July 25, 2010

The Land of Greatly Diminished Opportunity

On Saturday, the Obama Administration announced that, although it is forecasting robust economic growth of 4% annually in 2011 and 2012, it also expects unemployment to remain at close to 9% over the same period.  Given that demand is the engine that drives the economy, with nearly 1 in 10 Americans out of work for the next 24 months, it is entirely reasonable to ask just who will be fueling this healthy expansion of GDPChristina Romer, who chairs the president's Council of Economic Advisers, said the White House believes business investment and an emphasis on exports will lead the way. 

Leaving aside for the moment just what we can expect to happen to the long term unemployed during the next two years, this focus on growth driven by consumption from outside the United States is revealing.  In many ways, it is the logical culmination of the tax cut mania that has been part and parcel of national political discourse since Ronald Reagan was elected, for these policies have not - despite conventional wisdom - been the engine that drives growth for the country as a whole.  Rather, they have driven growth almost exclusively at the top of the economic ladder and been the root cause of the middle class' slow strangulation. 

As the graph below shows, the gap between the richest and poorest Americans is the widest it's been since World War I.  The largely boom years from the end of the second world war - which fueled an enormous expansion of the American middle class - have been replaced by a period in which the very rich have gotten  staggeringly wealthy, the poor even poorer, and those in the middle have been forced gradually downward.

[Click image to view at full size]

This concentration of wealth has been driven by tax cuts for the wealthiest Americans.  Since the Reagan Administration, it has been accepted wisdom that cutting taxes frees up money for investment by private individuals and corporations that would ordinarily be used by the government in a less efficient or effective manner.

The theory - basically the supply side economics of the Reagan years - says that letting people hold onto more of their money will allow them to make greater investments in a wiser fashion, since they are far more expert in their fields of endeavor than any government bureaucrat could hope to be.  These investments are in turn expected to spur economic growth and job creation that makes everyone better off.

While there is no question that for many people - myself included - the idea of having greater control of one's earnings is highly appealing, the truth of the matter is that, in aggregate, the promised effects of tax cuts haven't materialized in any sustainable fashion.  The concentration of wealth that has resulted has actually depressed real wages per capita - described in the graph below as an average in 1982-1984 dollars - which are lower now than they were in 1979.  That's right; purchasing power today - what one can buy with one's paycheck - is actually less than it was during the Carter Administration, despite steady growth in GDP.  So much for trickle-down theory:

Likewise, job growth doesn't track with tax cuts as one might intuitively expect.  Since 1992, the largest increase in employment to population ratio (the percentage of the populace that has a job) occurred after President Clinton's tax increases of 1993. By contrast, President George W. Bush's tax cuts - the very hallmark of his administration - appear to have reduced employment if they had any effect at all:

Job creation spurred by the investment of dollars that would normally go to taxes simply didn't occur at anywhere near the rate promised:

The reason?  In the wake of tax cuts, what seems to occur among the wealthiest is not enterprise re-investment or job creation, but profit-taking.  No longer incented to "protect their money from the government" by plowing it back into their businesses, the rich instead either save it - often in overseas tax havens - or spend it elsewhere.  Such spending does drive some level of growth, but on a scale altogether far inferior to that from reinvestment or even public sector spending.  It also results in a distribution of wealth that sees ten percent of the population controlling over two-thirds of the wealth in the United States:

For the bottom 90%, what appears to happen in the wake of tax cuts is a brief boom that develops into a bubble, which inevitably bursts. Worse, this illusion of growth seems to have a psychological effect on the vast majority of the population that isn't in the top-earning tier.  "Keeping up with the Joneses" drives people to live well beyond their means - apparently unaware that almost everyone else is doing the same thing - with the result that the personal savings rate plunges:

Author Larry Beinhart decided he'd check into the accepted wisdom of tax cuts, and found some very startling things:
  • Large income tax cuts are followed by a bubble and then a crash.
  • High income taxes correlate with economic growth.
  • Income tax increases are followed by economic growth.
  • Moderate income tax cuts are followed by a flat economy.
  • All of this is especially true as applied to the top tax rates, the amount paid on income that exceeds the highest bracket.
Mr. Beinhart describes the data in the following manner:
... I constantly see and hear tax cuts, particularly at the top, described as "pro-growth." So I went and looked at the numbers - tax rates, tax cuts and tax hikes - and placed them alongside job growth, the Dow Jones, growth in the GDP and median income.

