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August 31, 2006
Inequality and Insecurity: Which Matters More?
Joseph J. Thorndike

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Inequality and Insecurity

Joseph J. Thorndike is a contributing editor with Tax Analysts. E-mail: Joe_Thorndike@tax.org.


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Early last month, Treasury Secretary Henry Paulson triggered a debate over inequality. "Amid this country's strong economic expansion," he told a New York audience on August 2, "many Americans simply aren't feeling the benefits. Many aren't seeing significant increases in their take-home pay. Their increases in wages are being eaten up by high energy prices and rising health-care costs, among others."

It was a striking admission for President Bush's new point man on economic policy, especially because it came in his first public speech as secretary. But it was not unprecedented. On May 2, Edward Lazear, chair of the president's Council of Economic Advisers, used his first speech in office to make much the same point. "The general picture cannot be disputed," he said. "The difference between the earnings of individuals at the top and earnings of individuals at the bottom has grown."

When Republicans are worried about inequality, you know it must be a problem. But liberals were not exactly tripping over themselves to hail Paulson's speech. Indeed, a variety of liberal commentators, led by New York Times columnist Paul Krugman, rushed to attack the secretary. Not for his admission about stagnant wages -- which they considered long overdue -- but for his explanation of the nation's growing inequality.

To Paulson, the income gap is principally a function of education. "As our economy grows, market forces work to provide the greatest rewards to those with the needed skills in the growth areas," he said. "This means that those workers with less education and fewer skills will realize fewer rewards and have fewer opportunities to advance."

While endorsing efforts to help American workers compete in the global marketplace, Paulson tried to deflect blame for the growing income gap. "It is simply an economic reality," he said, "and it is neither fair nor useful to blame any political party. It stems from a number of factors, including technology and U.S. integration with the global economy. Rather than playing the blame game, we must focus on helping workers move up the economic ladder."

Krugman Complains

In an August 18 column, Krugman took issue with Paulson's emphasis on education, as well as his effort to depoliticize the debate over inequality. Far from being some sort of ineluctable economic reality, Krugman suggested, inequality has everything to do with politics and policy. To make his case, Krugman offered a grand historical theory that tries to correlate inequality trends with long-term political developments.

Since the 1920s, Krugman explained, there have been four "eras of American inequality." Between 1920 and 1947, during a period that Krugman and some other economists call the Great Compression, workers in manufacturing industries enjoyed a 67 percent increase in real wages, while the richest 1 percent of Americans saw their income drop by 17 percent. From 1947 to 1973, almost everyone enjoyed the fruits of a booming economy, as wages soared 81 percent and the top 1 percent saw a 38 percent increase in real income. Between 1973 and 1980, everyone again shared the economic trend, but this time on the way down; wages fell 3 percent while income for the top 1 percent dropped 4 percent. Since 1980, in a period Krugman calls the "New Gilded Age," the rich have enjoyed enormous gains, with income soaring 135 percent for the top 1 percent even as real manufacturing wages fell 1 percent.

Those four periods of inequality roughly correlate with political trends, Krugman contends: "What happened in each era was what the dominant political tendency of that era wanted to happen." In the first period, an ascendant Democratic Party sought to better the lot of American workers, and sure enough, income for workers grew dramatically. In the postwar decades, moderate Republicans embraced the fundamentals of the New Deal economic order, and the economy continued to distribute its spoils quite broadly. During the 1970s, everyone paid the price for higher energy prices, overwhelming the effect of politics and government policy. But since 1980, a revitalized and very conservative Republican Party has preached the gospel of wealth, and the distribution of income has widened dramatically.

Krugman is careful to avoid drawing any direct causal link between politics and inequality. "There were certainly other factors at work," he says, "including technological change, globalization, and immigration." But the correlation offers a prima facie case for the influence of government policy on inequality. Krugman identifies a few likely mechanisms for tracing that effect, ranging from the more obvious -- progressive taxation and the minimum wage -- to the more speculative, including policies toward organized labor.

Missing Mechanism

Krugman's column prompted an outpouring of commentary from sympathetic bloggers. Most shared his worries about inequality, but many questioned whether policy was really to blame. Brad DeLong, an economist at the University of California, Berkeley, and one of the left's most influential bloggers on economic issues, wrote for many skeptics:


    The problem that I have with Paul Krugman's argument here is that the shifts in income inequality seem to me to be too big to be associated with anything the government does or did. Yes, Roosevelt and company were pushing in the right direction. Yes, Reagan, Gingrich, Bush, and company have been pushing in the wrong direction. But what they did and do affects (I think) after-tax income inequality much more than the before-tax income inequality numbers, and the before-tax numbers show the trends remarkably strongly. And I can't see the mechanism by which changes in government policies bring about such huge swings in pre-tax income distribution.

