Political Parties, Income Inequality and Public Policy – 1A

Political Parties, Income Inequality and Public Policy – 1A DON’T WRITE DOWN ANY OF THE MATERIAL OVER THE NEXT 220 SLIDES. ALL OF IT IS IN THE COURSEPACK. JUST LISTEN TO THE DISCUSSION!

Political Parties, Income Inequality and Public Policy – 1B I. Policy Orientation of This Discussion A. Since the U.S. has the weakest social safety net and highest level of income inequality of any wealthy democracy the obvious comparison is to the other wealthy democracy that have stronger social safety nets and less income inequality than we do.

Political Parties, Income Inequality and Public Policy – 1C B. I know that isn’t “comforting.” We naturally want to think of our nation as “best” on all criteria. Realistically, this is impossible. A nation that has the lowest taxes won’t have the least inequality. The United States ranks high on some social programs (e.g., higher education) but not on income security and reducing inequality.

Political Parties, Income Inequality and Public Policy – 1D C. If I were teaching this class in a nation with a very strong social safety net and much less income inequality (e.g., Sweden), I would compare it to nations that have less strong social safety nets and greater income inequality (e.g., Canada and Great Britain with moderately strong social safety nets and the U.S. with a very social safety net).

Political Parties, Income Inequality and Public Policy – 1E D. Therefore, while I will touch on proposals to weaken the U.S. safety net, the vast bulk of the discussion ahead will focus on what other wealthy democracies do to reduce income equality, how well these policies work and what the U.S. could do in this regard while still preserving our freedoms and improving our political system.

Political Parties, Income Inequality and Public Policy – 2 I. Incentives of the Two Major Political Parties A. Unemployment has a large impact which disproportionately falls on low and middle-income voters. 1. Nonmonetary costs of unemployment

Political Parties, Income Inequality and Public Policy – 3 B. The poorest 80% of American households are relatively unaffected by inflation. However, inflation has a greater adverse impact on the richest 20% of American households.

Political Parties, Income Inequality and Public Policy – 4 C. Marginal Substitution Rate Democrats Independents Republicans .90 2.0 1.5

Macroeconomic Theory - 1 I. Macroeconomic Theory A. Neoclassical 1. The free market was assumed to yield full employment (i.e., no/low unemployment) and to grow without limitation and to correct any imbalances that might develop

Macroeconomic Theory - 2 2. Since the higher one’s income the greater the percentage of their income they save/invest and the smaller percentage of their income they spend, the greater the share of income the rich possessed the greater the investment, and hence, economic innovation/growth.

Macroeconomic Theory - 3 3. By this view, a major goal of macroeconomic policy was to keep the costs of production low (e.g., low wages – through the absence of labor unions, a low minimum wage, low taxes, little government regulation of business, etc.) in order to increase profits and investment. 4. Couldn’t explain the Great Depression

Macroeconomic Theory - 4 B. Keynesianism 1. If the non-rich lacked sufficient money to purchase goods, the economy would not reach its’ full potential because businessmen would not open new business, or expand current ones, if they felt they could not sell the resulting products or services.

Macroeconomic Theory - 5 2. This meant that middle and lower- income groups, who spend a greater share of their income than upper income groups, need to have a significant share of the national income (through a minimum wage, labor unions, etc.).

Macroeconomic Theory - 6 3. If economic demand was insufficient, Keynes argued that the government should increase its’ spending and be willing to run large deficits (i.e., spend more money than it receives in taxes). 4. If both inflation and unemployment are high (late 1970s & early 1980s) – trouble.

Macroeconomic Theory – 7A C. The aforementioned difficulties of Keynesian economics, plus the renewed political strength of a Republican Party whose ideology was similar to neoclassical economics, resulted in a rebirth of neoclassical economics under several different names.

Macroeconomic Theory – 7B D.Corporate profits were 25% to 30% higher at the official end of the Great Recession than they were before it started (2007). Meanwhile, wages as a share of national income fell to 58%. That’s the lowest wage share had been since it began to be recorded after World War II.

Macroeconomic Theory – 7C If wages were at their postwar (World War II) average of 63%, U.S. workers would earn an extra $740 (billion) this year (2012) or about $5,000 per worker. That’s a lot of consuming power.”

Macroeconomic Theory - 8 D. Supply-Side Economics - Ronald Reagan 1981 & Newt Gingrich 2012 1. Like Neoclassical Economics – much more concerned with reducing impediments to supply (high labor costs, taxes and regulations) than in stimulating demand.

Macroeconomic Theory - 9 2. Tax Cuts DON’T pay for themselves. 3. Gregory Mankiw – supply-side economics devised by “charlatans and cranks” E. Relationship between the philosophy/self-interest of both major political parties and the economic theory they use.

Political Parties, Income Inequality and Public Policy – 5 D.Recent research by political scientists shows that all income groups up through the 95th percentile (i.e., all but the richest 5% of households – today those earning about $200,000, or less, per year) gain under the Democrats relative to the Republicans. However, the poor gain at a greater rate under the Democrats.

