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Inequality as a social cancer

January 18, 2010

Income inequality makes a lot of things we care about worse, according to a new book, The Spirit Level: Why Greater Equality Makes Societies Stronger, by Richard Wilkinson and Kate Pickett. Looking across 20 or so rich nations and across the 50 American states, Wilkinson and Pickett find that countries and states with greater income inequality tend to have lower life expectancy, higher infant mortality, more mental illness, more obesity, higher rates of teen births, more murder, less trust, and less upward mobility.

The following plot of life expectancy by income inequality shows a pattern that appears again and again in The Spirit Level.

“The problems in rich countries,” Wilkinson and Pickett conclude, “are not caused by the society not being rich enough (or even by being too rich) but by the scale of material differences between people within each society being too big. What matters is where we stand in relation to others in our own society” (p. 25).

The book has received a good bit of attention. It’s been reviewed in a number of major newspapers and been the focus of events at progressive think tanks in London and Washington, DC. It’s easy to see why. Many progressives worry about inequality. Here is a book, referencing hundreds of social scientific studies and making extensive use of quantitative data, which says, in effect, that many of our social problems can be significantly eased by reducing income inequality.

Is it correct? I was initially skeptical, and after reading the book I remain so.

What’s the causal link?

It wouldn’t be surprising to find that inequality in the income distribution contributes to inequality in health, education, and so on. And there’s plenty of evidence that it does. Wilkinson and Pickett make a different claim: income inequality worsens the average level of health, education, safety, trust, and other good things. How does it do that?

Wilkinson and Pickett say high inequality increases status competition, which in turn increases stress and anxiety, which leads to social dysfunction.

“Greater inequality seems to heighten people’s social evaluation anxieties by increasing the importance of social status…. If inequalities are bigger, so that some people seem to count for almost everything and others for practically nothing, where each one of us is placed becomes more important. Greater inequality is likely to be accompanied by increased status competition and increased status anxiety.” (pp. 43-44)

Here’s how they see stress as the link between income inequality and a key health outcome, lower average life expectancy:

“One of the most important recent developments in our understanding of the factors exerting a major influence on health in rich countries has been the recognition of the importance of psychological stress…. The most powerful sources of stress affecting health seem to fall into three intensely social categories: low social status, lack of friends, and stress in early life…. Much the most plausible interpretation of why these keep cropping up as markers for stress in modern societies is that they all affect — or reflect — the extent to which we do or do not feel at ease and confident with each other. Insecurities which can come from a stressful early life have some similarities with the insecurities which can come from low social status, and each can exacerbate the effects of the other.” (p. 39)

“So how do the stresses of adverse experiences in early life, of low social status, and lack of social support make us unwell? … The psyche affects the neural system and in turn the immune system — when we’re stressed or depressed or feeling hostile, we are far more likely to develop a host of bodily ills, including heart disease, infections and more rapid ageing. Stress disrupts our body’s balance, interferes with what biologists call ‘homeostasis’ — the state we’re in when everything is running smoothly and all our physiological processes are normal.”  (p. 85)

Here’s the hypothesized link with obesity:

“People with a long history of stress seem to respond to food in different ways from people who are not stressed. Their bodies respond by depositing fat particularly round the middle, in the abdomen, rather than lower down on hips and thighs…. The body’s stress reaction causes another problem. Not only does it make us put on weight in the worst places, it can also increase our food intake and change our food choices, a pattern known as stress-eating or eating for comfort.” (p. 95)

And educational achievement:

“New developments in neurology provide biological explanations for how our learning is affected by our feelings. We learn best in stimulating environments when we feel sure we can succeed. When we feel happy or confident our brains benefit from the release of dopamine, the reward chemical, which also helps with memory, attention, and problem solving. We also benefit from serotonin which improves mood, and from adrenaline which helps us to perform at our best. When we feel threatened, helpless and stressed, our bodies are flooded by the hormone cortisol which inhibits our thinking and memory. So inequalities of the kind we have been describing in this chapter, in society and in our schools, have a direct and demonstrable effect on our brains, on our learning and educational achievement.” (p. 115)

Other mechanisms are discussed at various points in the book, including oppositional culture, perceived expectations of inferiority, and humiliation. But stress is the key.

An important question here, which Wilkinson and Pickett don’t address, concerns the tightness of the link between the degree of income inequality in a society and the degree of status competition. The United States has the most unequal income distribution among rich countries, but I’m not certain this results in it having more status competition than other countries. Some European nations with less income inequality have a long history of class divisions. American culture is relatively informal, and Americans tend to optimistic about the possibility of upward mobility. As a result, perceptions of status divisions may be less pronounced in the U.S. than in some other nations. The same is true for the American states. The states with the highest income inequality include Alabama, Arkansas, Georgia, Kentucky, Louisiana, Mississippi, North Carolina, Oklahoma, South Carolina, Tennessee, and Wyoming. Is status competition greatest in these states? I’m not sure.

How strong is the effect?

Wilkinson and Pickett are convinced that the effect of income inequality on social well-being is real, and perhaps it is. But if so, how strong is the effect? Social scientists frequently discover statistically significant effects that turn out to be trivially small in magnitude.

Look again at the chart above, which shows life expectancy by income inequality across affluent nations. If you follow the regression (“best-fit”) line, you’ll see it suggests that going from very high income inequality to very low income inequality will increase life expectancy by approximately two years (from about 77.5 to 79.5). The same is true across the 50 U.S. states. Is that a large impact?

