What a drag: inequality and the economy

April 27, 2016 Derek S. Hoff
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This series of Volume 3 response posts are written by former Miller Center fellows who offer their perspective on the topic of fiscal policy and how to best prepare the next president for the challenges of the first year. This series is coordinated and edited by Christy Ford Chapin, Assistant Professor of History at the University of Maryland, Baltimore County.

The essays in Volume 3: The Critical First Budget focus on the familiar headwinds that the economy and nation face. Certainly we need a carbon tax, which would increase much-needed revenue and signal to the rest of the world that Americans also intend to provide the planet with a little breathing room. Likewise, massive investments in infrastructure would improve our quality of life and pay for themselves through long-term economic growth, especially if they are financed by selling bonds to the American people.

It is also true that we need to “end magical fiscal thinking.” To bring our national debt down to healthy levels, anything other than an “all-of-the-above strategy” of spending cuts, tax increases, and entitlement reform is “cotton candy–land thinking,” as my high-school baseball coach used to put it. If the new president is a Democrat, she or he should continue to seek the “grand bargain” on spending and taxes that President Obama sought in vain. And just as it took a Republican to open relations with China, let us hope that a new Republican president would boldly lead his or her party away from the “no new taxes” mantra that became party dogma after George Herbert Walker Bush lost reelection in 1992.

Nevertheless, the essays in this series ignore the question of tax progressivity as they call for “tough choices” on fiscal policy. This reflects a decades-old blind spot when it comes to the headwinds of income and asset inequality and the aggregate benefits of modest redistribution. For example, Jared Bernstein’s fine piece labels record levels of inequality as one of the key structural problems facing the economy, but it fails to consider how mitigating inequality would not only improve the lives of many Americans but also help reduce the deficit and deepen economic growth, which is relatively easy to start but harder to sustain. In a 2011 study for the International Monetary Fund, Andrew Berg and Jonathan Ostry found that a 10 percent increase in equity “increases the expected length of a  growth spell by 50 percent.”

The new president must emphasize not only the moral and social benefits of lowering inequality, but also the macroeconomic benefits.

Therefore, any grand bargain on taxes—for example, lower corporate taxes in exchange for higher income taxes—must enhance the progressivity of the tax structure. Over the past century, progressive taxation has boosted growth and thus reduced federal debt as a percentage of the overall economy. As we return to fiscal health, however, we also must avoid the shibboleth of achieving balanced budgets at all costs—federal debt, used judiciously, has always been one of the great engines of growth. “Buy now, pay later” is an essential component of modern capitalism. It works most efficiently and broadly when the federal government—the safest creditor in the land—serves as the backbone of the credit system. As Alexander Hamilton predicted, “The national debt, if it is not excessive, will be to us a national blessing.”

In the middle decades of the twentieth century, economists, columnists, and leaders in both parties recognized that in an economy increasingly driven by domestic consumption, reducing inequality—or, put another way, putting relatively more money into the pockets of lower- and middle-class Americans—is a tried and true way to stimulate economic growth. With the decline of Keynesianism in the 1970s and 1980s and the rise of a supply-side economics, however, the emphasis switched to accommodating “job creators.” Moreover, the vogue for deregulation (which was crucial a generation ago but long ago reached diminishing macroeconomic returns), and the obsession with “innovation” and “entrepreneurship” obscured a vital fact: someone has to buy all the goods if we are going to sustain higher levels of economic growth as well as widespread prosperity.

Indeed, it’s been hard to find buyers for all those goods with stagnating wages. Despite the very real economic progress since the trough of the Great Recession, real median income in the United States has still not returned to its 1999 peak. Over the longer term, consider if there had not been a great surge in inequality after 1980. According to the Economic Policy Institute, by 2007, “the average income of the middle 60 percent of American households … would have been $94,310, roughly 23 percent (nearly $18,000) higher.” Especially because lower- and middle-class families have a higher propensity to spend than wealthier ones, $18,000 translates into a lot of children’s toys, automobiles, restaurant meals, and vacations.

The past few years have actually seen the emergence of a bipartisan willingness to address inequality. Left- and right-leaning economists (and many CEOs, for that matter) generally agree that less inequality would improve economic growth. Yet politicians have lagged behind. Donald Trump and Ted Cruz claim that free trade exacerbates inequality by shipping jobs out of the country, but they don’t discuss how social spending on the poor would increase mall traffic. Bernie Sanders’s webpage argues that the “issue of wealth and income inequality is the great moral issue of our time” but nowhere explains that increasing incomes would also help the profits of the corporations he excoriates. Secretary Clinton often emphasizes that “We must raise incomes for hardworking Americans so they can afford a middle-class life” without explaining that higher incomes for these Americans would benefit all of us.

In contrast, the new president should use the bully pulpit to channel his or her inner President Eisenhower, who understood that “no prosperity for one economic group is permanently possible except as all groups prosper.” With this approach, he or she may find surprisingly ripe opportunities for compromise. An emphasis on inequality would obviously placate Democrats, who have made it their key (moral) issue, while Republicans are more likely to embrace new distributional policies when they are accurately positioned as economic growth engines.

Obviously our poisonous politics promises an uphill battle. Obamacare was in part an effort to reduce inequality (even though the administration unwisely failed to sell it as much), but Republicans’ hatred for the reforms spawned charges that they have exacerbated inequality. And any effort to reduce inequality by shoring up unions will cut to the heart of our ideological tug-of-war.

Nonetheless, the new president should use the critical first year to reframe inequality as the crucial macroeconomic issue that it is. He or she should call for responsible reforms such as a modest increase in the minimum wage, enhanced progressivity of the tax system (as opposed to simply “taxing the rich”), student debt relief, and a reduction in Social Security taxes for working-class Americans. Steps like these would begin to reverse our record levels of inequality. They would also buy us what we require to solve all the other problems addressed in this series: more consumer spending, lower unemployment, productivity increases, and widespread prosperity. Ending “magical fiscal thinking” not only means making some tough choices but also means recognizing again the macroeconomic virtues of progressive taxation and social spending.

Derek S. Hoff is an Associate Professor of History, Lecturer, at the University of Utah. He is the author of The State and the Stork: The Population Debate and Policy Making in US History (University of Chicago Press, 2012), winner of the Pacific Coast Branch of the American Historical Association’s 2013 PCB award for best first book. With John Fliter, he is also the author of Fighting Foreclosure: The Blaisdell Case, the Contract Clause, and the Great Depression (University Press of Kansas, 2012).