The truth, both throughout the entire world as Oxfam International has now shown, and in the United States as my own statistics verify, is that the concentration of wealth in the hands of a very few individuals has gone way beyond even imaginable levels, and in both cases it is of a similar order of magnitude. What should have been clear all along is now becoming undeniable in the rational world: Inequality is fundamentally an economic problem; the distribution of wealth and incomes is all about money; and the distribution of money is the most important factor in determining prosperity, growth, and stagnation.
It seems strange to have to re-emphasize that reality over and over again, but even today in 2014, the neoclassical, mainstream community continues to deny that inequality growth has any economic consequences. I frankly do not know how anyone — especially trained economists — can think of economics and economic change without at least conceptually including the role of money at every stage. The mainstream perspective does, however, benefit the rich, for it follows from the proposition that inequality growth has no economic consequences that taxing them also has no economic consequences.
As discussed in previous posts (here, and here): David Brooks (1/16/14, here) outlined the propositions that wealth at the top is disconnected from poverty at the bottom, and that incomes, employment and social mobility at and near the bottom are determined by levels of training and education, social factors like single motherhood, and the declining availability of low-skill jobs. Raising the minimum wage, he said, would not help — money (evidently) is not a factor. Similarly, Harvard economics professor Martin Feldstein (1999, here) argued that inequality and poverty are stand-alone issues, that income inequality is not a problem, and that poverty is attributable to social factors such as inadequate training and education (which improves with private education). The amount of money available in an economy, its velocity and its distribution are (evidently) irrelevant, or at least not important enough to discuss.
What “Political” Problem?
Paul Krugman, the economics columnist for the New York Times and probably the best-known and most influential populist economist active today, has heretofore consistently taken the position that income inequality is a “political” problem (End this Depression Now! 5/12, Ch. 5), and he has resisted the conclusion of Joseph Stiglitz and Robert Reich that growing inequality depresses an economy because it depresses demand — an irrefutable and demonstrable consequence of Keynesian demand-side theory.
Take another look at the famous chart of top 1% income share from the data compiled by Thomas Piketty and Emmanuel Saez:
The top 1% income share reached its first peak in 1928, just before the stock market crash that brought on the Great Depression. It then peaked again in 2007, just before the even bigger stock market crash that ushered in the Great Recession. Krugman, strangely for a self-styled Keynesian, argued in his last book that this could be just a “coincidence.”
No, it cannot be a coincidence, not in demand-side theory: When the top 1% share reaches 24% of income, the bottom 99% is getting only 76%; for any given level of total income (GDP), bottom 99% income and purchasing power has substantially declined. This necessarily means reduced demand and slower growth. The facts since 1980, of course, bear out this reality, validating Keynesian demand-side economics. As this blog has frequently reported, not only has the economy shrunk, but the much larger top 1% share of the smaller pie turned out to be smaller than what the top 1% share would have been of the previous, much larger pie: Rising inequality has hurt everyone.
Unfortunately, Krugman’s argument that inequality is just a “political” problem is in line with the neoclassical, supply-side perspective. It would be one thing to take the position that the issue is political because of society’s failure to control income and wealth distribution, but that would add nothing of substance to the debate. It is quite another thing, however, to agree with the supply-side economic community that the issue only relates to social and institutional factors, while economic growth results solely from investment, which is stimulated only through monetary expansion and by reduced taxation of corporations and the wealthy. Calling inequality a “political” problem is therefore akin to arguing it is merely a collection of “social,” “behavioral,” “technological” or “institutional” problems. There are no other apparent senses in which inequality might be characterized as a “political” issue.
Thus Krugman, as a champion of liberal, populist causes, with this stance must confront his adversaries in their own ballpark, effectively conceding their core argument that inequality growth is not an economic problem, and undermining as well his own case against the “austerity” doctrine.
While his New York Times colleague David Brooks has been strenuously challenged on Keynesian grounds for arguing that inequality growth is not an economic problem, Krugman so far this year has been content to attack Pulitzer Prize winning columnist Bret Stephen’s year-end Wall Street Journal article (“Obama’s Envy Problem,” 12/31/13, here, and here). That exchange is informative:
“The President thinks America has inequality issues,” Stephens began. “What he has — what it has — is an envy problem.” After a brief political attack on Obama, Stephens then quoted Alexis de Tocqueville (1805-1859):
“Democratic institutions strongly tend to promote the feeling of envy,” and “a depraved taste for equality, which impels the weak to attempt to lower the powerful to their own level…”
Then he introduced the “Pareto principle”:
Inequality is not a problem simply because the rich get richer faster than the poor get richer. It’s a problem only when the rich get richer at the expense of the poor.