One way to think about this is to consider how much life expectancy has changed in these countries over time. Let’s compare 1980 to 2006. I got data for these two years from the OECD for 21 of the 23 countries included in Wilkinson and Pickett’s graph. In 1980 the average life expectancy in these countries was 71 years. By 2006 it had jumped to 78 years. This increase is not simply a function of the poorer countries making huge leaps. In the three richest countries — Norway, the United States, and Switzerland — life expectancy rose by five or six years. The smallest rise, in the Netherlands, was four years.

If Wilkinson and Pickett’s estimate of the impact of income inequality is correct, reducing inequality in the United States to Sweden’s level would improve life expectancy by two years. Yet in the past generation life expectancy in the U.S. increased by more than twice that amount. By this gauge, inequality’s effect isn’t an especially large one.

Are the correlations true?

The point-in-time associations in Wilkinson and Pickett’s graphs are their key piece of evidence. Are they accurate? In studies such as this, there almost always is reason to worry about data and measurement choices. I’ll mention just one here. Wilkinson and Pickett measure income inequality for countries using data from the United Nations’ Human Development Report. It’s not a bad choice, but a more reliable source when comparing across nations is the Luxembourg Income Study (LIS). The LIS has data for fewer countries, but if an association is genuine it ought to hold for a subset of the countries examined by Wilkinson and Pickett.

The following chart plots life expectancy by income inequality as of 2005, using LIS data for inequality. There is no association.

Actually, this isn’t so much because of the difference in data source; it’s mainly a function of the particular countries that drop out when switching to the LIS data. The association in Wilkinson and Pickett’s chart rests heavily on the position of Japan, Singapore, and Portugal, none of which are in the LIS database. A small number of countries, often the United States and Japan, exert a good bit of influence on the patterns in a number (though not all) of Wilkinson and Pickett’s scatterplots. This is worrisome.

Are cross-sectional point-in-time associations the appropriate empirical test?

Patterns of association across countries or states at a single point in time may be very useful evidence. Or they might not. With this kind of evidence, we worry about other ways in which countries differ from one another that could be the true drivers of the observed association.

To supplement cross-sectional snapshots, we can, where data availability permits, look at what happens over time. Wilkinson and Pickett presumably would think this a good idea. In the book’s final chapter they note that the level of income inequality has changed in a number of these countries over the last few decades. And in the conclusion to an article that summarizes the book, they say “Standards of health and social well-being in rich societies may now depend more on reducing income differences than on economic growth without redistribution.” If income inequality is reduced, they’re suggesting, life expectancy and other social outcomes should improve; if inequality rises, outcomes are likely to worsen.

Yet The Spirit Level includes virtually no analysis or discussion of over-time developments. There is one over-time chart in the chapter on trust, a brief discussion in the chapter on crime, and a few references to other studies in a summary chapter. But as best I can tell, that’s all.

This is an important omission, because researchers who have examined over-time relationships between income inequality and average levels of health have tended to find no support for the hypothesized link (Jennifer Mellor and Jeffrey Milyo; Jason Beckfield; Andrew Leigh, Christopher Jencks, and Tim Smeeding). Here’s one way to see this. The following chart plots life expectancy on the vertical axis and income inequality on the horizontal. Each country is shown at two points in time, around 1980 and around 2005. For each country, a line connects the two data points. In most of the countries income inequality has increased and yet so has life expectancy. That’s not what Wilkinson and Pickett’s argument and findings would lead us to expect. Moreover, in the two countries where inequality was already low and then decreased, the Netherlands and Denmark, life expectancy rose the least.

I haven’t looked carefully at over-time data for the other outcomes Wilkinson and Pickett examine. But a few trends in the United States seem problematic for their argument. Average educational achievement has improved over the past generation even while income inequality soared. Violent crime began increasing in the mid-1960s, well before the rise in inequality, and it has dropped considerably since the early 1990s. Trends such as these don’t necessarily mean inequality has had no effect, but at the very least they call into question its magnitude.

Interestingly, Wilkinson and Pickett report that anxiety, the mechanism through which they believe income inequality causes social dysfunction, has been increasing steadily in the United States and other rich nations over the past half-century. But as they note, that isn’t due to rising income inequality: “That possibility can be discounted because the rises in anxiety and depression seem to start well before the increases in inequality which in many countries took place during the last quarter of the twentieth century. (It is possible, however, that the trends between the 1970s and 1990s may have been aggravated by increased inequality.)” (p. 35). This leaves us with an important unanswered question: Why would income inequality be a key determinant of stress across countries at a point in time, as Wilkinson and Pickett posit, but not within countries over time?

In sum, longitudinal developments offer further grounds for skepticism about the effect of income inequality on average levels of health, education, safety, and other social goods.

What to do

Improving social outcomes is certainly a worthwhile aim. What’s the best way to do it? According to Wilkinson and Pickett,

“Attempts to deal with health and social problems through the provision of specialized services have proved expensive and, at best, only partially effective…. The evidence presented in this book suggests that greater equality can address a wide range of problems across whole societies.”

I wish it were that simple. I share Wilkinson and Pickett’s conviction that it would be good for America and some other affluent nations to reduce income inequality, but this book hasn’t convinced me that doing so would help us to make much headway in improving health, safety, education, and trust. To achieve those gains, my sense is that our best course of action is greater commitment to specialized programs and services, coupled with poverty reduction.