The brute facts say the opposite of the myth.
But what about self-determination, hard work and success on the basis of merit - some of the core values on which Americans pride themselves? Aren't people free to pull themselves up by their bootstraps to acheive the station they deserve through industriousness and ingenuity? Aren't tax cuts a mechanism to make that happen?

Unfortunately, while that element of our national character remains strong in the hearts of the citizenry, it has become more folklore than truth. The likelihood of anyone moving from the bottom half of wealth-holders to the upper middle class has shrunk dramatically since World War II, as has the probability of anyone moving in the opposite direction.  In other words, the American class structure has become increasingly rigid:

So, does this mean that the government automatically knows best and that taxes should always be high?  No, it does not.  What it does mean is that the roles of government and private enterprise are out of balance.  Tax dollars may not always be spent efficiently, but they are at least spent, rather than squirreled away overseas or used to buy limited luxury goods.  Likewise, the success of the private sector does not come without the assistance of public assets such as infrastucture, law enforcement and market regulation.  We need to re-recognize the true relationship between these two elements of our economy. 

The idea that private enterprise is always better than public sector effort has been ingrained in our national psyche over the last three decades to such a degree that it has become accepted without question.  Almost everyone has a government horror story they can use to support that contention, but we have become a country which generally ignores or forgives similar tales associated with private malfeasance, or at least one which doesn't ascribe such misdeeds to the very character of capitalism.

Further, we have become a nation that seems to rarely bother looking at the actual results of policy.   (This goes far beyond taxation, but that's a topic for another time.) The fact that someone like Senator John Kyl can not just advocate a $678 billion tax cut that would benefit the rich, but actually deny the need to offset that cut, should tell us all we need to know about the rigor with which macro policy positions are often developed.  (And the claim by people like Senate Minority Leader Mitch McConnell that tax cuts actually increase government revenues is a fantasy.)

According to a new study (PDF) by the Center on Budget and Policy Priorities (CBPP):
  • In 2007, the share of after-tax income going to the top 1 percent hit its highest level (17.1 percent) since 1979, while the share going to the middle one-fifth of Americans shrank to its lowest level during this period (14.1 percent).
  • Between 1979 and 2007, average after-tax incomes for the top 1 percent rose by 281 percent after adjusting for inflation — an increase in income of $973,100 per household — compared to increases of 25 percent ($11,200 per household) for the middle fifth of households and 16 percent ($2,400 per household) for the bottom fifth. 
  • If all groups’ after-tax incomes had grown at the same percentage rate over the 1979-2007
    period, middle-income households would have received an additional $13,042 in 2007 and
    families in the bottom fifth would have received an additional $6,010.
  • In 2007, the average household in the top 1 percent had an income of $1.3 million, up $88,800
    just from the prior year; this $88,800 gain is well above the total 2007 income of the average
    middle-income household ($55,300).
The middle class - the engine that drives the economy - is withering, and withering at an accelerating pace. The truth of the matter is this:  The current distribution of wealth and the socio-economic stangnation that comes with it are unsustainable if we wish to remain a country that is truly a land of opportunity.  Tax-cut driven policies have demonstrably failed to deliver what they have promised, and the belief that social mobility can be achieved through the mechanism of hard work is increasingly just that: an article of faith unsupported by actual fact.

It will take careful, well-considered effort - not to mention strong political will - to bring the relationship between the public and private sectors back into equilibrium.  In the meantime, however, one thing is for certain: despite the fever dreams of people like Glen Beck, olicarchy (or "oligarhy") in the United States will not arrive cloaked in the the mythological socialism of Barack Obama; it is already here, and it was delivered by Reaganomics.

AUTHOR'S NOTE:  Thanks to Gus Lubin at Business Insider for a number of the charts used here.  Mr. Lubin's 15 Mind-Blowing Facts About Wealth and Inequality in America lives up to its billing.


Batocchio said...

Thanks - I recently did a long post on plutocracy in America, and these charts are useful.

Tex Shelters said...

Thanks for the post. I found it after doing research on income inequity as part of a post on Obama's tax "compromise".

Well done. I will probably post on Monday.

Tex Shelters

PBI said...


Glad you enjoyed it and found it useful. I'll look forward to reading your post - I did one recently in a similar vein called "The President's Tin Ear"...