Inequality, Social Mobility and Growth : Reflections on Recent Literature

There has been a recent deluge of academic work and elite media analysis of the inequality phenomenon and its societal implications. As is customary, pundits of both political persuasions have extracted findings which reinforce their ideologies to make sweeping pronouncements about the pernicious long term effects of inequality, or lack thereof.

This is a shame because much of the new research and analysis sheds important new light on the issue, particularly its downstream effects on social mobility and long term economic growth. Indeed, a sober evaluation of the recent work does much to advance our understanding of the precise explanations for social stagnation and why, for example, some metropolitan areas fare better than others in the United States.

The Latest Research and Analysis

The primary source of new data comes from the American Economic Association and its summer volume of The Journal of Economic Perspectives (JOEP). This periodical produced a stellar symposium on the subject of inequality based primarily on new data from The World Top Incomes Database, a collection of tax and other economic information on the long-run distribution of income share at the top of various countries.

The symposium generated fascinating papers that argued for and against the ascendancy of the richest earners in countries across the world and especially in the United States. While there is broad based agreement on findings such as the unprecedented rise in top income share in countries like the US and Britain and much slower increases in top incomes in Japan, France and Germany, distinct differences remain as to what governments should do to address current circumstances from a public policy perspective.

The Top 1%

In an article that appears in the aforementioned JOEP, authors Facundo Avaredo, Anthony Atkinson, Thomas Piketty and Emmanuel Saez state that narratives which attempt to explain recent increases in inequality simply by way of supply and demand for skills are insufficient to explain the extreme top tail of earnings income distribution. Additionally, they state that only evaluating earned income when assessing the issue without taking into consideration capital income (which includes inherited wealth) is incorrect. The authors point to the top 1% as the most staggering statistical culprit in the United States. From 1976 to 2011, the top 1 percent share of income more than doubled from 9 percent to 20 percent.

In most of continental Europe and Japan, where similar technological and productivity developments have taken place, the authors find that institutional and policy differences are instrumental in explaining inequality at the very top. They point to taxation as a key indicator of income distribution in the top 1%. In countries such as the US and Britain where top marginal income tax rates were reduced dramatically following World War II, the total share of the income by the 1% grew the most. Moreover, the authors go on to cite that since 1960, there is no correlation between economic growth and top tax rates. They state that all rich counties have grown at approximately the same rate since this period despite wide variations in tax policies.

Finally, the authors point to recent reductions in capital taxation and the decline in macroeconomic growth as two underlying explanations for increased income growth at the top. Inheritance flows which are described as monetary values passed on through bequests and gift have dramatically increased in places like France and Germany and to a lesser degree in the US since 1950. To this extent, the authors note that trans-continental tax policy has accommodated private wealth transfers resulting in sustained inter-generational wealth among the elites.

Evolving Market Forces

In an important piece by Financial Times columnist Tim Harford, we are asked to ponder the following question about inequality, “Should we care”? Harford notes that indeed we should care for reasons that have to do with both process and outcome.

Citing analysis in the JOEP symposium from Steve Kaplan and Joshua Rauh, Harford first points to significant increases in executive pay across different lines of business. Not simply confined to the much maligned bank executives, lavish income increases have been realized in varying industries ranging from senior law partners to top athletes. They note that market forces in the form of freely agreed contracts are the real reason behind such drastic increases in pay at the top. The emergence of winner take all markets, where the best entrepreneurs, be they fund managers, software developers or actors take an increasing amount of the available national income. He casts asides the emotionally attractive though incorrect notion of banker fat cats simply stealing the have nots' money based on poor corporate governance and financial greed. Harford importantly notes that market shifts have benefited the most talented among us.

Harford’s goes on to make perhaps his most profound point in the remaining portion of the piece. He closes by addressing the connection between an unfair process and a harmful outcome for society immersed in pervasive economic inequality. He notes that one feeds the other and that the more unequal a society becomes, the greater the incentive for the rich to protect their economic position above the rest using a poignant metaphor of “pulling the ladder up behind them”.

Harford notes that the plutocrat class has the ability to move their children into the best neighborhoods, universities, and has access to the best internships and jobs. The wealthy can shape national policy and media narratives through political donations and media ownership.

Harford argues that all of this feeds the notion that the more unequal our societies become, the more we all become prisoners of the supposed inequality. He goes on to note that the wealthy do all they can to prevent their children from slipping down the ladder while the poor see the best schools, colleges, and other important formative programs become increasingly unaffordable. Harford concludes that the idea of a market based society is that everyone can reach their full potential by way of a good education and hard work and that is inevitably slipping away. He notes that unfortunately, somewhere along the way this basic theory of economic ascendancy fell by the wayside.