The blogosphere responded with a long debate over possible mechanisms by which policy might affect not just the post-tax distribution of income, but the pretax distribution as well. Following Krugman's suggestion, many pointed to labor policy, and specifically to government support for -- or opposition to -- new organizing efforts.

A few commentators argued that taxation might influence pretax inequality. In an e-mail to DeLong, Krugman pointed to the long-term decline in corporate taxation. "Don't forget that some taxes affect the pre-personal-tax distribution of income. Taxes on corporate profits went from a minor inconvenience before FDR, to a major source of revenue under Eisenhower, and back again."

Mathew Yglesias, writing at http://www.tpmcafe.com, also suggested that high-end compensation might be restrained by steep tax rates.


    When the top income tax rate was very high -- 70 percent or above -- this not only meant that rich people paid a lot in taxes, it also meant that there were a broad range of circumstances where it didn't necessarily make much sense to offer well-compensated people even more compensation. When you have a very progressive rate structure, an employer can get a lot more bang for his buck by directing his employment budget at middle-income people than at rich people. As you flatten the tax structure, this becomes less-and-less the case.

And Max Sawicky, an economist with the Economic Policy Institute, suggested a few other possibilities, including the pretax effects of tax avoidance and evasion, as well as declining tax enforcement. Sawicky also noted the disincentive effect of high tax rates on the propensity to seek additional income -- "especially important if you're a conservative who thinks marginal tax rates are hugely influential," he observed.

More Grist for the Mill

Whatever the effect of government policy on pretax income distribution, it seems clear that a larger debate over inequality is likely to continue. Data released on August 29 by the Census Bureau provided more evidence of a growing gap in household income. And the attention those numbers are getting from both ends of the political spectrum suggests that inequality will be a hot topic in the coming months, if not years.

Many liberal observers expect inequality to be the crucial political topic for the foreseeable future. As Krugman notes: "Inequality seems to be an issue whose time has finally come, and if the growing movement to pressure Wal-Mart to treat its workers better is any indication, economic populism is making a comeback."

Even most centrist Democrats are on board. In a July 19 op-ed in The Wall Street Journal, Steven Rattner, an adviser to the Brookings Institution's Hamilton Project, called inequality "the mother of all electoral issues." While warning that Americans shouldn't use the tax system to "redistribute our way out of the widening gap," he specifically called for a rollback in President Bush's "outlandish tax cuts."

But will inequality really prove to be the golden ticket for Democrats seeking a return to power? That seems uncertain. History would suggest that inequality is a dicey foundation for electoral success.

Let's consider the 1920s, an era often cited as the last great era of unchecked inequality. The vaunted prosperity of the Jazz Age left many Americans behind, including most workers, a huge number of farmers, and minority populations across the country. But Democrats were unable -- and to some degree, unwilling -- to frame a successful appeal based on the growing gap between rich and poor. Complaints about the Andrew Mellon tax cuts fell on deaf ears among middle- income voters, many of whom seemed willing to overlook the rising fortunes of the rich as long as their own prospects were still solid. And a series of GOP corruption scandals did almost nothing to bolster Democratic fortunes.

As Franklin Roosevelt confided to a friend after the Democrats' crushing defeat in the 1924 congressional and presidential races: "Much as we Democrats may be the party of honesty and progress the people will not turn out the Republicans while wages are good and the markets are booming."

Today, of course, wages are not so good. Not only is the income gap growing, but many Americans' household income is actually stagnant or falling. That reality has led some Democrats to focus less on inequality and more on insecurity.

And that's important: Historically, insecurity has been a winning issue for progressive politicians. When Democrats finally managed to reverse the Republican ascendancy of the 1920s, it came as a result of the Depression; only when insecurity overwhelmed hope did Democrats find their opening. The same is true for an even earlier period of economic reform. The late 19th and early 20th centuries gave rise to pervasive insecurity among the American working class and their middle-class allies when industrialization (and an earlier form of globalization) disrupted the patterns of American society. That insecurity paved the way for the Progressive movement, including its signature reform: the modern income tax.

Inequality and insecurity are not at loggerheads. Indeed, they no doubt derive from many of the same forces, including globalization and technological change. And they may both be ameliorated by similar policies.

But politically, inequality and insecurity are often worlds apart. The former can lead Democrats toward a rhetoric of anger, including a focus on the rising fortunes of the rich. Insecurity, by contrast, prompts a rhetoric of empathy, leading Democrats to look to their natural -- if often fickle -- electoral base: the sometimes struggling but always ambitious middle class.