Consider the Evidence

This news is discouraging, but hardly unexpected. According to a Marketplace report, a survey by the Transamerica Center for Retirement Studies (pdf here) finds that the share of workers borrowing from their 401(k) retirement funds increased from 11% in 2006 to 18% in 2007. Nearly half of those taking out such loans in 2007 cited the need to pay off debt, compared to a quarter in 2006.

Stagnant wages and salaries, most spouses already employed, rising health care and college tuition costs, higher mortgage debt loads, and falling home values mean lots of American households — including many middle-income ones — are pinched financially. The late 1990s economic boom lessened the strain for a while. Then home equity loans helped. More recently, credit card usage has jumped. Borrowing against retirement savings is the logical next step.

See more discussion here, here, and here.

Getting ahead or losing ground: economic mobility in America, by The Economic Mobility Project

Movin’ on up: reforming America’s social contract to provide a bridge to the middle class (pdf), by Shawn Fremstad et al.

Poverty is poison, by Paul Krugman

Integrating poverty into a more encompassing progressive narrative about the economy, by Shawn Fremstad

Barack-onomics: What is it really?, by Howard Gleckman

Elitist fools and hopeless blowhards, by Mark Thoma

America’s economy risks the mother of all meltdowns, by Martin Wolf

My other car is a bright green city, by Alex Steffen (via Ezra Klein)

Confusion about the changing positions of political parties in the U.S., by Andrew Gelman

Linear regression is not dead, by Andrew Gelman

Opportunity for upward mobility is key to the American dream. What does our government do to assist it?

A recent report (pdf) by the Economic Mobility Project attempts to answer this question. The report groups federal government spending into three broad categories: (1) expenditures aimed, at least in part, at promoting mobility; (2) expenditures on income maintenance, such as social security, health care, welfare, and housing support; (3) expenditures on public goods such as defense, environment, and transportation. As of 2006 about one fifth of federal spending — $740 billion, or 6% of GDP — was in the mobility-promotion category. Most of this takes the form of tax subsidies rather than direct expenditures.

The most striking of the report’s findings is how little of the federal government’s mobility expenditure goes to those with low incomes. This chart shows the estimated amounts that go to lower-income households (bottom two quintiles of the income distribution) versus middle-and-upper-income households (top three quintiles). In total, only about a quarter goes to the former group.

This seemingly-perverse distribution is not surprising. Spending decisions aren’t made by an omniscient policy czar seeking to maximize opportunity for upward mobility. They are a product of a political system characterized by clashing interests, ideologies, motives, and means.

Imagine, though, that we could move money around within the broad category of mobility-promoting expenditures — not increase spending, not take money from other areas of the federal budget, just shift funds from one type of (ostensibly) mobility-promoting program to another. What would help the most?

Let’s start with where to take the money from. By far the largest amount, about $240 billion, currently goes to employer-related work subsidies for pensions, health insurance, life insurance, and other fringe benefits. Surely some of this money could be better spent elsewhere, but I’m not sure it would be much.

A better target would be the $100 billion that goes to saving and investment incentives. The Economic Mobility Project report points out that almost all of this goes to households in the top fifth of the income distribution, and there is little evidence that it boosts saving.

I would favor also taking a large chunk from the roughly $160 billion currently spent on homeownership subsidies (after the current housing downturn abates). There is little indication that reducing or even fully removing the tax deduction for mortgage interest and property tax payments would lower the rate of homeownership in the United States. As the report notes, more than 80% of this tax break goes to the top quintile of households. And homeownership rates in several other rich countries are similar to ours despite the absence of a homeownership subsidy. Furthermore, homeownership’s contribution to upward mobility is ambiguous. On the one hand, it can help people accumulate assets. On the other hand, for those with low income it can be a risky and ineffective way of doing so, as this piece (written long before the recent downturn) rightly emphasizes. Moreover, homeownership discourages geographic mobility; it’s easier to pick up and move in search of better job opportunity if you don’t have to sell your home.

What would be more effective at fostering mobility?

1. Universal preschool for 4-year-olds and subsidized high-quality care for under-4s. Evidence is mounting that much of the inequality in cognitive skills and noncognitive abilities that exists when Americans finish formal schooling is there when they enter kindergarten (see here and here). The better we do at stimulating and supporting development in the early years, the greater the opportunity for mobility later on among those in the lower portion of the income and wealth distributions.