The Economic Case for Social Mobility

In a piece by Brookings Institution Fellow, Richard Reeves, the author argues that the most overlooked aspect of reductions in social mobility is the connection to economic growth. Reeves argues that economic growth, of course, matters the most because it is the most basic way of creating jobs and improving real incomes. Furthermore, he states that growth is the primary engine of absolute social mobility ensuring that most people are better off than their parents.

The author offers new research conducted by Professor Raj Chetty and his team of researchers from Harvard and Berkeley. The researchers evaluated the link between economic growth and mobility in 741 “commuting zones” across the United States. The researchers found a strong link between growth and relative mobility, but found that variations in economic growth did not account for variations in mobility when other factors were taken into account. The difficulty that Reeves finds is determining the precise nature of the causal relationships. He notes that therefore while growth in and of itself appeared to have little effect, it is growth that creates the tax base to fuel schools and community programs, jobs that help families put food on the table and it is growth that boosts spending on community activities.

Reeves points to a 2010 OECD study that makes the case for greater social mobility as a necessary condition for growth. He compares and contrasts areas such as Des Moines and Salt Lake City where the chances of someone born into the poorest fifth of the income distribution scale making it to the richest fifth is 10 percent. As opposed to cities such as Charlotte and Atlanta where the equivalent odds are less than 5 percent.

Reeves points to three main reasons why entrenched mobility reductions are harmful to long term growth:

1)Permanent Welfare Class – Reeves notes that a sustained and semi-permanent welfare class is a drain on public resources. Money pegged for welfare programs could be put to more productive uses such as pre-K education, infrastructure and job programs. He states that the inheritance of poverty is both a fiscal drag as well as a moral stain.

2)Reductions in Labor Supply – Reeves states that the lack of opportunities for upward movement could retard the supply of available labor. He points to the rise in the number of people with low skills who are not only unemployed but are detached from the labor market altogether. Harford postulates that the retreat from work represents a loss of faith in the economy’s ability to provide upward movement.

3)Loss of Human Capital – Harford compellingly argues that low rates of upward mobility from the bottom imply a loss of human capital. Essentially, when smart yet poor children can’t escape their born into class, their skills are lost to the economy as a whole. He points to a an analysis by the Boston Consulting Group that estimated that closing the educational gap in Britain could add 4 percent a year to GDP by the year 2050.

The author closes by noting that mobility and weak rates of economic growth are typically seen as separate policy challenges. Often they are construed as economic and moral, to be evaluated on distinctly divided grounds. However he notes, this could turn out to be terribly incorrect as we need economic growth to create opportunities, but conversely we need to bolster opportunity to foster economic growth.

Conclusions

As we approach the 50th anniversary of Martin Luther King’s “ I Have a Dream Speech” and the Civil Rights Movement’s “March on Washington”, it is all the more important that we consider social mobility not only in a broad sense but within social, racial, and ethnic parameters. The latest bout of research shows that income inequality is not only increasing in the United States and among the very wealthiest in society, but that such growth is having deleterious effects on labor markets and macroeconomic conditions around the world. While much has been made about the fairness of such unequal societies, perhaps the argument should be framed on the negative economic effects that inequality begets.

As a number of developing nations such as China, Brazil, and India begin to join the ranks of the rich world over the next generation, they would be wise to implement policies that reduce concentrated wealth among a few, if for only to ensure more robust and sustained economic growth occurs. And as the US and the rest of the rich world continue to recover from the Great Recession, they too should begin to think of social mobility and inequality mitigation as a public policy imperative. The future of our economies and the dreams of the less fortunate depend on it.

Rethinking our Tax System: Consumption vs. Income

As I read through my usual blog-roll of economic websites today, I was struck by Simon Johnson's latest post at The Baseline Scenario. Johnson's post was mostly centered around what he describes as the three competing views on the necessity of raising the debt ceiling. However he ended (rather abruptly) with an interesting and little talked about idea for restructuring our tax system in the context of the debt and deficits debate - taxing consumption rather than income.

Johnson argues that if indeed we spend too much relative to revenues:

It would make sense, therefore, to find ways to tax consumption more and income less. This could be done in a way that is not regressive, that does not punish people at the lower end of the income scale. Some of the most progressive tax systems in the world are based in large part on consumption taxes.