Then again, I’m not certain that Wilkinson and Pickett are wrong. I’ve focused here mostly on the effect of inequality on life expectancy, because that is the social outcome for which the hypothesized causal link (stress) seems most plausible and because it has received the most attention in prior research. I’m skeptical that income inequality has much of an impact on average life expectancy. But perhaps life expectancy will turn out to be the exception to the rule.

Posted in Book reviews, Health, Inequality | 10 Comments »

A strategy for reducing income inequality

November 23, 2009

It’s no secret that income inequality has been on the rise in the United States over the past generation. But it has been increasing in most other affluent countries too. This is not a product of cuts in taxes or social programs; it’s due mainly to rising inequality of market income.

Suppose we think it would be good for countries to try to maintain or move toward relatively low levels of inequality, something akin to the levels in contemporary Denmark or Sweden. What is the best way to do that?

My attempt at an answer is in the September-October issue of Challenge.

Posted in Abroad, Employment, Inequality, Social policy | 4 Comments »

Exchange on inequality

October 14, 2009

This week and next I’m taking part in an exchange on inequality at Cato Unbound. John Nye, Elizabeth Anderson, and I will be responding to Will Wilkinson’s essay “Economic inequality and the mirage of injustice,” followed by some back-and-forth. My initial comment is titled “Is consumption the grail for inequality skeptics?“

Posted in Inequality | Leave a Comment »

Did Blair and Brown fail on inequality?

June 1, 2009

In a Financial Times op-ed, Matthew Engel says

This month, it was revealed that the UK’s Gini coefficient, measuring inequality between rich and poor, had reached its highest level on record — after the longest period of Labour government ever. You do not have to be a Labour voter to wonder what, then, has been the point of it all.

I wouldn’t want to offer a full-scale defense of the Labour governments’ strategy (see ch. 11 of this book for my views), but there is a reasonable response to this particular challenge. Inequality of market incomes has been increasing almost everywhere. Arguably, it has risen less, and government has done more to mitigate its impact, under Labour than would have been the case under the Conservatives. It’s impossible to know that for certain, of course, but the following data on inflation-adjusted income growth during the most recent periods of Conservative and Labour rule are consistent with this assertion.

Posted in Abroad, Inequality | 1 Comment »

Do schools make inequality worse?

May 21, 2009

“Far from leaning against economic inequality, U.S. schools make it worse.” This sentiment, from a recent Clive Crook op-ed, expresses a view that’s commonplace on both the left and the right, and among both proponents and opponents of school reform.

It’s wrong. Americans do leave the schooling system more unequal in cognitive and noncognitive skills than when they enter it. Yet that inequality is less — probably much less — than it would be in the absence of schools. Schools don’t increase inequality; they just don’t do enough to overcome the inequality produced throughout childhood by differences in families, neighborhoods, peers, and other influences.

How do we know that? First, children are vastly unequal in ability when they enter the school system at age five or six. This is due partly to genetics and partly to environmental differences.

Second, we have evidence from the natural experiment that is summer vacation. During those three months out of school, the cognitive skills of children in lower socioeconomic status (SES) households tend to stall or actually regress. Kids in high-SES households fare much better during the summer, as they’re more likely to spend it engaged in stimulating activities. In his book Intelligence and How to Get It, cognitive psychologist Richard Nisbett concludes that “much, if not most, of the gap in academic achievement between lower- and higher-SES children, in fact, is due to the greater summer slump for lower-SES children” (p. 40).

Without schools this pattern would be magnified, and the gap in cognitive and noncognitive abilities at age 18 almost certainly would be much greater than it now is.

This by no means implies our educational system is doing fine. It could and should do much better at helping children from disadvantaged environments. But saying it currently makes things worse suggests the situation is hopeless. Instead of promoting reform, that undercuts it.

Posted in Education, Inequality | 3 Comments »

“The tyranny of dead ideas”

May 4, 2009

Matt Miller’s new book, The Tyranny of Dead Ideas, is very good. I agree with a great deal of what he has to say. On what Miller thinks is our most important problem, though, the book falls a little short.

Here’s a brief summary of what Miller suggests are six influential but misleading ideas, why they’re wrong, and what we should do:

1. Taxes hurt the economy, and they’re always too high

It’s time, says Miller, to stop pretending that federal tax revenues can remain at their current level, much less be reduced. Rising costs of Medicare (and eventually Social Security) alone will require increases. And real solutions to the myriad other problems we face necessitate further increase. Even (honest) conservatives acknowledge this, though few are willing to do so publicly. “Once this rendezvous with reality trickles down from conservative intellectuals to pols, and liberals find the courage to say the obvious, we’ll start the debate we need: not about whether taxes should go up, but given that taxes are going up, what’s the best way to fund the government we want, consistent with strong economic growth and other vital goals such as saving the planet?” (p. 183).

Miller’s answer is a value-added tax (VAT) and a carbon tax. On the former, “liberals will find that they can offset the regressive tilt of a VAT in several ways: first, by using it to fund progressive programs (like universal health coverage); second, by using a fraction of the proceeds to boost subsidies to the working poor; or third, by exempting certain basic necessities from the tax” (p. 186). I agree.

2. Your company should take care of you

Structuring our health insurance system around employers was reasonable once upon a time, but these days it’s asinine. It results in bloated health care expenditures, inadequate coverage, and an excessive cost burden on firms. This role needs to be shifted to government. Yes.

