Saturday, August 22, 2009

The good and bad of narrowing inequality in the US

Excellent graphic in the NYT about how the financial meltdown and the resultant economic recession has pulled down the incomes and wealth of the richest Americans, thereby slowing down the pace of increase in inequality.

While highlighting the sharp declines in the financial assets held by the rich Americans and their consequent loss of wealth and income, the article does not shed much light on whether the incomes of the non-rich have increased or remained stagnant. In light of the economic recession that followed the bursting of the asset bubbles, it may not be incorrect to claim that the incomes of the remaining Americans too have either declined or at best remained stagnant. In the present crisis, the economic crisis that followed has badly affected all others too, with the severest impact, in relative terms, being felt by the poor.

After all, it is one thing for your income to drop from $10 million to $ 1 million, and an altogether different thing for it to drop from $10,000 to $8000. In substantive terms, the rich have been forced to cut on their luxury purchases, while the poor have been squeezed on their basic needs. Being forced to auction off your summer retreat or luxury yatch is qualitatively different from being forced out into the streets.

However, in any recession, especially that induced by a crash in asset values, the rich, being the most exposed to such markets, will be more adversely affected than the poor. Jonathan Parkerand Annette Vissing-Jorgensen have found in a recent NBER working paper, the incomes of the affluent tend to fall more, in percentage terms, in recessions than the incomes of the middle class, and those of the very affluent — the top one ten-thousandth — fall the most.

Though the falling incomes of the rich may have narrowed inequality, the stagnant incomes of the rest of the population may have left the economy with the worst of both worlds. On the one hand, the falling incomes of the rich will quickly translate into lower tax revenues, fall in consumption spending and decreased philanthropic activity, all of which will act to further depress aggregate demand and the economy. On the other hand, the poor do not benefit by any increase in their incomes and bear the brunt of the depressed economic activity. Of course, there is a strong and well-established case that narrowing inequality is good by itself, in so far as it slows down the entrenched and institutionalized discrimination that comes with the concentration of economic and political power among a relatively small group.

The Times article points to Mohamed A. El-Erian, chief executive of Pimco, one of the largest bond traders in the US, who describes the spectacular asset bubble of the last twenty years since 1987 thus, "We are coming from an abnormal period where a tremendous amount of wealth was created largely by selling assets back and forth... You had wealth creation that could not be tied to the underlying economy and the benefits were very skewed: they went to the assets of the rich. It was financial engineering."


Emmanuel Saez and Thomas Piketty have used the IRS income data from the late seventies to 2007 and found that the cutoff to qualify for the highest-earning one ten-thousandth of households jumped from roughly $2 million, in inflation-adjusted, pretax terms to $11.5 million and the cutoff to be in the top 1 percent doubled to roughly $400,000. In contrast, pay at the median — which was about $50,000 in 2007 — rose less than 20 percent, and at the bottom of the income distribution, the increase was a mere 12 percent.

In 2007, the top one ten-thousandth of households took home 6 percent of the nation’s income, up from 0.9 percent in 1977, and the highest such level since at least 1913, the first year for which the IRS has data, and the top 1 percent of earners took home 23.5 percent of income, up from 9 percent three decades earlier. Further, since 1980, tax rates on the affluent have fallen more than rates on any other group, as the graphic below shows.

Update 1
The census data for 2008 shows that poverty increased, median household income fell, and the percentage of Americans with employer-based health coverage continued to decline in 2008. The poverty rate rose to 13.2 percent, its highest level since 1997. The number of people in poverty hit 39.8 million, the highest level since 1960. It also finds that the $787 bn ARRA has helped keep atleast 6 million Americnas out of poverty. The official poverty rate rose in 2008 to 13.2 percent, from 12.5 percent in 2007.

Analysing the IRS data, Thomas Piketty and Emmanuel Saez find that two-thirds of America's total income gains from 2002 to 2007 flowed to the top 1 percent of U.S. households, and that top 1 percent held a larger share of income in 2007 than at any time since 1928.

Economix finds two distrubing trends - economic growth in the current decade has been slower than in any decade since before World War II; and inequality has risen sharply that so much of the bounty from our growth has gone to a relatively small slice of the population. The result has been a decade with no real income gains for the median household for the decade ending 2008.

And here are a series of excellent graphics from the census report.

Update 2

From Economist and Emmanuel Saez.

Update 3 (14/4/2010)
David Leonhardt debunks the conservative arguement that rich Americans pay a disproportionately high tax rate and that American tax system is highly progressive here, here and here. Taking all taxes (and not just federal income taxes) - other federal taxes like payroll taxes and capital gains taxes, state and local government taxes (which are mostly indirect taxes and lot less progressive) - into account, it becomes clear that American tax system is not as progressive as being claimed and that the rich are those most benefitted by the taxation system. He writes

"Add it all up, and you can see why the wealthy are paying a greater share of federal taxes even though they are paying less tax on each dollar they earn. They’re simply making many more dollars than they used to."

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