This is, of course, the same rationale we use throughout the tax code. Tax those things which we desire less of, and reduce taxes for things we wish to encourage. These are the basic laws of incentives, something that both Democrats and Republicans alike agree drive the human decision making process. A couple of easy examples which illustrate this point include taxing carbon dioxide or reducing taxes for businesses performing research and development. Doesn't it make sense then, to tax consumption (spending) more heavily than income?

Its an interesting proposition, and one which does have some merit when carefully considered. When we think of taxing consumption, we typically think of the Value Added Tax or VAT that is common in the European Union. The VAT works as standard tax on the purchase price for the consumer. In the case of the manufacturer, they are taxed only on those items in the supply process they purchase to make the product beyond their own. For example, a refrigerator manufacturer would pay taxes only on the component parts of the refrigerator above and beyond those created at its own factory. Once the refrigerator is sold at a retail store, the consumer pays the VAT much the way he or she typically pays a sales tax at point of sale. The VAT differs however, by taxing each purchase in the arch of the supply chain. The end goal is to increase revenue whenever consumption occurs. For the consumer, theoretically, they could avoid all taxes by simply putting their paycheck directly in the bank and abstaining from any and all purchases. The French generate nearly 50% of all total revenue by way of a VAT.

So, if it follows that we spend too much relative to income and if both sides have historically structured the tax system in line with desirable behavioral incentives, the idea of a VAT, or any other tax which attempts to encourage savings and disincentivize spending, at least deserves broader discussion. While it is certainly not a short term budget fix, it does potentially address the long term structural problems which afflict the way America taxes and spends.

For a couple of differing takes on the Value Added Tax, see this piece by the Urban Institute's William Gale and another by the Cato Institute's Daniel Mitchell.

Why Democrats SHOULD Support the Lieberman/Coburn Medicare Proposal

DEMOCRATS MUST ACT TO REDUCE GOVERNMENT HEALTH CARE SPENDING

As a Democrat, it comes with no sense of ideological fervor or compelling political joy that I announce my support for the Medicare reduction proposal being offered by Senators Joseph Lieberman (I-CT) and Tom Coburn (R-OK). The Medicare Program has been a cornerstone of liberal orthodoxy and one of civilization's crown achievements of the 20th century. And so, it is with this understanding that I now make a case for the program's reduction. Given the current economic climate, which shows mountains of deficits and debt as far as the eye can see, it is time we reevaluate the Medicare Program and make it functionally sound so generations to come can count on its sustained solvency.

Sen. Lieberman and Coburn unveiled an ambitious plan this week to reduce Medicare costs by gradually increasing the eligibility age, requiring higher out of pocket costs from wealthier individuals and couples, and by restructuring Medicare's cost sharing and reimbursement policies. This plan comes on the heels of a recent Congressional Budget Office (CBO) report which showed dangerous levels of debt and deficits in the coming decades. As the CBO made clear in its latest report (http://1.usa.gov/kXMqXh), the U.S. budget deficits are "daunting". It reports that deficits in recent years are the largest, as a share of the economy, since 1945. Moreover, by the end of this year, the debt held by the public will reach 70 percent of Gross Domestic Product -- a number not seen since the end of WW II. The report goes on to state that under current law, spending on mandatory health care programs alone will increase from less than 6% of GDP today to more than 9% in 2035 and increase thereafter. Compounding the problem further, the retirement of the baby boom generation assures that government health expenditures will increase sharply as a greater portion of the population draws on Medicare, Medicaid, and Social Security. It is precisely this combination of sustained structural deficits, and an inevitable demographic shift, that portends massive financial hardship for America including the real possibility of default over the medium and long term.

The CBO goes on to state that such massive annual deficits and accumulated debts were not merely the result of the recession, but indeed deeper revenue and spending imbalances that date back some time. While tax revenues as a percentage of GDP are the lowest in 60 years, spending as a percentage of GDP is the highest in four decades. Such glaring and obvious imbalances reflect not only the gravity of the situation we currently find ourselves in, but also demonstrate the staggering incompetence of Washington to perform basic accounting when legislating.

As we consider ways to reduce annual deficits, bring down our $14.5 trillion debt, and create a stronger environment for economic growth, it is imperative we find a smart, effective, and balanced approach to reducing spending and raising revenues where possible. And let it be known, it is indeed possible. This is not to say, it will be without hardship. Whenever we extend ourselves beyond our means, the ensuing belt tightening process is always uncomfortable. But it is the exceptional nature of American greatness and a sense of unified national purpose that must ripen, one that moves beyond the petty and short-sided political brinksmanship that pervades our current political system. We can begin to put ourselves on a more sustainable financial trajectory, and it begins with policies that serve up a dose of touch medicine and legitimately address the underlying causes of accrued debt without fear of short term political reprisal. The Lieberman/Coburn Medicare Proposal (LCMP) is an important start.