3. Free trade is “good,” no matter how many people get hurt

The fact that free trade is good for Americans on average doesn’t mean that it’s good for all Americans. Some lose their jobs, and some experience stagnant or falling wages. The answer isn’t protectionism; that would hurt lots of people in developing nations who are far poorer than we are. Instead, we need “a new formulation: that free trade is good, provided we have protections in place to make people feel sufficiently secure in a time of rapid economic change. This means health care and pension security that aren’t tied to a job that can suddenly disappear. It means broader trade adjustment assistance, job retraining, and wage insurance that keeps offshoring from being a catastrophe for affected families” (p. 60). Good.

I think Miller is wrong, however, on an important tactical question. He says politicians should not commit to any further expansion of trade until these protections are in place (p. 60). I disagree.

4. Schools are a local matter

Our decentralized educational system, in which administration and funding of public elementary and secondary schools are primarily local responsibilities, does a disservice to virtually all students, but particularly to those living in districts that are poor and/or have overly intrusive school boards. We need enhanced federal government spending, mainly to raise the salaries of good teachers, and imposition of nationwide performance standards. I like this too.

5. The kids will earn more than we do

For most of the period since World War II, Americans have taken it for granted that income would grow steadily across generations. But new technologies facilitate the automation of more and more jobs, and globalization encourages the offshoring of others. In the past generation many kids have ended up with incomes no higher than their parents’, and in Miller’s view this is likely to continue.

Part of the answer, he ways, is technology, which continuously reduces prices, improving living standards for the middle class and the poor even as their incomes stagnate or decline. Beyond that lie changes in our preferences: “The economic challenges ahead will spark a renaissance of interest in less material sources of meaning and happiness, and for many a flight from the consumer culture altogether…. Time with friends and loved ones will become more cherished. The craving for community will deepen. And curiosities like today’s nascent ’slow movement,’ which cheerleads for (among other things) longer meals savored with loved ones and a quieter pace of life in general, will expand from a niche lifestyle to a broader force in the culture” (pp. 202-03). Again good, though I would add that expansion and improvement of public services can help to push up the floor of consumption and experience.

6. Money follows merit

Traditionally, Americans haven’t gotten too worked up about high levels of income inequality because they’ve believed that the big paychecks go to those who contribute the most. But when CEOs of companies whose stock price has fallen through the floor walk away with $25 million severance packages and financial players run the economy into the ground yet rake in mammoth bonuses, things clearly have gone awry. Miller says frustration is likely to be especially pronounced among highly-educated professionals who, for reasons that seemingly have nothing to do with merit or societal contribution, bring home a mere $150,000 a year instead of $15 million.

Inequality is a major problem, in Miller’s view. Indeed, he says it is “the preeminent economic issue of the twenty-first century” (pp. 146, 148).

Here’s what he believes these “lower uppers,” and more broadly we as a society, will and should do:

Now that their second-tier status is awakening them to the fragility of ‘merit’ as the source of their self-esteem and as the basis for where they ‘deserve’ to stand in society, Lower Uppers will start seeing luck’s hand elsewhere. They’ll see it not only in their own story or in the fate of the ultrarich above them, but in the destiny of millions of their countrymen, now buffeted and struggling with rapid economic change. They’ll be open to fresh appeals about what these powerful forces outside people’s control should mean for society’s basic arrangements. As a result they’ll become stronger voices for equal opportunity, and for some set of minimal protections appropriate for a wealthy nation like the United States. Like their Progressive Era predecessors … they’ll also see justice (and take satisfaction) in asking the ultrarich to kick a little more into the pot to make this happen. (pp. 195-96)

Compared to Miller’s other proposals, this is pretty vague. One of the things I like most about Miller’s earlier book, The Two-Percent Solution, is that he picked a small set of problems and offered specific proposals for what to do. To some extent that is true of The Tyranny of Dead Ideas as well. Miller gives us concrete numbers for what the federal government’s contribution to school expenditures should be and for what share of GDP tax revenues will need to rise to, and he tells us what specific programs will help to cushion the impact of globalization. But here, on this “preeminent issue,” detail is absent.

This omission is even more problematic because though Miller advocates higher taxes on those with top incomes, in a prior chapter he offers a caution: “Some suggest … we eliminate the cap on the amount of earnings subjected to the 12.4 percent payroll tax, so that it would apply to a person’s entire income. While at first blush this step might seem fair, if it were done in addition to proposals to return marginal income tax rates to the 39.6 percent that prevailed under President Clinton, it would effectively boost marginal rates beyond 50 percent — and this would be before high tax states and localities add what could be another 7 to 10 percent. You don’t need to be a Reagan Republican to think that marginal income tax rates at these levels would have negative economic effects” (p. 185).

It isn’t easy to figure out exactly what the tax rate should be on high-income households, or what programs would be most useful in boosting the living standards of those in the lower half of the income distribution. I wish Miller, whose policy thinking tends to be both interesting and level-headed, had made more of an attempt. It’s a small scar on what’s otherwise a very helpful book.

Posted in Book reviews, Inequality, Living standards, Social policy | 2 Comments »

How to pay for inequality reduction: follow-up

April 20, 2009

One way to make some progress in reducing income inequality is to significantly increase redistributive transfers and public services. I’ve suggested that it will be difficult to fund that solely by heightening taxes on those at the top of the income distribution. Robert Waldmann asks, quite reasonably: Where’s the math?

Here’s an answer. I’ll use numbers for 2006, since that’s the most recent year for which we have good income and tax data from the Congressional Budget Office.

Suppose we need to increase tax revenues’ share of GDP by 5 percentage points. As the following chart shows, that would still leave us near the bottom among the world’s rich countries. But if the money were used well, it would be a notable advance.

