: 2012, September 2013; Paul Krugman, “The Damage Done,” New York Times, Oct. 17, 2013; Joseph Stiglitz, “Inequality Is Holding Back the Recovery,” New York Times, Jan. 19, 2013; Dean Baker, “Krugman versus Stiglitz on Inequality and Economic Growth,” Center for Economic and Policy Research, Jan. 20, 2013; Macroeconomic Advisers, LLC, The Cost of Crisis-Driven Fiscal Policy, Peter G. Peterson Foundation; Alan Krueger, “The Rise and Consequence of Inequality in the United States,” White House Council of Economic Advisors, Jan. 12, 2012.

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