2. Improve K-12 public schooling by increasing teacher pay. How to improve elementary and secondary schools is one of the policy issues on which there is least agreement among analysts. My view is that the key deficit is in teacher pay. Higher pay will attract better teachers and help keep them in teaching for longer. In his book The Two-Percent Solution, Matt Miller offers useful suggestions for how to make this politically feasible.

3. Encourage lifelong learning. Just 28% of 25- to 29-year-olds have a four-year college degree. That percentage has increased over time, but at a relatively slow pace; it was 8% in 1950 and 19% in 1973. We need to accept that for the foreseeable future, a very large share of American adults will continue to have less than a college degree. They could benefit from assistance with learning new skills or upgrading existing ones. The Lifetime Learning Credit, enacted by the Clinton administration, gives Americans a 20% credit on learning and training expenditures up to $10,000 per year. I like Gene Sperling’s proposal (in his book The Pro-Growth Progressive) for a more generous credit of 50% of qualified education and training expenses up to $15,000 per decade.

4. Make college more affordable. The earnings of those with a four-year college degree tend to be substantially higher than of those without one, and a college education sharply increases the odds of economic success for persons from disadvantaged backgrounds (see here). College should be a financially viable option for all Americans.

Why isn’t this at the top of my list? While affordability certainly matters, it appears that the main obstacle to increasing the share of Americans with a college degree is the low rate of high school completion. James Heckman and Paul LaFontaine estimate the current rate of high school completion to be around 75% — considerably lower than the official figure and down by about 5 percentage points from a generation ago. And this is among non-immigrants. Drawing on their own research and that of others, Heckman and LaFontaine suggest that “The slowdown in the high school graduation rate accounts for a substantial portion of the recent slowdown in the growth of college educated workers in the U.S. workforce. This slowdown is not due to a decline in rates of college attendance among those who graduate from high school.”

5. Universal health care. The principal rationale for extending health insurance to all Americans is fairness. But doing so would aid economic mobility too — for some by eliminating the fear of losing Medicaid if earnings are too high and for others by removing the worry about losing health insurance or facing non-covered preexisting conditions when switching employers (see this, for example).

6. Expand the Earned Income Tax Credit. The Economic Mobility Project report rightly includes the EITC in the mobility-promoting category of government expenditures. By subsidizing earnings, the EITC increases the incentive for employment among those likely to earn relatively low wages. It is a very good policy. It would be even better if it were somewhat more generous, particularly for adults with no children.

7. Wage insurance. Proposals for wage insurance (such as this and this) have in mind the same type of incentive as that created by the EITC. Imagine a program that provides a subsidy of 50% of the drop in hourly wage experienced by a person who loses her or his job and then takes a new one that pays less. This would increase the financial incentive to return to work even when, as is often the case, doing so means accepting a pay cut. It also would reduce insecurity and stress among those who fear their current job is at risk.

8. Boost income maintenance. The Mobility Project report does not count most income maintenance programs as part of the mobility budget. This is because those programs “are not aimed at increasing the private ownership of assets, the acquisition of additional ability or education, or additional work or saving.” But researchers have identified low income during childhood as an impediment to cognitive development and later economic opportunity (see here, here, and here). Thus, even if income support programs such as TANF, Food Stamps, and unemployment insurance are not mobility-enhancing for their adult recipients, they may improve opportunity for upward mobility among their children.

With the imposition of time limits on TANF receipt beginning in 1997, the danger of long-term benefit dependence has been substantially lessened. Thus, TANF benefit levels could be increased with little or no adverse employment effect. The same is true of unemployment benefits, which are limited to 26 weeks.

9. Job placement assistance and public employment as a last resort. The mid-1990s welfare reform signified a policy choice to emphasize employment as the chief route out of poverty. Yet compared to countries such as Denmark and Sweden, whose policies also express a societal preference for employment, we do relatively little to help people find jobs. Public job placement programs have tended to be underfunded and not well coordinated with employers in local labor markets. Placement assistance is no panacea, but we could do better. Beyond this, anyone jobless for more than a year should be offered a temporary “public works” position assisting with neighborhood beautification or performing other socially useful tasks. To encourage recipients to move on to private-sector or regular public-sector employment, the wage level could be set at or just below the minimum wage. Neither of these programs would cost a lot of money. Both would enhance upward mobility among the most needy.

Paul Krugman suggests, using calculations by Tim Smeeding (see table 2), that the United States is second-worst among affluent countries on absolute poverty. I don’t think that’s quite right.