For Democrats its never easy to make a case for reduced social spending, particularly when the reductions come from a beloved program like Medicare. But quite simply -- its where the MONEY is. Medicare, Medicaid, and the CHIP programs account for more than 21% of the Federal Budget. Of this, Medicare accounts for around 2/3 with approximately $452 billion spent on Medicare in 2010. Putting the growth trajectory of Medicare in perspective, in 2007 the CBO reported that Federal expenditures on Medicare and Medicaid could increase from 4% in 2007 to 19% in 2082. Such a dramatic shift would radically reorient the US economy with a disproportionate amount of national GDP funding government run health programs.

This is why we must remake the Medicare program to better align with the budgetary needs of 2011 and the demographic realities of the retirement generation. The LCMP aims to reduce Medicare spending by $600 billion over the next 10 years representing a significant step towards controlling government health care costs and immediately reducing annual deficits. The plan reduces spending by doing 3 critically important things:

1) Raise the Eligibility Requirement - According to the Centers for Disease Control, when Medicare was passed in 1965, the average lifespan for Americans was 70.2. In 2006, the average lifespan for Americans was 77.7 – an increase of 10.6%. This increase in the length of time an enrollee may be covered by Medicare has significantly raised the costs of the overall program. The LCMP would bring the eligibility requirement more in line with the original formula used for appropriating Medicare dollars.

2) Require Higher Out of Pocket Costs from Wealthy Individuals and Couples - The Lieberman/Coburn proposal will ask wealthier Americans to pay for more of their Medicare. The proposal will do this by increasing the newly created annual maximum out-of-pocket cap to higher levels for those with significant monetary means. This reflects the progressive structure of our tax system which requires that those with greater means contribute more.

3) Restructuring Cost Sharing and Reimbursement - The LCMP changes the way that costs are shared by Medicare enrollees and the government and changes the nature of Medicare reimbursement . Without getting into the arcane details of the various changes, the plan essentially requires that enrollees share an additional burden of out of pocket or up front deductibles where prudent. This is not to say, this is simply cost shifting. But rather it seeks to require higher out of pocket costs where certain groups or classes of individuals disproportionately draw on benefits relative to what they pay in. The plan also restructures reimbursement to hospitals and physicians to assure consistent and sustainable expenditures over the long term.

All of these measures, in conjunction, comprise a responsible set of policies designed to reign in the strangling costs of health care for the U.S. government. Do they require some seniors to pay more out of pocket in specific instances? The answer is unequivocally, yes. Does it mean that retirees will have to wait longer to receive Medicare benefits? Again, a definitive yes. And these are hard things to swallow for myself and the many constituencies that donate blood, sweat, and tears to Democratic causes. However, such hardship doesn't automatically assume ideological recalcitrance. Putting the program on a more sustainable footing while reducing the long term deficit and debt ensures that the very seniors Democrats wish to protect are able to draw on the program for generations to come while assuring America's economy remains strong. Of course, this measure is a spending side reduction. And true deficit and debt reduction will need to be accompanied by serious revenue increases either through the closing of loopholes and/or raising marginal tax rates on the highest tax bracket.

In closing, the LCMP is a significant first step towards re-balancing the government to meet the needs of today's economic environment. While for Democrats it is a tough pill to swallow, ensuring that Medicare is solvent makes the LCMPP the right medicine at the right time.

Welcome to The Policy Hub

Hello and welcome to the Policy Hub. The Policy Hub will serve as the new central platform from which I comment on major issues, and in particular, public policies that affect the United States and the world. After writing for a number of publications and websites throughout the years, I found it due time to create a dissemination mechanism (blog) of my own.

Beyond my personal take on matters, I hope the Policy Hub will function as a forum for informed discussion. I imagine the Policy hub as a running, robust intellectual colloquy devoid of the partisan sniping found on so many of today's political blogs and websites. My intent is to create an environment in which well reasoned and passionate debate will flourish and a civil tone will endure throughout.

At a time when the consequences of public policy are of such profound importance to this country's future, I hope this blog will contribute to a more informed citizenry over the coming months and years ahead.

-John W Karabias Jr.

In addition, I will also link important news articles and columns to the Policy Hub as appropriate. However, I do not want this site to become yet another "aggregator", and so posts will be targeted and content rich.