The Influence of Politics
Paul Krugman writes that politics matters for the income distribution, citing the long-term trends in inequality and their close correlation with long-term political trends. Brad DeLong says he thinks this is wrong, political changes can and do have a large impact on after-tax income distribution but the trends show up strongly in pre-tax income. "I can't see the mechanism by which changes in government policies bring about such huge swings in pre-tax income distribution."
I note for the edification of readers that one thing I've learned since arriving in DC is that a difference of opinion on this subject is a major divide within the progressive economic policy community. Most mainstream economists -- including most liberals -- agree with DeLong. Politics and policy affect the secondary distribution (after tax and transfer) and what happens with the primary distribution is just out there. Leftier economists tend to say this is mistaken.
I would side with Krugman on this. The trend data is too striking to be ignored. If you have a phenomenon and are having trouble identifying the cause, the thing to do is to try harder to identify the cause, not assert that the phenomenon isn't happening. But what is the cause? I can think of some plausible stories.
One thing to say is that tax policy impacts pre-tax distribution. 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.
Similarly, very high tax rates encourage high income people to engage in more leisure and less work whereas right now we have the somewhat odd situation where highly compensated people tend to work more than do the moderately compensated.
All this, I think, makes a big difference.
Then the other factor to note is probably unionization which is much more impacted by policy decisions than people often seem to realize.
I agree with much of what you are saying, and I definitely side with the Krugman-ists here.
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I think there is a multitudinous range of ways government structures the economy and income distribution.
Trade policy, unionization policy, marginal tax rates, the business tax code, other business incentivization, budgetary policy, pension policy, education policy, infrastructure investment, and quite a few others all play huge roles.
Ten thousand governmental decisions can all be taken with an eye towards building a society driven by the top, or building a society driven by a broad middle.
August 20, 2006 12:14 PM | Reply | Permalink
On this issue I am pretty sure that the right answer is "nobody knows." If you read Krugman, he's just expressing a suspicion, not describing a mechanism, and this is really a pretty good description of all the "explanations" of rising inequality. It's an international phenomenon, which makes it hard to come up with government-driven explanations that span a diverse array of regimes. At the same time, things we can point to in the labor market are either too weak to explain very much (e.g., decline in unionization) or don't fit the data all that well when you look more carefully. One important feature of the US data is a sharp and massive decline in inequality at the onset of WWII that persists for decades. It looks like a strong candidate for the government-driven position, except that the massive change in policy that caused it is missing, or at least unknown to me.
August 20, 2006 12:50 PM | Reply | Permalink
I don't think this is right on one key point, and I'd qualify another.
There is a wide consensus among economists that although global competition does exert downward pressure on the wages of the middle class and poor in all the developed countries, countries have shown that policies can weaken the effects. The controversy is not over whether you can resist these forces, but what it costs you in growth or flexibility to do so.
That should be intuitive even in light of the policies chosen in this country, where inequality would be much greater than it is now if we eliminated Social Security, minimum wage laws, unemployment compensation, WIC, Medicaid and the Earned Income Tax Credit.
Of course, all of that discussion is post-transfer. If anyone has information about differences in pre-tax distribution or the reasons for them, I'd be fascinated to see it.
The qualification goes to your other point - regarding the distribution of income in the US post-1945. I agree with you on the big picture - the 1930s and 1940s were the big event for redistribution downward, and the next 30 years were comparatively uneventful.
However, even within that big picture, there were some very important income shifts. For example, there was a steady drift of income away from the wealthiest 1% from 1945 through 1972. In 1945, the top 1% took in about 11% of the national income. That percentage declined fairly steadily to 1972, when it bottomed out at around 7% - a reduction of about 35% pre-tax and transfer. That's a significant development, it seems to me. (Oddly, the income share of the top 10% seems to have moved almost not at all in this period, which is also interesting, and surprising as well.)
See the table at: http://elsa.berkeley.edu/~saez/pikettyqje.pdf#search=%22income%20distribution%20since%20world%20war%20ii%20united%20states%22
One other group we can't overlook, again post-transfer, are the very poor, who are plainly much better off because of government policies. For example, it is uncontroversial that the percentage of elderly persons in poverty declined sharply as the result of expansions in the Social Security program -- from 35% in 1960 to about 10% in the late 1980s. See the tables at http://www.nber.org/aginghealth/summer04/w10466.html
There are many things we don't know how to do, but we do know that government policies can have an effect on post-transfer income.