Political Parties, Income Inequality and Public Policy – 6 E. Our Current Situation 1. Tremendous loss of consumer demand due to the collapse of real estate 2. Government needs to replace this lost demand – i.e., NOT cutback

Political Parties, Income Inequality and Public Policy – 7 3. 300 billion dollars of stimulus will reduce the unemployment rate by 1%. The Obama Stimulus Plan was approximately 775 billion dollars spread over two years. Given the composition of the Obama Stimulus Plan (e.g., tax cuts – which have low stimulative value) it is equivalent to about 510 billion dollars of stimulus rather than 775 billion dollars.

Political Parties, Income Inequality and Public Policy – 8 This means that, due to the Obama Stimulus Plan, the unemployment rate, while high, is about 1.7 percentage points lower that it would have been without the plan (510/300 = 1.7).

Political Parties, Income Inequality and Public Policy – 9 4. Many economists think that the federal government needs to do two things to improve the economy: (1) provide a larger stimulus than the Obama Stimulus Plan; and (2) more strongly regulate the financial markets (to avoid the bad loans that precipitated our current problems). This is difficult for the Republican Party: their ideology conceives of government as “the problem,” not “the solution.”

Political Parties, Income Inequality and Public Policy – 10 Income Inequality in Wealthy Democracies in the Mid-1980s – Percentage Distribution Japan Sweden U.S. Richest 20% 37.5% 41.7% 42.0% Poorest 20% 8.7% 7.4% 5.0% 2009 >>> 3.9%

Political Parties, Income Inequality and Public Policy: 11A Richest RichestRichest Year 10% 1% ½ of 1% 1920 39.0% 14.8% 11.1% 1970 32.6% 9.0% 6.3% 2008 48.2% 21.0% 16.9% SHARES FOR THE RICHEST 1% AND ½ OF 1% ARE ABOUT TWICE AS HIGH AS IN EUROPE

Political Parties, Income Inequality and Public Policy: 11B U.C. Berkeley Economist Emmanuel Saez’s comments on the reasons for increase income inequality in the U.S.: “…The changes in income concentration are just too abrupt and too closely correlated with policy developments for the standard story about pay equaling productivity to hold everywhere.

Political Parties, Income Inequality and Public Policy: 11C Between 1971 and 2007, U.S. hourly wages, adjusted for inflation, rose by 4%. (That’s not 4% a year; it’s 4% over 36 years!) during those same decades, productivity increased by 99% - that is, it nearly doubled. In other words, the average worker’s productivity rose 25 times more than his pay. Los Angeles Times, May 14, 2013, page A11).

Political Parties, Income Inequality and Public Policy: 11D That is, if pay is equal to productivity, you would think that deep economic changes in skills would evolve slowly and make a gradual difference in the distribution—but what we see in the data are very abrupt changes. Basically all western countries had very high levels of income concentration up to the first decades of the 20th century

Political Parties, Income Inequality and Public Policy: 11E and then income concentration fell dramatically in most western countries following the historical narrative of each country. For example, in the United States the Great Depression followed by the New Deal and then World War II. And I could go on with other countries.

Political Parties, Income Inequality and Public Policy: 11F Symmetrically, the reversal—that is, the surge in income concentration in some but not all countries—follows political developments closely. You see the highest increases in income concentration in countries such as the United States and the United Kingdom (Great Britain),

Political Parties, Income Inequality and Public Policy: 11G following precisely what has been called the Reagan (Republican President from 1981-1988) and Thatcher (Conservative Party Prime Minister of Great Britain from 1979-1990) revolutions: deregulation, cuts in top tax rates, and policy changes that favored upper-income brackets.

Political Parties, Income Inequality and Public Policy: 11H You don’t see nearly as much of an increase in income concentration in countries such as Japan, Germany, or France, which haven’t gone through such sharp, drastic policy changes.

Political Parties, Income Inequality and Public Policy: 11I Apportioning the 12 percentage Increase in the Share of Income Going to the Top 1% - 1976-2008 (8.9% to 20.9%) Tax Reductions – 45% Political Polarization – 28% Unexplained - 26% Conservative tax changes and the increased conservatism of the Republican Party have had a large impact on inequality.

Political Parties, Income Inequality and Public Policy – 12 If you include government transfers and subtract taxes from 1979 to 2006, the richest 1% of households had a 256% increase income while middle-income households (40th-60th percentiles) had a 21% increase and low-income households (1st-20th percentiles) only an 11% increase. In the United States today, the richest 1% of households have over 1.5 times as much income as the entire poorest 40% of households combined.

Changes in California - 1 In California, between 1987 and 2009, more than 33% of the income gains went to the richest 1% of Californians, and almost 75% went to the richest 10% while the bottom 90% received just over 25% of the growth in incomes. During the last two decades, the average income of the richest 1% of Californians increased by more than 50%,

Changes in California - 2 after adjusting for inflation, while the average income of the middle fifth (i.e., the 40th – 60th percentiles) decreased by 15%. In 2009, the average income of the richest 1% of Californians was $1.2 million – more than 30 times that of Californians in the middle fifth. California’s income gap is wider than most other states.