“As it is,” Stephens asked, “to whom except the envious should it matter that the boss now makes a lot more, provided you, too, also make more?”
Finally, he challenged the numbers Obama cited in his speech related the widening gap between CEO compensation average worker pay and the record level of wealth concentration; and using quintile data (which averages in the huge gains in the top 1%), Stephens argued that growing income inequality is no big deal: “The richer have outpaced the poorer in growing their incomes, just as runners will outpace joggers.”
Krugman (“Disinformation on Inequality,” New York Times, 1/2/14, here): took Stephens to task for using nominal figures (falsely implying that incomes are growing at the bottom); criticized Stephens for using Census Bureau (top 20%) data obscuring the more relevant narrow band of top 1% data; confirmed the accuracy of Obama’s numbers; and cited CBO data to disprove Stephens’ suggestion that inequality hasn’t changed much since 1979:
The point here, as on so many other economic issues, is that we are not having anything resembling a good-faith debate.
We could have a debate about whether rising inequality is a problem, and whether measures intended to curb it would do more harm than good. But we can’t have that kind of debate if the anti-populist side won’t acknowledge basic facts – and it won’t. In his piece Stephens trashes Obama, accusing him of making a factual error when he did no such thing; then proceeds to commit just about every statistical sin you can imagine in an attempt to minimize the rise in inequality. In the process he leaves his readers more ignorant than they were before. When this is what passes for argument, how can we have any kind of rational discussion?
Krugman is correct that Stephens wrote a terrible piece, full of inaccuracies, but that was just low-hanging fruit. Krugman’s approach to the issue is troubling: The political right has been distorting the facts in this way for several years, so why should the populist side be content now with merely quibbling about the numbers? Stephens and supply-siders like him likely don’t care about merely being called out on their inaccuracies: It’s to their advantage to limit the inequality debate to discussions of data accuracy year after year. Meanwhile, others on the neoconservative team continue to hammer their argument that inequality growth is nothing more than the natural consequence of globalization and other social and technological developments (See, e.g., “What President Obama Doesn’t Get About Inequality,” by Peter Morici, Money News, 1/21/14, here), while inequality continues to grow. They are winning, so why wait for them to show “good faith” before engaging in a “rational discussion”?
It’s up to those of us who consider inequality growth to be a major economic problem, indeed a grave threat to the future of our economy and society, to make our case. We must identify the economic effects of inequality growth and explain how to counter them. Will Krugman join in this effort? In this article, he didn’t even challenge Stephens’ position that income inequality growth is no dig deal. Indeed, he voluntarily framed the issue for debate as whether “measures intended to curb [rising inequality] would do more harm than good,” implying at least partial agreement, potentially, with Stephens’ supply-side viewpoint.
Krugman will not make a positive contribution on this topic until he unequivocally reverses his dangerous neoclassical posture. The point of attack on Stephens should have been on the Pareto principle, which Martin Feldstein also advanced (here). With increasing amounts of wealth continuously transferring into the top and the top 1% income share continuing to grow, people high up in the top 1% have simply been confiscating the money supply, badly harming everyone else.
[* Indeed, reflect on how the poor and rich might get richer at the same time: That would require a gain in productivity, so that there is more actual wealth per capita to distribute, and the actual distribution of a portion of that gain to the poor; not just rising pay for everyone. For any given level of tangible work product, more income for everyone means higher prices — i.e., inflation. (added 2/6/14)]
Almost all new income today is going to the top. By the Pareto standard Stephens and Feldstein themselves cite, growing inequality is completely unacceptable.
A Krugman Awakening?
In two of his last three Op-eds, it appeared that Krugman might be gearing up to take on the economics of inequality. In “The Undeserving Rich,” (New York Times, 1/19/2014, here), he declared:
The reality of rising American inequality is stark. Since the late 1970s real wages for the bottom half of the work force have stagnated or fallen, while the incomes of the top 1 percent have nearly quadrupled (and the incomes of the top 0.1 percent have risen even more). While we can and should have a serious debate about what to do about this situation, the simple fact — American capitalism as currently constituted is undermining the foundations of middle-class society — shouldn’t be up for argument.
