Mind the gap
from David Ruccio
For those (like Paul Krugman) who are floundering around trying to understand whether or not there’s a link between inequality and capitalist crises, the similarities between 2007 and the situation just before the Great Depression couldn’t be clearer.
The latest study by the Center for Budget and Policy Priorities shows that the gap between the very top and the rest of the recipients of income in the United States increased enormously in the last three decades.
The gaps in after-tax income between the richest 1 percent of Americans and the middle and poorest fifths of the country more than tripled between 1979 and 2007. . .Taken together with prior research, the new data suggest greater income concentration at the top of the income scale than at any time since 1928.
The gap in income between the wealthiest Americans and all others has grown strikingly in recent decades, the CBO data show. In 1979, when the data begin, the average after-tax incomes of the top 1 percent of households were 7.9 times higher than those of the middle fifth of households. By 2007, top incomes were 23.9 times higher than those of the middle fifth — a more than tripling of the income gap.
The gap between the top 1 percent and the poorest fifth of Americans widened even more sharply. In 1979, the incomes of the top 1 percent were 22.7 times higher than those of the bottom fifth. By 2007, top incomes were 74.6 times higher than those at the bottom — more than tripling the rich-poor gap in 28 years.
And for those who think that changing tax rates will solve the problem, the study has the answer:
The bulk of the increase in after-tax income inequality since 1979 reflects changes in pre-tax incomes. The incomes of the top 1 percent rose 141 percent from 1979 to 2007 before taxes are considered, the CBO data show. The top 1 percent’s share of before-tax income (like its share of after-tax income) more than doubled from 1979 to 2007, from 9.3 percent to 19.4 percent.
By 2007, the top 1 percent had before-tax incomes that were 24 times higher than those of the middle fifth of Americans — a share that had nearly tripled since 1979.
The rapidly rising pre-tax incomes of the wealthy help to explain the notable rise in the percentage of total tax revenue collected from these households. CBO’s data show that the share of total federal taxes paid by the top 1 percent of households rose from 25.5 percent in 2000 to 28.1 percent in 2007, the second-highest share since 1979 (only 2006 was higher).
The increase in the share of taxes paid by the wealthy is often cited erroneously as evidence that their tax burden is rising. In reality, the effective federal tax rate for the top 1 percent of households — the percentage of their income that they pay in federal taxes — declined from 33.0 percent of income in 2000 to 29.5 percent in 2007.
The top 1 percent paid a growing share of total taxes chiefly because they received a growing share of total before-tax income: 19.4 percent in 2007, compared to 17.8 percent in 2000.
So, if we want to understand the links between inequality and capitalist crises, we need to start by analyzing the growing gap in the distribution of income prior to the onset of the crises. And if we want to eliminate that gap and avoid the next crisis, we have to move beyond the class structures of capitalism that created them in the first place.
I have two criticisms:
1. You have provided some data on income inequality in 1979-2007. You’ve told us virtually nothing about income inequality in the 1920s – however, I’ll take your word for it that inequality grew during that time. You’ve made no attempt to demonstrate a causal link with the financial crisis. Your last paragraph is a bold leap from statistics to …nothing of any substance whatsoever.
2. Class structures are a largely a matter for sociologists and politicians, not economists. You are critical of a market outcome, but you suggest that class structures are to blame. As a market liberal economist, I believe that unequal outcomes are to be expected based on unequal contributions. Very unequal outcomes may be evidence of a flourishing economy with strong rewards for effort and success. If “class structures” prevent certain parts of society from contributing and earning their full potential then that’s bad for the economy: such structures should be broken down – but that may have positive, neutral or negative impact on income inequality.
It’s a typical state-interventionist’s critique – “inequality grew because governments didn’t do enough, and this caused a crisis.” It’s a great excuse for governments not to examine their role in appalling mismanagement of the economy.
A weak post.
Class structures are simply one of many factors that free market theorists have chosen to exclude from their analysis. Others include transaction costs and institutions of all sorts. This places a deeply disturbing restriction on the value of any outcomes from your models: they do not model the real economy and so have little to say about it.
Thus it is easy, perhaps facile, for you to sweep aside David’s observation that the ‘market’ produces undesirable outcomes and that those outcomes could, possibly, be a result of institutional factors.
And it is not enough for you to fall back on the old Alchian and Friedman argument concerning the realistic nature of the model inputs: people like Coase, Richardson, and Buchanan have thoroughly debunked that argument – I refer you to Maki’s excellent commentary on the ontological problems with the orthodox theory of choice you appear to propound.
The problem appears to be that theorists such as yourself have abstracted away, not just extraneous factors in your modeling, but factors which appear as central features of a functioning economy. Without them economies simply don’t work. To exclude them is an error that condemns your project to irrelevancy. In the vernacular it is an example of erroneous input producing fallacious output.
David may or may not be correct in his assertion that class is an integral part of a functioning capitalist economy and thus needs to be accounted for in the theory building process, but your assertion that his is simply a “typical state-inetrventionist critique” misses the point entirely: simple observation of real world economies tells us that they are cluttered with things like class, business processes, gender biases and so on. Those features are not the outcome of “appalling mismanagement” by governments, but appear to be independent of government activity. They are very real and contribute either positively or negatively to the outcomes that the economy produces. Models that exclude such features are thus not attempts to discover, or examine, the workings of real economies, but are self-referential exercises within a flawed, and, frankly, absurdly restricted view of what economics is about.
So to toss aside class structures as “largely a matter for sociologists and politicians” is a telling statement about the poverty within your kind of economics. Whatever it is, it is not the study of real economies.