GDP in 2006 was approximately $13 trillion; 5% of that is $0.65 trillion ($650 billion). President Obama has pledged to not increase taxes for the bottom 95% of Americans, so let’s presume the added revenue will come from the top 5%. In 2006 this group, 5.9 million households, had an average pretax income of $564,200. Their total pretax income was thus $3.3 trillion. The $0.65 trillion needed in order to boost tax revenues by 5% of GDP amounts to 20% of that $3.3 trillion in income. Thus, the effective tax rate (taxes paid as a share of pretax income) on the incomes of the top 5% of households would need to be increased by 20 percentage points.

The following chart shows the effective federal tax rate on the top 5% of households going back to 1960. The data from Piketty and Saez begin in 1960; the CBO data begin in 1979. I use the federal rate not only because data are available, but also because these taxes — mainly individual and corporate income — are the ones most likely to enhance the progressivity of the tax system (also included are payroll and excise taxes).

Incomes are higher in the top 1%, so what if we focused on that group? In 2006 the average pretax income among those 1.1 million households was $1,743,700. Their total income was thus $1.9 trillion. The effective federal tax rate on this group would have to be raised by 34 percentage points in order to increase tax revenues by $0.65 trillion, or 5% of GDP. Here’s what that would look like in historical context.

Whether desirable or not, increases of this magnitude strike me as unlikely. It’s worth thinking about additional potential sources of revenue.

Let me emphasize that my aim isn’t to discourage increases in taxation of the richest. I favor doing that. Rather, it’s to encourage the American left to think beyond heightened tax progressivity when considering strategies for inequality reduction.

Note: I’ve corrected an error in the earlier version of this post.

Posted in Inequality, Taxes | 6 Comments »

Reducing inequality: how to pay for it

April 17, 2009

The Labour Party returned to power in the U.K. in 1997 based in part on a pledge by Tony Blair and Gordon Brown not to raise taxes’ share of the British economy. In his 2008 presidential campaign, Barack Obama promised to reduce taxes for the bottom 95% of Americans. In both instances this commitment succeeded in insulating the progressive candidate from what had become the right’s most powerful electoral club: stoking fear of tax increases by the left.

But while it may be smart electoral politics, committing not to increase taxes’ share of GDP, as Blair did, or to lower taxes for most of the population, as Obama has done, makes it difficult for a government to make much headway in addressing income inequality. Obama has some leeway; the economic crisis has necessitated increases in government spending that can justifiably excuse some backtracking on his campaign pledge. Fully consistent with his promise, he should increase the tax rate on high-end incomes (beyond simply letting the Bush reductions expire). Two other progressive tax reforms are worth pursuing, though they would affect some in the bottom 95%. One is to reduce or end the homeownership subsidy. More than 80% of the $160 billion in foregone revenues from the deduction for mortgage interest and property tax payments goes to households in the top income quintile. The other is to introduce a modest tax on financial transactions.

But should the focus be confined to steps that make the tax system more progressive? Many on the left view heightened progressivity as the key to inequality reduction. Yet in the United States and other rich countries the tax system overall, including taxes of all types and at all levels of government, is essentially flat; households throughout the income distribution pay roughly similar shares of their market income in taxes. As the following chart shows, inequality reduction is achieved not through taxation but with government transfers (and services).

Taxes help to reduce inequality mainly via their quantity rather than their progressivity. The greater the tax revenues, the more government is able to boost incomes and living standards of those in the lower half of the distribution with transfers and services.

Moderate or high levels of tax revenue can’t come solely from higher rates or new taxes on the rich; the math simply doesn’t work. To significantly increase spending on transfers and/or services, President Obama and/or his successors will need to increase taxes on the middle class. One way to do this would be via a federal consumption tax, such as a value-added tax (VAT). We have state and local consumption (sales) taxes, but we raise less money from consumption taxes than any other rich country. Consumption taxes are regressive, and for that reason they’re often dismissed by the American left. But they can be tweaked to limit the degree of regressivity. And if the money is put to progressive use, the benefits may outweigh this drawback.

Posted in Inequality, Taxes | 7 Comments »

Reducing inequality: what to do about the top 1%

April 17, 2009

In my view, raising and indexing the minimum wage, enhancing the Earned Income Tax Credit, and expanding and improving public services ought to be our top priorities for boosting the incomes and living standards of Americans in the lower half of the income distribution. What about the other component of rising inequality: soaring incomes of those in the top 1%?

It’s tempting to want to intervene directly in markets to reverse this trend. One way to do so is to legislate some sort of pay cap — a maximum wage, if you will. I don’t think this is the right way to go. If the value-added by particular individuals — a CEO, financial innovator, top athlete, movie star, or what have you — is sufficient to merit pay above the cap, firms will figure out ways to get around it, for instance by providing non-monetary perks or deferring pay.

Stricter regulation of the financial sector is another possibility. This is a good idea, though mainly to prevent a repeat of the current economic downturn. If doing so has the indirect effect of reducing enormous payouts to financial players, so much the better.

The simplest and best strategy is to let markets largely determine high-end earnings and incomes and use the tax system to redistribute (more here and here). We should increase the top income tax rate and/or add one or more new rates for those with very high incomes.