August 20, 2006 2:11 PM | Reply | Permalink
I've just realized that Saez and Piketti updated their work on income shares to include an international comparison, published in 2006. The paper is behind a paywall, but here is the abstract:
"This paper summarizes the main findings of the recent studies that have constructed top income and wealth shares series over the century for a number of countries using tax statistics. Most countries experience a dramatic drop in top income shares in the first part of the century due to a precipitous drop in large wealth holdings during the wars and depression shocks. Top income shares do not recover in the immediate post war decades. However, over the last 30 years, top income shares have increased substantially in English speaking countries but not at all in continental Europe countries or Japan. This increase is due to an unprecedented surge in top wage incomes starting in the 1970s and accelerating in the 1990s. As a result, top wage earners have replaced capital income earners at the top of the income distribution in English speaking countries. We discuss the proposed explanations and the main questions that remain open."
http://papers.nber.org/papers/w11955
August 20, 2006 6:01 PM | Reply | Permalink
This will repeat some of what has been said above, but I think that the implicit decision from about 1975 on that the Federal government would no longer enforce the right of workers to organize unions has had a huge impact on income distribution. If the Federal government had acted since the mid-1970's to enforce labor laws as they were then interpreted (no substantive doctrinal changes from the NLRB), if penalties for violating labor law were indexed to inflation, and if government procurement (at the state, federal, and local levels) had incorporated labor peace provisions, then the level of union density in the US today would be much closer to Canada's. While there would still have been increases in income inequality since then, these policy positions would have had a huge impact on the pre-tax distribution of income.
I also suspect that since the "economists" position (DeLong, the DC think tank types, etc) would follow Robert Gordon's recent work and explain the increasing inequality of the pre-tax distribution as a result of:
a) increasing returns to education
b) increasing CEO pay and
c) increased rents accruing to sports and entertainment stars as media markets go global.
It is worth pointing out - for the sake of argument - that each cause may be greatly affected by public policy.
For instance, obviously access to quality public education up through college and even post college is in principle a matter of public policy. There are many policies our gov't could adopt to improve the least well pefroming public schools, to make college education more affordable, etc. (though I'm sympathetic to Matt's argument that poverty is much more a cause of poor eductational performance than the other way around).
Similarly, if the Federal government adopted uniform national standards for company law - requiring annual elections for all corporate directors, requiring majority votes for directors, requiring competitive elections for director seats, requiring some % of seats to be set aside for non-executive employee shareholders and individual shareholders, requiring all the same for mutual funds, then it is vastly more likely that CEOs would be unable to reward themselves as handsomely has they have been able to over the last several decades.
Finally, as Dean Baker thankfully never tires of pointing out, intellectual property protections (such as copyrights) are what make sports, Hollywood films and certain music so profitable globally - these protections could be sharply reduced, which would reduce the profitability of global sports and entertainment enterprises and their stars.
So its really not at all hard to see how government policy affects the pre-tax income distribution, and I'm surprised Brad DeLong couldn't recognize that before he posted.
August 20, 2006 6:03 PM | Reply | Permalink
I agree. Especially when every one of those ten thousand policy decisions, not just tax policy, is geared towards maximizing your party's control and keeping your donors - both corporate and private - rolling in the dough. Same thing really.
Bush did NOT lie when he said, "The haves, and the have-mores. Some people call you the elite, I call you my base." He takes care of that base through such wonders as the K-Street Project, land use policy, energy subsidies, giant no-bid contracts, yadda yadda yadda. It goes waaaay beyond tax giveaways.
The Democratic base has tended to be the have-nots, so their policies and the corresponding political calculations tend to favor them financially. Seems pretty simple, without a lot of hi-fallutin economic theory.
August 20, 2006 6:09 PM | Reply | Permalink
I'm with Krugman -- or, I suspect I would be, if we had a more equitable income distribution and I made enough money to justify getting TimesSelect.
Let me offer a potential mechanism that I haven't seen yet in the comments. The notion of putting more economic risk on the middle class -- in Orwellian, the "Ownership Society" -- reduces the bargaining power of middle-income employees. The more risk people bear, the more they cling to the remaining hedges against uncertainty. Which usually means the job that they have. This shows up most starkly in the "job lock" problem with health care. Want to quit your job and start a business? Better not have any preexisting conditions.
The result is that employees are ever more dependent on employers -- at a time when employers' responsibilities are systematically dismantled.
August 20, 2006 7:14 PM | Reply | Permalink
Re: The more risk people bear, the more they cling to the remaining hedges against uncertainty.
Income volatility has increased enormously at ALL levels of society. Of course a billonaire who sees his income halved (or even worse) is probably no where near in as much difficulty as a lower middle income working person who experiences the same thing.
August 20, 2006 7:35 PM | Reply | Permalink
Re: For instance, obviously access to quality public education up through college and even post college is in principle a matter of public policy.
How so when the same pheoneomenon has happened in almost every country on Earth no matter what policy its government has followed?
Re: However, over the last 30 years, top income shares have increased substantially in English speaking countries but not at all in continental Europe countries or Japan
This is simply not true. In almost every nation income inquality has inceased. To be sure in some countries the increase has been less than in others, but you would be hard pressed to find a single nation (with exceptions for "basket cases") in which the rich have not gotten richer.
August 20, 2006 7:40 PM | Reply | Permalink
"whereas right now we have the somewhat odd situation where highly compensated people tend to work more than do the moderately compensated."
