Observations on inequality in the US

John Judis in The New Republic points to an interesting debate between Paul Krugman and Joseph Stiglitz on whether economic inequality is contributing to keeping recovery on hold. Stiglitz has argued that "our middle class is too weak to support the consumer spending that has historically driven our economic growth" and that the loss of middle income is "holding back tax receipts".

As Judis points out, since the rich have much less marginal propensity to consume, an economy where the income gains are concentrated at the top is not likely to "provide sufficient demand to boost the economy". Despite Krugman's scepticism, I find this logic compelling. In this context, there are two observations.

1. In recent weeks the growing cash piles of corporates in the US and elsewhere has attracted great interest. The twenty largest technology firms in the US, led by Apple, have been sitting on half-trillion dollar cash pile. Some investors have suggested share buy-backs to boost share values and transfer wealth to share-holders. But tax problems - the majority of these shares are held outside the US and bringing them back would attract the 35% US corporate tax - are likely to come in the way of large scale buy backs.
   
As Paul Krugman points out, it is not just tech firms, but there has been a surge in overall corporate profits as a share of GDP since the recession struck.

It therefore does appear that corporations are taking a much bigger slice of total income, mostly at the cost of labor. Its contribution to the widening income inequality in the US cannot be underestimated. Furthermore, despite this cash pile, corporations appear reluctant to either redistribute back to investors or invest in business expansion.

2. The second point comes from this graphic that shows the contribution of taxes and transfers to the reduction of inequality. It is strikingly evident that the Anglo-Saxon economies fare badly in the use of taxes and transfers in the reduction of income inequality.

In this context, I had blogged earlier about Lane Kenworthy's superb disaggregation of the respective contributions of taxes and transfers to the reduction of economic inequality. As this graphic shows, it is transfers, and not taxes, however progressive, that reduces inequality.

But then, a pre-requisite for the required transfers is availability of large enough tax revenues!

Both these observations resonates with the situation in India. Here too corporate profits have grown, though economic growth is weak and investment activity anemic. Furthermore, though tax revenues have been growing, it has not been accompanied with increase in the effectiveness of the delivery mechanisms for welfare transfers.