This would help to reduce income inequality. And it follows logically from the rationale for progressive taxation: the higher your income, the larger the share of it you can afford to pay in taxes. Since high-end pretax incomes have risen sharply in recent decades, those at the top can afford to pay a greater share of those incomes in taxes than they did in the past. So far they haven’t had to do so, as the following data on the top 0.01% of households (about 10,000 households) indicate. This group’s average inflation-adjusted pretax income soared from $7 million in 1979 to $35 million in 2005, but the share of that income they paid in taxes didn’t increase.

What’s the proper effective tax rate on top incomes? It’s the rate that is consistent with fairness norms and produces the most tax revenue without (significantly) reducing work, investment, and innovation. I don’t know what that rate is. Maybe it’s 40%. Perhaps it’s 50% or 60%. It could conceivably be even higher. Figuring this out requires policy adjustment and monitoring.

Posted in Inequality, Taxes | 6 Comments »

Reducing inequality: expand and improve public services

April 16, 2009

How do we boost the incomes of Americans in the lower half (or two-thirds) of the distribution? I’ve discussed what I think are some helpful and some probably-not-so-helpful proposals. But our focus shouldn’t be exclusively on income. The well-being of lower- and middle-class Americans can be improved markedly by enhanced provision of government services.

Service use (consumption) doesn’t show up in income statistics. But services matter for living standards. If I have two kids in a public school that spends about $10,000 per year per child, I’m receiving the equivalent of a government transfer of $20,000. Other public services and public spaces — health care, child care, policing, transportation, roads, parks, libraries, and so on — have the same property. So too does free time funded or mandated by government via holidays and paid parental leave.

When provided by government at little or no cost to users, these services are akin to a transfer given in equal dollar amounts to all individuals or households. Our tax system is roughly flat: households at different points in the income distribution pay approximately the same share of their market (pretransfer-pretax) income in taxes. But a flat tax rate means those with high incomes pay many more dollars in taxes than do poor households. If the value of the government services the rich and poor use is roughly the same in dollars, then the tax-services system overall is quite redistributive. Here’s a way to see this, using tax payment data for 2004 and hypothetical data for consumption of public services:

Some services charge user fees that are structured progressively; those with higher incomes pay more. This makes the tax-services system even more redistributive. Financial aid means this is true for public (and many private) colleges here in the U.S., though we could go much farther. In Denmark and Sweden, fees for child care are scaled according to household income.

Imagine an America in which high-quality public services raise the consumption floor to a high level: most citizens can put their kids in high-quality child care followed by good public schooling and affordable access to a good college; they have access to good health care throughout life; they can get to or near work on clean and efficient public transportation or roads with limited congestion; they enjoy clean and safe neighborhoods, parks, roads, museums, libraries, and other public spaces; they have low-cost access to information, communication, and entertainment via reliable high-speed broadband; they have four weeks of paid vacation each year, an additional week or so of paid sickness leave, and a year of paid family leave to care for a child or other needy relative. Even if the degree of income inequality were no less than today and we still had CEOs, financiers, and entertainers raking in tens or hundreds of millions of dollars in a single year, that society would be markedly less unequal than our current one.

It’s worth emphasizing that markets too boost the consumption floor. New technologies and consumer products — indoor plumbing, cars, air conditioning, cell phones, ipods, and many others — have eventually become affordable for even the least well-off, and in doing so they reduce inequality of living standards. But markets haven’t, and likely won’t, bring us affordability coupled with high quality in health care, education, child care, safety, and mass ground transportation. In these and other areas, government is needed.

The United States provides less in the way of public services than many other rich countries, but we nevertheless have a rich history here, from universal elementary and secondary education to the interstate highway system to the internet. There’s a legacy to build on, and good reason to do so.

Posted in Inequality, Social policy | 3 Comments »

Reducing inequality: boosting incomes in the bottom half

April 16, 2009

So far in this series of posts on reducing income inequality in America I’ve said that it would be good if there were less inequality, that greater unionization might help but probably isn’t in the cards (even if EFCA becomes law), that more and better education would be a good thing but isn’t likely to make much of a dent in the inequality problem, and that curtailing globalization is a bad choice for progressives even if it would help a lot. So what should we do?

Recall that there are two key components of the rise in inequality: slow income growth in the lower half (or two-thirds) of the distribution and soaring incomes at the top. Let’s start with the first of these two. I think a key component of an effective and politically feasible strategy is an enhanced statutory minimum wage and Earned Income Tax Credit (EITC).

This year the minimum wage will increase to $7.25 per hour. I’d like to see it raised again in 2010, to $8.00. A more important change is to index the minimum wage to inflation. As the following chart shows, since the late 1970s the minimum wage has been allowed to languish for lengthy periods with no increase, resulting in large declines in its inflation-adjusted value. With increases in 2007, 2008, and 2009, it will be at a reasonably high level compared to the past three decades, though still below its late-1960s peak. Raising it to $8.00/hour and keeping it at that value would be a significant step in the right direction.

Is $8.00 an hour high enough? It’s difficult to tell. Two considerations make me inclined to prioritize locking in something like that level rather than aiming for a larger increase right away. The first is jobs. Opponents of raising the minimum wage often contend that any increase will produce employment declines. Our experience with past increases suggests little support for this notion, but it’s equally wrong to presume there won’t be an adverse employment effect no matter how high the minimum wage. Surely there is some level that is too high. This argues for incremental upward adjustment from a stable floor. Second, proponents of a sizable increase in the minimum often point out how inadequate it is given the cost of living in certain parts of the country. That’s quite true, but it’s probably better addressed by state and local governments stepping in with their own higher statutory minimums, as a growing number have done over the past decade.