That's only odd if you have a really simplistic model of human nature.
August 21, 2006 4:19 AM | Reply | Permalink
The mechanism is simple.
There's a class of wealth that didn't get there by working for someone else. People only get ridiculously rich by some combination of rent, interest, dividends, capital gains, blank checks written to themselves and inheritance.
Republicans tax, spend and regulate in ways that make all these things easier.
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-- All successful revolutions are the kicking in of a rotten door. (John Kenneth Galbraith) --
August 21, 2006 6:32 AM | Reply | Permalink
It's a truly simplistic model of human nature that depends entirely on crude 'laws' of microeconomics. So I guess, Brett, that the more you got paid per hour the more hours you'd want to work? But limited by what? Would you eschew sleep for work? Family?
I don't think there are any people so simplistic that they'd rather work 16 hours a day than 4 hours a day if they earned $50,000 an hour.
August 21, 2006 8:32 AM | Reply | Permalink
A simplistic model which, for instance, assumes that nobody actually ENJOYS the work they do, and therefore will work insane hours no matter how much they get paid. I could point out other complexities in actual human behaivor which would easilly explain this supposed anomaly, but my lunch is over. Ta!
August 21, 2006 10:19 AM | Reply | Permalink
While government actions can promote or retard business policies that lead to very unequal income distributions, they're unlikely to be the cause.
Galbraith, long ago, pointed out that corporations are "owned" by their managers who, post-Depression, post-WWII, have had two goals: corporate solvency and maximizing their managerial incomes.
Prior to the 1970s managers remembered the Depression, feared insolvency and its concomitant, debt, and sought to maximize equity (retained earnings). Consequently, they had less monies at the end of the year with which to reward themselves.
As memories of the Depression faded in the 1960s corporations began to alter their debt/equity ratios, a trend which accelerated in the Milliken "unlocking shareholder values" '80s and further in the M & A '90s.
The incomes of the wealthiest have been based on society's willingness to dis-save -- to turn bricks and mortar into debt instruments.
What, if anything, government has done to foster this pattern should be the question.
August 21, 2006 11:26 AM | Reply | Permalink
You took a lunch break? I can't believe it!
August 21, 2006 11:38 AM | Reply | Permalink
"This is simply not true. In almost every nation income inquality has inceased."
Kind of. You have to look at the paper to see how they define "top income shares." They observe that the income share of the super-rich in the United States (top 1% and top fraction of 1%) has simply skyrocketed over the past thirty years. Astonishingly, they've captured nearly all of the productivity gains. If you graph the share taken by the top 1% in Japan, Germany and France over the same period, the take is dead flat.
That story is consistent with your view that income inequality has increased; it's just that the English-speaking countries have experienced changes that are (so far) unique in developed countries.
Beyond that the picture gets a lot more complicated. As you say, though, by and large the story in OECD countries is growing inequality, particularly pre-transfer, albeit to a lesser degree than the US, and with important exceptions.
But it's a very interesting question, this pre-transfer vs post-transfer issue.
August 21, 2006 6:37 PM | Reply | Permalink
There's another possibility, and that is that there are multiple causes.
Post Great Depression middle-class boom - caused by the politics driven from frustration at the experience of the Great Depression. Krugman's right on this one.
Post WWII Boom - caused by the fact that every competent country capable of competing with the US was in ruins (I deliberately rule out the USSR and China because communist governments are not competent). The US was able to prosper with generous worker handouts and entitlements because no one else could compete at all.
1970s Stagflagration - caused in part by the recovery of Europe and Japan, and the end to the "free lunch" that the Americans had been getting over the last 30 years.
1980s + - with worldwide competition, labor capacity and infrastructure growing stronger and stronger, companies gain the upper hand over workers, in terms of the mobility of capital vs. the mobility of labor. It's the "superstar" era, where (as one previous commentator mentioned) it's the guys and gals who perform just a little bit better who get a disproportionate share of the income. Fair, no, not particularly. But what's the alternative?
I know many here will disagree with me, but re-unionization will make american workers less attractive. increasing the taxes on the rich will (IMO) reduce risk taking, reducing innovation and moving more innovation overseas. This is standard competitive advantage stuff.
I'm a software developer, and every day I have to "compete" against 1000 Indian, Chinese and other offshore programmers. Would I like the government to double my income? Sure, but I know that it would more than likely reduce my attractiveness to a global marketplace, and put my job at more risk. This is true of almost every manufacturing/production job out there. The only jobs that can't be outsourced are "loathed" direct customer service jobs, and raw material collection. Downside - more risk for people who used to flourish in the US. Upside - more products at lower prices, increasing the standard of living (house size, # of cars, # of tvs, luxury items, etc).
I'm curious - at this point, what exactly do you think we can do about the global marketplace? I assume the answer is "tax the rich and retrain everyone." To do what, exactly?
August 22, 2006 5:46 AM | Reply | Permalink