We’re facing class warfare, Krugman said, “with the plutocrats on offense.” Then, however, he merely reviewed the strategies used for “crude obfuscation” — the falsification of numbers, blaming poverty on the poor themselves, and the mythology of the deserving rich. He referred again to Bret Stephens and his use of false numbers to support the conclusion that inequality is no big deal. There is nothing new here, and no discussion of “what to do about this situation.” Still, for the first time (to the best of my knowledge) Krugman has acknowledged that inequality has real economic consequences.
In “The Populist Imperative,” (New York Times, 1/23/14, here), Krugman extended that acknowledgment, making some important observations: (1) “jobs and inequality are closely linked if not identical issues”; (2) “There’s a pretty good although not ironclad case that soaring inequality helped set the stage for our economic crisis, and that the highly unequal distribution of income since the crisis has perpetuated the slump,” and (3) “There’s an even stronger case to be made that high unemployment — by destroying workers’ bargaining power — has become a major source of rising inequality and stagnating incomes even for those lucky enough to have jobs.” The upshot: “Beyond that, as a political matter, inequality and macroeconomic policy are already inseparably linked.”
But this is an economic, not a political, matter. It is fair to ask whether our leading populist spokesman is belatedly discovering, along with the rest of us, the immense macroeconomic power of income and wealth distribution, the reality the entire economics profession has ignored (or suppressed) for generations. Has his understanding of this issue grown since the IMF conference in the fall, with his recognition of the “mutilated economy”?
In “Paranoia of the Plutocrats,” (New York Times, 1/26/14, here), Krugman seemed implicitly to acknowledge the role of taxation in controlling inequality, though that was not the subject of his post. He uncritically reported, however, a claim that requires close attention: “Between the partial rollback of the Bush tax cuts and the tax hike that partly pays for health reform, tax rates on the 1 percent have gone more or less back to pre-Reagan levels.” Because the Reagan tax cuts started this inequality spiral, that claim must be carefully reviewed.
The Urgent Need for Progressive Taxation
This is a graph of data from the Piketty/Saez personal income data base (“Optimal Taxation of Top Labor Incomes: A Tale of Three Elasticities,” by ThomasPiketty, Emmanuel Saez and Stefanie Stantcheva, DP No. 8675, CEPR, November, 2011), revealing the very close relationship between income taxation and the top 1% income share.
The graph shows the marginal (top) rates for income and capital gains over the past century, and the top 1% shares of personal income and capital gains. It shows that high marginal income tax rates have consistently produced effective taxation of the wealthiest among us sufficient to prevent the growth of inequality and the excessive concentration of wealth; and conversely, when the top rate is too low, inequality has grown. At least until very recently, effective tax rates have been highly correlated with the marginal rates applicable to each income category.
Piketty and Saez have properly defined a “progressive” tax structure as one that prevents further increases in income inequality. (“How Progressive is the U.S. Federal Tax System? A Historical and International Perspective,” by Thomas Piketty and Emmanuel Saez, Journal of Economic Perspectives, Winter, 2007, here.) A progressive tax structure is essential to curb the excessive wealth accumulation, in the first instance, within the top 1%. Without that, the bottom 99% economy will continue to shrink. This will nullify the promising gains from the President’s executive campaign to induce U.S. companies to increase employment, to raise wages, and to reduce the poverty at the bottom end of the inequality gap, initiatives he outlined in today’s State of the Union Address (here). Beyond that, the inevitable result is a deeper depression.
An initial take from this data is that a top rate on ordinary income of about 70% and a capital gains rate of 35% might be needed to reverse the inequality tide. The case is clearest for capital gains: We saw from the CBO data in the first of this series of posts that capital gains are the most highly concentrated of income sources, by far, and we see from this chart that the top 1% share of capital gains began a steep climb immediately upon reduction of the top capital gains rate from 35% to 28% to 20% in the early 1980s.