An expanded Earned Income Tax Credit would be similarly helpful for low- and middle-income Americans. The EITC is a terrific policy: it boosts the incomes of low-earning households, it encourages employment, it has low administrative costs, it creates minimal stigma for recipients, and it’s indexed to inflation. Currently the maximum value of the credit is about $5,000, available to households with two children and with earnings between $12,500 and $19,500. It then declines steadily until it reaches zero at around $43,000 in earnings. For households with one child the credit is lower, and for those with no children it is quite small. A chart showing the current level and structure of the credit is available from the Tax Policy Center.

I’d like to see the EITC look something more like this:

This EITC would extend well into what most of us think of as the middle class. It wouldn’t provide a lot to those with earnings above $50,000, but it would help. Phasing out the credit more rapidly (making the slope of the line on the right side steeper) risks creating work disincentives. Moreover, there’s a potential political advantage to including those with higher incomes. When the middle class uses the same programs as the poor, it tends to be more supportive of those programs; the “us” versus “them” mentality that weakens support for social policy is likely to have less political bite. This EITC expansion would not be cheap. I’ll say a bit about how to pay for it in a future post.

With these changes in the minimum wage and the Earned Income Tax Credit, a single adult working full-time year-round at minimum wage would have an income — earnings plus EITC — of approximately $19,000, compared to 15,500 under current policy. A family of four with two minimum wage earners would have an income of about $38,500, compared to $32,500 currently. That’s not a full solution to the inequality challenge, but it’s a good start.

Posted in Inequality, Social policy | 2 Comments »

Reducing inequality: put the brakes on globalization?

April 15, 2009

Trade, outward foreign investment (movement of plants and services abroad), and immigration very likely have contributed to the growth of U.S. earnings inequality over the past several decades. Reducing any or all of them might well help to boost wages among Americans in the lower half of the distribution.

But in my view this shouldn’t be even a minor part of a strategy for inequality reduction, much less its chief focus. Trade, investment abroad, and immigration tend to benefit citizens in and from poor countries, which includes the bulk of the world’s population. Most of these people are substantially poorer than even the poorest Americans.

Yes, globalization enriches some rapacious corporations and despotic rulers, and vulnerable workers are exploited. But access to the American market and to employment by U.S.-based transnational firms has helped improve the lives of hundreds of millions of Chinese, Indians, and others in recent decades. And moving to the United States almost invariably enhances the living standards of immigrants from poor nations. It would be a bitter irony if American progressives succeeded in making a real dent in our inequality problem at the expense of the world’s poorest and most needy. We should look elsewhere for solutions.

I’m not suggesting we should sit idly by and let globalization have its way with the Americans who lose their jobs or experience falling wages. But rather than try to slow or block globalization, we should instead do what we can to enhance their flexibility and adaptability and to provide adequate cushions and supports. Among the things we Americans can learn from the Danes, Swedes, and Dutch, one of the most valuable is that it’s possible to embrace globalization (and other sources of economic change and disruption) and still have a high-opportunity, low-inequality, low-poverty society. The following chart offers one indication of this. It shows earnings inequality by imports as of the mid-2000s. Import-heavy countries are by no means doomed to high inequality.

Most of us want policies like wage insurance, better unemployment compensation, portable health insurance and pensions, support for retraining, and assistance with job placement not just because they can help to blunt the adverse consequences of globalization, but because they do so for economic change in general — whether it’s a product of technological progress, geographical shifts of industries and firms within the United States, or what have you. Arguing for limits on globalization directs attention away from these policies, making their adoption less likely. Paradoxically, then, we end up with the worst of both worlds: marginal trade limits, half-hearted steps to curtail investment abroad, confused and ineffective immigration policy, and too little of the supports and cushions needed for successful adjustment.

If you don’t like my take on this, consider what the following have to say before you make up your mind: Alan Blinder, Paul Collier (ch. 10), Brad DeLong, James Galbraith, Nicholas Kristof, Paul Krugman, Dani Rodrik (ch. 9), Amartya Sen (ch. 4), Gene Sperling, Joseph Stiglitz (ch. 3).

Posted in Globalization, Inequality | 14 Comments »

Reducing inequality: education to the rescue?

April 14, 2009

When social scientists first began noticing and studying the rise in earnings and income inequality in the United States, much of the focus was on technological change. The idea is that in the past generation technology — especially computerization — has advanced more rapidly than skills, so employers have bid up pay for those able to use and improve new technology and reduced pay for (or gotten rid of) employees less adept at doing so.

Though this remains perhaps the single most popular explanation, many are skeptical. In their book The Race between Education and Technology, Claudia Goldin and Lawrence Katz offer an especially compelling critique. They suggest that the pace of skill-biased technological advance actually hasn’t changed much over the past century. What distinguishes recent decades, they contend, is that growth of educational attainment has slowed. Here’s their key picture (the vertical axis shows the share with a college degree):

Among Americans born between 1875 and 1950, the share getting a college degree rose more or less continuously. According to Goldin and Katz, as they became a sizeable portion of the labor force (assume a lag of about 30 years), inequality held steady or declined despite technological progress. But among those born between 1950 and 1965, who became an important part of the labor force beginning around 1980, college completion was pretty much flat, falling for males and increasing just slightly for females. This, say Goldin and Katz, is the key to the rise in earnings inequality that began at that time.

I think there’s something to this story, but I’m not sure it takes us very far in understanding the rise in U.S. earnings inequality or that it points us toward a solution.