Smeeding calculates absolute poverty rates as of 2000 using two poverty lines — the official U.S. line and 125% of that line. The U.K. is higher than the U.S. using either line. Krugman suggests that the U.K. rate may be lower than ours by now due to the Blair government’s anti-poverty initiatives. That is possible — we won’t know until more recent data are available — but the U.K. rate as of 2000 was significantly higher than ours, so the progress would need to have been dramatic.

Sweden and Finland have lower absolute poverty rates than the U.S. using one of Smeeding’s lines, but higher rates using the other.

According to my calculations, using the same Luxembourg Income Study data, five additional countries that Smeeding does not include — France, Australia, Ireland, Italy, and Spain — have higher absolute poverty than the U.S.

Here are my calculations. They’re from this paper. I use absolute income levels at the tenth percentile of the income distribution (so higher is better) rather than poverty rates. I prefer P10 incomes because poverty rates ignore the depth of poverty, but the two approaches yield very similar results.

This is not to suggest that we should be satisfied with our absolute poverty ranking. Given our nation’s economic wealth, incomes for Americans at the low end of the distribution are far lower than they could be. And as Krugman rightly points out, and I discuss in detail here and here, an exclusive focus on income overlooks the relevance of work hours and of public services such as health care, schooling, and child care for the well-being of the poor.

Addendum: Contra Tyler Cowen’s suggestion, the data for the U.S. used here do include the Earned Income Tax Credit and Food Stamps (though not Medicaid).

No, it isn’t.

Poverty comparisons across affluent nations typically use a “relative” measure of poverty. For each country the poverty line — the amount of income below which a household is defined as poor — is set at 50% (sometimes 60%) of that country’s median income. In a country with a high median, such as the United States, the poverty line thus will be comparatively high, making a high poverty rate more likely. Measured this way, the U.S. does indeed have the most poverty among the rich nations. That leads to statements such as Paul Krugman’s in his otherwise insightful op-ed in Monday’s New York Times: “Poverty rates are much lower in most European countries than in the United States.” (See also here and here.)

Though widely used, and not without merit, a relative measure should not be the principal basis for poverty comparisons. It focuses too heavily on the distribution of income and too little on the absolute income level of those at the bottom. Using a relative measure, the U.S. poverty rate is higher than Romania’s and only slightly lower than Mexico’s (see here). Similarly, Mississippi’s relative poverty rate is the same as Connecticut’s.

I’ll say more about this in a future post. For now, if you’re interested there’s more in this paper and in this one (both pdf).

Which political party is better at improving living standards?

A commonplace view is that Democrats favor policies that boost the well-being of the poor while Republicans’ policy preferences are more conducive to economic growth and rising incomes. Debates about high vs. low taxes, generous vs. stingy social programs, and heavy vs. light regulation of business often are framed in terms of a tradeoff between compassion and growth. Should government do more to assist the poor? Or should it intervene less, thereby helping the economy to grow more rapidly?

For the most part this debate is a battle of rhetoric and assumptions. Many on the right assume that lower taxes, less regulation, and less generous social policies must be good for economic growth. Some on the left accept this assumption but argue that growth will fail to trickle down to the poor. Others dispute the assumption.

Evidence can help. There is a great deal of it that is potentially relevant. Here is one piece. Using tax records and surveys, the Congressional Budget Office has compiled good data on household incomes from 1979 through 2005 (here). The presidency was held by a Republican from 1981 to 1992, by a Democrat from 1993 to 2000, and by a Republican since 2000. The following chart shows average rates of income growth (adjusted for inflation and with taxes subtracted) for each of the five quintiles (fifths) of households during these three periods.

Income growth for each of these groups, from the poorest to the middle to the richest, has been faster during Democratic administrations than Republican ones.

Does this prove that Democrats are more effective than Republicans at promoting income growth? No. A government’s ability to affect income growth is limited, Democrats controlled one or both houses of Congress during Republican presidencies and vice-versa, and each of these periods has idiosyncratic features (see here, here, and here, for instance). Still, the data offer reason for skepticism about the notion that policies favored by the right are better at raising living standards.

Nor is this peculiar to the American context. Here is a counterpart chart showing income growth in the United Kingdom over the same period. The Conservative party held the government from 1979 to 1997; the Labour party has held it since. The data are from the Institute for Fiscal Studies (here).