It will not be a simple matter of merely returning the top U.S. income tax rates to levels that were once progressive. Here are some complicating factors:
1) In an increasingly global world, American corporations are increasingly establishing foreign residences to avoid American taxes, and wealthy Americans along with the wealthiest people from other nations are increasingly depositing their personal incomes in off-shore accounts, to avoid taxation. Based on reports such as the one recently released by Oxfam International, I have reported that an estimate of total U.S. off-shore accounts of $5-8 trillion appears reasonable. International cooperation will be important to deal with this problem, and the U.S. will need to devise new methods for increasing the progressiveness of its tax structure;
2) The federal government will need to significantly revise its spending priorities. In 1980, according to the Piketty/Saez data, during 1960-1969, the period of peak growth of American prosperity and least unequal distribution of incomes, only 11% of all new income was going to the top 1%, while the next 9% got 24% and the bottom 90% got 65% of all growth. Income was unequally distributed, but gains were widely distributed throughout the economy. That gradually changed, however, and most recently Saez has reported that 95% of all new income has been going to the top 1%. The economy is structured to funnel nearly all income growth into the top 1%, so increased federal taxation of the top 1% will likely fail to stimulate the economy, and those revenues, when spent, will just end up back in the top 1%. New organizations and institutions that permit broader growth beneath the top 1% will have to be established.
It will not be easy to determine a level and design of taxation that will be sufficiently progressive, and Krugman’s suggestion that “[b]etween the partial rollback of the Bush tax cuts and the tax hike that partly pays for health reform, tax rates on the 1 percent have gone more or less back to pre-Reagan levels” must be carefully reviewed from that perspective:
(1) At first blush, it is difficult to see how that could even be true. The roll-back of the Bush tax cuts for the top 1% involved increasing the top rate from 35% back to 40%, a far cry from the 70% pre-Reagan level. My earlier efforts to determine the revenue impact of the rollbacks on top 1% tax revenues have not been completely successful, but it appears that every 5% increase in the top tax rate produces about $50-100 billion of additional revenue, so a tax increase effectively producing $300-600 billion of additional revenue is implied, and these changes don’t appear to come close to doing that.
(2) It’s unclear how that claim, even if true, would impact inequality growth. Krugman did have a citation for his assertion, a source (“In 2013, the Top 1% Will Pay Their Highest Total Tax Rate Since 1979,” by Jordan Weissmann, 1/2/13, here) predicting that the average effective federal tax rate for the top 1% would exceed 35% in 2013, for the first time since the Clinton Administration and before that, 1979. I don’t know whether that prediction panned out. We do know, however, that when the top 1% rate peaked during the Clinton administration, as the chart above shows, it was a period during which income inequality, especially capital gains inequality, experienced its most rapid growth prior to the Crash of 2008. So an effective tax rate over 35% for the top 1% does not necessarily mean we have sufficient tax progressiveness to combat rampant inequality growth.
(3) As Krugman has I believe acknowledged, the inequality problem at the top is traceable mainly to extraordinary gains within the top 0.1% and 0.01%, and in these narrower bands of extremely high incomes, the history of effective taxation is much different:
Our inequality problems began, and grew, after the extremely wealthy highest-income class began to slash their contributions to federal taxation. The top 0.01% effective tax rate plummeted from 45% in 1980 to less than 25% in 2009. (“There’s Only One Way To Fix The Deficit — And Actually It’s Totally Painless,” by Joe Weisnethal, Business Insider, 12/28/12, here).
Just as Stephens obscured the significance of the inequality gap by comparing averages of the top and bottom quintiles, the impact of reduced taxation on inequality is obscured by considering the top 1% rather than the top 0.1% and 0.01% effective tax rates. To say the least, the inference from Krugman’s comment that we can expect the current level of taxation of the top 1%, 0.1% and 0.01% to slow and stop the inequality cycle is improbable, and likely very wrong. There is an urgent need to further investigate the relationship of tax progressiveness to inequality, decline, and stagnation.
A Statement of the Case:
The redistribution of wealth and incomes is a real, macroeconomic problem, and in the U.S. it involves the confiscation of extraordinary wealth, through an ever-broadening income gap, by those within the top 0.1% and the top 0.01% income categories. They have done this by cutting their own contributions of tax revenue to federal and state governments while, simultaneously, using taxpayer dollars and the national debt to greatly enhance their already excessive profits.
They have been supported in these efforts by a neoclassical economic ideology that asserts their actions don’t hurt anyone else and, further, that as they get wealthier the better off everyone else becomes. This neoclassical “pixie dust” fantasy, which in deference to the neoconservative Martin Feldstein I will call the “magic bird” school of economics, insists that all gains at the top are disconnected from all losses at the bottom; and since the gains of the most wealthy cannot not hurt anyone else, they likely believe, the decline at the bottom cannot really hurt them either. They must believe there is a limitless supply of money for them to skim out of the economy because, it seems, there always has been.
But none of that is true. When they’ve finished their destruction of the market economies of the world, whenever that may be, they will eventually go down along with everyone else.
JMH – 1/29/14