“Thus it is easy, perhaps facile, for you to sweep aside David’s observation that the ‘market’ produces undesirable outcomes and that those outcomes could, possibly, be a result of institutional factors”
– he doesn’t “observe” this, he tells us that there is an explicit link, but he doesn’t explain what that link is. Nor, I note, do you.
When I say that “Class structures are a largely a matter for sociologists and politicians” I mean that economists don’t have the tools to break them down. I firmly believe (as I stated) that they should be broken down if and when they constrain the ability of people to produce (and be rewarded) to the fullest of their ability. Please, please let’s have the sociologists and politicians create a freer society, to all our benefit. A starting point might be to look at educational opportunities across the economy.
J – ‘unequal contributions’ means what, exactly? contributions to what? … and where’s your causal link between contributions and outcomes? You seem to imply that if you’re lazy, you’ll naturally earn less, or something of the sort. The examples are manifest where it is NOT true that the harder you work, the more money you earn. In fact, this is the norm. There is NO causal link between contributions and outcomes. Does a $1B/yr. HF manager ‘contribute’ more by end-running suitability requirements to generate an avg. 10% ROA, while skimming a 20% fee than a $40K/yr. road maintenance guy who makes it possible for the HF manager to commute to his job? Your arguments are exactly those that are undermining the economics profession. If there’s no causal link between economic theory and the relative well being of societies, then what’s the point?
Re J’s comments:
1. Possible causal link – asset bubbles are caused when people with lots of money have no place else to invest it. “Easy” fed res money isn’t enough – got to have a mal-distribution of money as well.
2. “Class structures are a largely a matter for sociologists and politicians, not economists” Mmmm … reciting dogma in defense of a research “paradigm” few people here accept as adequate won’t make it so. But if you do believe that “unequal outcomes are to be expected based on unequal contributions” there is nothing empirical, I bet, that you’d accept as counter-evidence. Or is there? Whole communities and races of people have unequal smaller shares in outcomes – in your book, that would always have to be for either 1) Those people just don’t do as much (they are not virtuous) or 2) The state is burdening them in ways that the successful are not (some other GROUP is using the State to advantage ITS members at the expense of other groups.)
So, post some research suggestions to get past the dogma. Personally, I like the kind of work Sam Bowles does, but I’m not on your team….
That’s the fundamental difference between our approaches: you consign class to sociology and politics while I see class as an important part of capitalist economy. And that’s one of the fundamental problems of contemporary mainstream economics: it overlooks class, and therefore is unable to provide an analysis of the class conditions and consequences of capitalist crises, whether of the Great Depression or now.
The fact that there was rising economic inequality before the onset of both crises is incontrovertible. The choice, then, is either to ignore or dismiss the significance of that inequality or to actually spend some time analyzing its role in creating the conditions that led to the crises.
“either to ignore or dismiss the significance of that inequality or to actually spend some time analyzing its role in creating the conditions that led to the crises”
– which is exactly what I, in the first paragraph of my reply, encourage David to do. Please, provide the analysis – don’t just present blank assertions.
Your first paragraph asks for a causal link from David. Perhaps you can reciprocate by supplying the evidence for the attack on “government mismanagement” in your last paragraph? Or is that simply a non-substantiated and ideologically based statement of no consequence? I suggest, in the spirit of your highly restricted view of economics, that we leave it to sociologists and political scientists to discuss the role of government and its efficacy in the economy.
Come to think of it: given your definition of economics, maybe they’re the only people who can discuss the economy. Economists should stick to applying mathematics to distribution and allocation models.
I just published a book titled “The deadly crisis”, Livanis edition, Athens 2010 (in greeK)exactly on the same subject. Comparison of the economic and social conditions prevailing before the two big crises, insisting on the huge inequalities in both cases, proposing the necessity of a large redistribution of world income as, otherwise, the global as well as the national economies will be unable to fuction normally and the systemic crises will become more and more frequent.
Maria Negreponti-Delivani
When some of us get to reap the increase in land value which is actually produced by all of us, this is the sort of result we can expect. So-called “capital” gains are generally the recognition of appreciation in land value, in the value of natural resources (the non-renewable kind) or the sale of privileges of various kinds (“privilege” being private laws which benefit some of us — and that benefit doesn’t come out of thin air; it is permitting some to reap what others sow).
Selling a privilege from one private entity to another, one corporation to another, one set of shareholders to another, may provide a windfall which gets taxed at a mere 15%, while labor itself is taxed at higher levels.
We ought to be seeking the root of the problem. We ought to be returning to the study of political economy (PE is the science which deals with the natural laws governing the production and distribution of wealth and services). Start with Henry George’s fine book “Progress and Poverty” which still stands up well today, 130 years after its publication. A good modern abridgment is at http://www.progressandpoverty.org/. And you’ll find other related material at henrygeorge.org, wealthandwant.com, and many other sites.
Thank you for this post. I follow local issues in my small Los Angeles suburb. I have been fairly distrubed since I started researching the local government, in the amount the top employees are paid, while at the same time the city has contracted out numerous services [landscaping, trees, custodial], and since the crisis, are on their way to even more, including sanitation. So, we take away good middle class jobs in public service, while the city manager now earns almost a quarter million a year. I see what the J commenter thinks, that this pattern is good in that it ‘rewards’ those with skill and talent, but those who point out that economic analysis must be looked at in terms of the real world are speaking more of my language; although I think there are some people who do not feel inequality is undesirable. That, I suppose, is a value judgement. Of course, like the last comment said, this is where the political arena is important; however in my local scene I have not seen any strong leaders willing to accept the complexity of issues such as contracting out of public services.