Incomes of the richest fifth increased slightly more rapidly during the years of Conservative government, but most British households have fared as well or better under (New) Labour.

“Income statistics don’t tell the whole story of Americans’ living standards. Looking at a far more direct measure of American families’ economic status — household consumption — indicates that the gap between rich and poor is far less than most assume….”

So argue Michael Cox and Richard Alm in a New York Times op-ed. Using data from the Survey of Consumer Expenditures (CEX), they find that households in the top fifth of the income distribution spend “only” about four times as much, on average, as those in the bottom fifth.

The shock value in their piece comes from their report that while average annual income among the bottom fifth of households is $10,000, average spending among this group is $18,000. How can that be? Paul Krugman and Dean Baker rightly point out, as have others, that there are reasons to worry about the reliability of the expenditures data in the CEX. The income data Cox and Alm cite also is likely wrong. The $10,000 figure for income is from the Bureau of Labor Statistics’ Current Population Survey (CPS). Actually, the CPS puts the figure at a little over $11,000, as you can see here. In any event, a better data source is the Congressional Budget Office, which merges CPS data with income tax records. That source estimates average after-tax income among the bottom fifth of households to be $15,300 (here), which is closer to the expenditure figure cited by Cox and Alm. It isn’t surprising that those with low incomes spend more than they have. Some have credit cards or access to other forms of credit, and some get income from friends or family that they don’t report.

There is a more fundamental problem with Cox and Alm’s argument. I agree that it is helpful to consider consumption in addition to income, but the point applies more to our assessment of poverty (on which Mark Thoma has helpful discussion and links) than to our assessment of inequality. After all, the portion of their income that high earners don’t spend gets saved. It is therefore available for later spending. And income saved becomes an asset that provides financial and psychological security.

While there is less inequality of consumption than of income, the flip side — because those with high incomes are able to save and invest much more — is that inequality of wealth is much greater than inequality of income. The following chart shows the shares of income and wealth of the bottom two quintiles (fifths) and the top three quintiles of households in 2004 (the most recent year for which wealth data are available). The calculations are by Edward Wolff (here), using data from the Federal Reserve’s Survey of Consumer Finances. The bottom two fifths of households have just 0.2% of the total household wealth. The top fifth have 85%.

If we focus on spending, we miss this key part of the inequality story.

For most left-of-center Americans, the paramount concern with respect to taxes is progressivity. The aim: reduce income inequality. The means: raise income tax rates for the rich and/or lower them for the poor.

A look at the experiences of other affluent nations suggests consideration of an alternative — though by no means antithetical — strategy.

The following chart shows the amount of inequality reduction achieved by taxes and by government transfers (social security payments, unemployment benefits, the Earned Income Tax Credit, and so on) in the United States and nine other rich countries. The calculations are mine, using data from the Luxembourg Income Study database, which provides the best available comparative data on incomes. Inequality is measured using the Gini coefficient. I calculate inequality in each country using household incomes before and after taxes are subtracted; the difference between the two is the amount of inequality reduction achieved by taxes. I do the same for government transfers. Being farther to the right in the chart indicates greater reduction of inequality.

None of these countries achieves much inequality reduction via taxes. Instead, to the extent inequality is reduced, it is mainly transfers that do the work.

The chief contribution of taxes to inequality reduction is indirect. Taxes provide the money to fund the transfers that reduce inequality. The next chart shows this. On the horizontal axis is a measure of the quantity of taxation: tax revenues as a share of gross domestic product (GDP). On the vertical axis is the measure of inequality reduction via government transfers used in the first chart above. Not surprisingly, countries that significantly reduce inequality via transfers tend to tax more heavily.

The comparative experience thus suggests that for inequality reduction, it is the quantity of taxes rather than the progressivity of the tax system that matters most. Affluent countries that achieve substantial inequality reduction do so with tax systems that are large but no more progressive than ours.

What lesson should Americans draw for tax reform? In my view, the key one is that a national consumption tax — as a supplement to the income tax, not a replacement for it — is worth serious consideration (see more here and here and here).

The drawback is that consumption taxes tend to be regressive; because the poor (by necessity) spend a larger fraction of their income than the rich, they pay a larger share of that income in consumption taxes. Yet the degree of regressivity is a political choice. It can be greater or lesser, depending on whether certain items, such as food, are exempted.

A national consumption tax (we currently have state and local sales taxes) would help to raise revenue. As the following chart shows, one way other affluent nations generate more tax revenues than the United States does is by making greater use of consumption taxes.