Political Parties, Income Inequality and Public Policy – 13 Americans in the poorest 10% had a living standard 22% below low-income Finns, 24% below low- income Dutch and 15% below low-income Italians. However, the wealthiest 10% of Americans had incomes 50% higher than the wealthiest 10% in the other OECD nations (Great Britain, France, Canada, Japan, Australia and New Zealand).

Political Parties, Income Inequality and Public Policy -14 One fundamental reason the poor in the U.S. have a lower standard of living than in several other nations is that, after taxes, the U.S. transfers only about one-third the percentage of income to the poorest 20% of households (1.5%) as does the average (4.2%) of the world’s wealthy democracies.

Analysis from the World Bank Publication, “Social Safety Nets and Target Assistance: Lessons from the European Experience,” Chris de Neubourg, et. al. While the average American has a higher living standard than the average resident in the other countries, this does not hold for the entire spectrum of the income distribution. Despite the higher aggregate and average standard of living in the United States, people in the lower deciles of the income distribution are far worse off in US than poorer persons or households in Europe, if compared to the median income of their own country. (p. 5)

Political Parties, Income Inequality and Public Policy – 15 The median Swedish family has a living standard roughly comparable with that of the median U.S. family: wages are, if anything, higher in Sweden, and a higher tax burden is offset by public provision of health care and generally better public services. As you move further down the income distribution, Swedish living standards are much higher than in the U.S.: at the 10th percentile (poorer than 90% of the population) the Swedish living standard is 60% higher than in the U.S.

Political Parties, Income Inequality and Public Policy – 16 In this light it is worth noting that approximately 38% of the benefits from the Bush Tax Cuts go to the richest 1% of the households (i.e., the same households who have been receiving a much higher share of personal income over the past 40 years). The richest 1% of U.S. households receive more money from the Bush Tax Cuts than the entire poorest 70% of U.S. households combined (roughly households with annual incomes of about $90,000 or less).

Political Parties, Income Inequality and Public Policy – 17 Wealth is a storehouse of assets: trusts, stocks, bonds, etc. whereas income is what you live on over a short period – say, a year. As the following statistics will make clear: Wealth is even more unequally distributed than income. In the United States the wealthiest 1% of households have over 33% of the national wealth while the poorest 50% of households have approximately 7% of the national wealth.

Political Parties, Income Inequality and Public Policy – 18 A rather large amount of research tells us the following: (1) Americans vastly overestimate their chances of becoming rich; (2) vastly underestimate the degree of income inequality (i.e., do not think the wealthy are as wealthy as the actually are); and (3) have a difficult time connecting public policy to economic outcomes (e.g., not that many see the Bush Tax Cuts as a tremendous redistribution to the wealthy).

Political Parties, Income Inequality and Public Policy – 19 Currently, wealth in America is distributed as follows: the richest 20% of households (percentiles 81-100) have approximately 84% of the wealth, the next richest 20% (i.e., percentiles 61-80) have approximately 11%, the middle quintile (i.e., percentiles 41-60) have approximately 4%, the next poorest 20% (i.e., percentiles 21-40) have approximately .2% (two tenths of 1%) and the poorest quintile (i.e., percentiles 1-20) have approximately .1% (one tenth of 1%).

Political Parties, Income Inequality and Public Policy – 20 Americans do desire a less unequal distribution of wealth. Recently, two scholars tried an interesting experiment. Not being told what nations had what distribution of wealth, Americans were offered three choices: (1) the current American distribution of wealth;

Political Parties, Income Inequality and Public Policy – 21 (2) perfect equality (i.e., each quintile getting an equal – 20% - share of the wealth); or (3) the current Swedish distribution of wealth (the richest 20% of households approximately 36% of the wealth, the next richest 20% approximately 21% of the wealth, the middle quintile approximately 18% of the wealth, the next poorest 20% approximately 15% of the wealth and the poorest quintile approximately 11% of the wealth).

Political Parties, Income Inequality and Public Policy – 22 The results were as follows: 47% chose Sweden’s distribution, 43% chose perfect equality while only 10% chose the current American distribution. Additionally, American’s are less satisfied with their lives than citizens in a number of European countries that have less per capita income, but much stronger safety nets/less income inequality than the U.S.

Political Parties, Income Inequality and Public Policy–22A I.How Should We Measure “Well-Being”? A. If someone spends $1,000 on diabetes medicine it counts as part of GDP. However, wouldn’t the same person have a better life if they didn’t have diabetes but spent $750 on a computer? Since $1,000 is greater than $750, in this example GDP would be higher for diabetes oriented spending than for buying a computer.

Political Parties, Income Inequality and Public Policy–22B B.GDP (Gross Domestic Product) only measures the monetary value of the economy. It tells nothing about how the money is used or any nonmonetary value (national health, the functioning of the political system, job security and measures of community well-being).

Political Parties, Income Inequality and Public Policy – 1A