For one thing, comparative evidence doesn’t seem especially supportive of the Goldin-Katz hypothesis. The following chart shows changes in earnings inequality from 1979 to 2004 (the most recent year of available data) by changes in average years of schooling completed over the same period. There is a negative association, as Goldin and Katz would predict, but it’s mainly a function of the United States; if we remove the U.S. the relationship largely disappears.

Second, the Goldin-Katz story says pay for college graduates has jumped because their supply stopped growing around 1980. But the key features of the rise in U.S. income inequality are soaring incomes among the top 1% of households (especially the top 0.1%) and slow income growth in the bottom half of the distribution.  A slowdown in the supply of college graduates is unlikely to be the key to either of these two developments. It might seem implicated in the latter until we recall that college graduates have never accounted for more than a third of working-age Americans.

Finally, the above chart from Goldin and Katz indicates that college completion began rising again for cohorts born in 1980 and after. Does this mean earnings inequality will soon level off or perhaps even decrease? Absent other changes, I wouldn’t count on it.

Education is important for individuals and for society, and I certainly favor efforts to improve both its quality and its quantity. But it doesn’t seem to me likely to get us very far in reversing the rise in American income inequality.

Posted in Education, Inequality | 5 Comments »

Reducing inequality: are unions the answer?

April 14, 2009

Unionization in the United States has been declining since the 1950s, and at a particularly rapid clip since the 1970s. Many analysts who have studied the growth of income inequality in America over the past several decades agree that union decline has played a role, and some see it as the single most important factor. The Employee Free Choice Act (EFCA), which would make it easier for employees to unionize, stands a chance of becoming law in the next year or two. Would that help to reverse the rise in inequality?

I’m not optimistic. An increase in unionization would very likely help middle and low-end households to capture a larger share of economic growth. But even if EFCA is passed by Congress, I don’t expect a dramatic surge in union membership.

Yes, survey evidence suggests that many American workers who aren’t currently a union member would like some sort of organized representation. And yes, American labor law and its weak enforcement have been a key culprit in union decline. Yet other rich countries have labor law that’s much more favorable to unions, and unionization has been declining in most of them too. Consider the following figures, from the best available comparative data source. Only a few countries have avoided a sharp fall in unionization, and they’re mainly ones in which eligibility for unemployment insurance is tied to union membership.

Why the widespread decline in unionization? The causes are multiple: greater competition and profit pressure on employers, the shift from manufacturing to services, increases in part-time and temporary employment, shrinking public sectors, and attitudinal shifts across generations, among others.

How then are unions in other countries able to secure greater wage gains, and thus less inequality, than their American counterparts? The key is “extension” practices: by agreement between union and employer confederations (most nations) or due to government mandate (France), union-management wage settlements apply to many firms and workers that aren’t unionized. The following chart shows that in a number of countries the share of the workforce whose wages are determined by collective bargaining is much larger than the share of workers who are union members.

I would like to see EFCA become law. The ability of workers to bargain with management collectively rather than individually is, in my view, an important element of a just society, and these days the playing field is too heavily tilted in management’s favor. But I doubt EFCA will get us very far in reducing income inequality. Extension of union-management wage settlements would likely have a bigger impact, but at the moment that isn’t even part of the discussion.

Posted in Inequality | 4 Comments »

Reducing inequality: what’s the problem?

April 13, 2009

I’ll be doing a series of guest posts at Crooked Timber this week on strategies for reducing income inequality in the United States. I’ll cross-post them here.

Here’s the problem (more discussion here):

There are two linked components to this rise in inequality: the surge in incomes for those at the top of the distribution and the slow growth of incomes for those in the middle and at the bottom.

Is this really a problem? Would it be better if income inequality were reduced? I think so, for the following reasons.

1. Fairness. Market processes have produced enormous incomes for various financial operators, CEOs, entrepreneurs, athletes, and entertainers in recent decades. A good bit of this is due to luck — being in the right place at the right time, genetic talent, having the right parents or teacher or coach, and so on. I don’t mind some inequality due to luck, and I recognize that monetary incentives are helpful. But the current (or recent, I should say; the downturn will reduce top incomes somewhat) magnitude of inequality in America strikes me as unfair. An income of several hundred million dollars when the minimum wage gets you about $15,000 is too much inequality. What’s the proper amount of income inequality? I don’t have a precise answer, but that doesn’t mean it’s wrong to feel that our current level is excessive.

2. Inequality’s consequences. Even if you don’t worry about exorbitant incomes in and of themselves, there’s no avoiding the fact that they have consequences for the incomes and well-being of Americans in middle and lower parts of the distribution. The social pie isn’t zero-sum. But our economy hasn’t grown faster in the past few decades than it did before, so the dramatic jump in incomes among those at the top has come in part at the expense of the rest of us. The following chart offers one way to see this. It shows GDP per family and median family income over the past six decades. Relative to growth of the economy, incomes in the middle (and below) have increased slowly since the 1970s.

As Robert Frank has pointed out, super-high incomes also have led to an arms race in consumption, especially in housing. Spending among the rich has escalated dramatically, encouraging middle- and upper-middle-class households to take on more and more debt in order to keep pace.

Over the past decade a number of social scientists have looked at the effect of inequality on other societal outcomes. We have studies suggesting that inequality is bad for education, health, crime, economic growth, economic mobility, civic engagement, political participation, political influence, and political polarization. I’m not convinced that all of these findings are correct, but some of them are quite plausible.

So what should we do? Stay tuned.

Posted in Inequality | 3 Comments »

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