One possibility to consider: a national consumption tax on the order of 5% that is earmarked to fund universal health care, universal preschool, and/or high-quality child care. This would reduce the progressivity of the tax system somewhat, but the payoff might well be worth it.

Douglas Hibbs’ “bread and peace” model has been extremely effective at predicting the outcomes of U.S. presidential elections. This chart, covering elections from 1952 to 2004, gives you the gist:

On the vertical axis is the incumbent-party candidate’s share of the two-party vote. On the horizontal axis is the growth rate of per capita real disposable personal income (DPI) over the three and a half years leading up to the election. The growth rate is adjusted so that more recent periods (quarters) are weighted more heavily. Income growth — “bread” — is a strikingly good predictor of the vote outcome.

There are two main exceptions: 1952 and 1968. (These aren’t included in calculating the regression line in the chart.) This is where the “peace” component of the model comes in. In those two years the incumbent (Democratic) party suffered from a large number of American casualties in a war for which it was viewed as responsible — Korea in 1952 and Vietnam in 1968. Those two wars were still relevant in the ensuing elections, in 1956 and 1972, but the incumbent (Republican) party didn’t suffer much because it hadn’t started the wars.

In analyses in a 2000 article and a recent update (here; hat tip to Andrew Gelman), Hibbs finds that other factors neither add to the explanatory utility of the bread and peace model nor reduce the estimated impact of income growth and war casualties.

What does the model predict for the 2008 election? It’s early yet, but nevertheless interesting to take a look. Through the end of 2007, Hibbs’ weighted income growth rate measure is 1.4% (my calculation). If that continues and “bread” dominates, as it has in most prior elections, the model projects a victory for the Republican candidate. The next chart shows this as “2008a.”

Surprised? Many citizens and pundits expect a Democratic victory. And seemingly with good reason. The current Republican president is extremely unpopular, the Democrats did very well in the 2006 mid-term elections, Democratic voters appear to be more energized than their Republican counterparts, and the two issues voters say are most important to them, the economy and the Iraq war, seem likely to favor the Democratic candidate. Still, some recent polls (such as this and this and this) suggest a Republican nominee might well defeat either Hillary Clinton or Barack Obama in the general election.

Lots of things could result in a Democrat winning in November. In the context of the Hibbs model there are three relevant scenarios.

1. The 2008 election is an exception. In politics there are no immutable laws. Even if average income growth and war casualties have been and continue to be key factors in presidential elections, they might not determine the outcome of this one.
2. Like in 1952 and 1968, the incumbent party is hurt by American casualties in a war it initiated. As a result, its candidate receives less than 50% of the two-party vote despite relatively rapid income growth. This is shown in the chart as “2008b.” Hibbs reports that approximately 29,000 Americans had been killed in Korea at the time of the 1952 election, and almost exactly the same number had died in Vietnam by November of 1968. As of February 2008 nearly 4,000 Americans have been killed in the Iraq war. That’s far fewer than in 1952 or 1968, but the public’s tolerance threshold may be considerably lower now (see here, for instance).
3. Income growth slows in 2008. That would reduce the predicted vote share of the incumbent-party (Republican) candidate, especially since growth in recent periods is weighted more heavily in the model. This is shown as “2008c” in the chart. At the moment, with the economy teetering on the brink of recession, a slowing of income growth appears extremely likely.

Another possibility is that the model no longer works well. You can see in the first chart above that 1996 and 2000 are not predicted very well by income growth, and unlike 1952 and 1968 they cannot be explained by war casualties. The model predicts 2004 accurately, but perhaps that is a fluke, due to fear of terrorism and the incumbent president’s at-that-time seemingly successful prosecution of the Afghanistan and Iraq wars.

Why might the model no longer work well? One hypothesis is that as a society gets richer, pocketbook issues recede in importance for voters.

A second consideration is that growth of per capita personal income is no longer a useful indicator of how voters have fared economically. In recent decades the bulk of income gains have gone to a small slice of the population — those at the top of the distribution. Measuring growth via an average misses this. The next chart illustrates the point. From the late 1940s through the mid-1970s per capita (i.e., average) DPI and median family income both increased steadily. Since the mid-seventies per capita income has continued to do so, but median family income has been relatively flat.

If the model’s effectiveness has indeed declined, other factors may matter more in 2008 than they have in the past. Which factors? And with what outcome? Your guess is probably as good as mine.