The Agenda

The Joint Economic Committee’s Democratic Staff on Inequality

Alas, it seems that Annie Lowrey is more persuasive than yours truly: a number of congressional Democrats are planning to back a millionaire’s tax bracket:

TPM has confirmed the rumors with a House aide: “Some Democrats want to create a tax bracket for people earning $1 million and up, a shift that could give the party the rhetorical edge this fall.” (I will update as soon as I know who is proposing what.)

And there is some movement on the Senate side as well. Sen. Jim Webb’s (D-Va.) office confirmed to me that the senator, who previously said he does not support raising taxes for households making more than $250,000, might support raising taxes for households earning some larger amount. (His office did not have any more details than that.)

We’ve discussed the millionaire’s bracket before, so I don’t want to belabor the point. I just can’t help myself.

Annie cites a report issued by the Democrat staffers on the Joint Economic Committee that makes a number of conceptual leaps:

First, they put the blame for growing American income inequality on George W. Bush’s shoulders, arguing, “Middle‐class incomes stagnated under President Bush. During the recovery of the 1990s under President Clinton, middle‐class incomes grew at a healthy pace. However, during the jobless recovery of the 2000s under President Bush, that trend reversed course. Middle‐class incomes continued to fall well into the recovery, and never regained their 2001 high.”

It is also true that the Clinton years saw rare restraint in the growth of non-cash compensation, which many attribute to the proliferation of managed care. When we factor in non-cash compensation, the picture looks somewhat different. Moreover, the productivity growth experienced from 1995 to 2000 was materially different from the productivity growth experienced from 2003 to 2006. Organizational capital played a larger role, and this phenomenon doesn’t appear to be an artifact of policy.

Also, the JEC staffers are basing their analysis on middle income households. The composition of middle income households has been changing. A large and growing number are single-person and thus single-earner households. As a result, the share of population varies considerably across income quintiles. In 2007, the top quintile contained 25 percent of the population, the fourth quintile contained 22.8 percent, the middle quintile contained 20.3 percent, the second quintile contained 17.5 percent, and the bottom quintile contained 14.4 percent. Another way of looking at this is that in the 2007 the aggregate number of earners in the top quintile was 48,717,000 in the top quintile and 42,434,000 in the fourth quintile while there were only 33,317,000 in the middle quintile, 22,638,000 in the second, and 11,392,000 in the bottom. This doesn’t change the fact that the top 1,000,000 earners have made extraordinary gains, which is why the failure of the JEC to correct their analysis for household size is so disappointing.

Terry Fitzgerald of the Minnesota Fed has explored this issue in detail:

Average household sizedeclined substantially during the past 30 years, so household income is being spread across fewer people. The mix of household types—married versus single, young versus old—also changed considerably, so the “median household” in 2006 looks quite different from the “median household” in 1976. Finally, the measure of income used by the Census Bureau to compute household income excludes some rapidly growing sources of income.

The goal of this article is to examine the income gains made by middle American households over the past 30 years. The analysis requires a careful look at data, with the payoff being a more comprehensive picture of income gains by middle-income people. The analysis will also clarify how the modest growth in median household income is consistent with the large increase in income per person.

The main finding is that—after adjusting the Census Bureau data for three key factors—inflation-adjusted median household income for most household types increased by roughly 44 percent to 62 percent from 1976 to 2006. The only household types with substantially lower growth were “working-age male householder without spouse present” and “male householder with children but without spouse,” but these types constitute just 10 percent of all households. Household income inequality increased notably over this period; nonetheless, middle American households had substantial income gains.

As Fitzgerald explains, the sharp decline in married-couple households is key:

Married-couple households have much higher incomes than other household types, and there has been a large decline in married-couple households. This decline depresses overall median income growth. As an extreme but illustrative example, consider what would happen if one-half of all married couples were to divorce next year. Median household income would plummet as each higher-income married-couple household is dissolved into two lower-income households—the same income is spread across more households. This would be true even if wages increased substantially for all workers, so that household types had large income gains. (See the table below for detailed results used throughout this article.)

Increasing inequality has undoubtedly played a role. But it’s clear that the changing mix of households has been very important. These numbers weren’t dramatically different in the 1990s, yet the trend towards assortative mating has strengthened over time. So the JEC staffers haven’t given us the most useful portrait of inequality. Indeed, they make a number of outlandish claims, e.g.:

Because of those tax policy shifts, the Clinton administration ushered in a period of income growth for families across the income distribution (See Figure 7). The economic boom of the1990s impacted all Americans, regardless of their position in the income distribution.

That is, the staffers are suggesting that tax policy shifts were responsible for income growth. I’d suggest that productivity gains in the service sector and restraint in the growth of non-cash compensation were responsible for income growth, and that tax policy shifts contributed to reducing the federal budget deficit.

In part, this could reflect the fact that the JEC intends to advance a political message rather than offer an accurate portrait of how living standards have changed.

And [the staffers] argue for many causes — a primary one being financial deregulation. This both helped middle-class families become indebted, and high-income earners to find investment products to take even bigger shares of the gains, the JEC writes: “The everyday consequence of stagnant middle‐class paychecks is the creation of demand for credit in order to make ends meet – and to keep up with the Joneses, as the rich get richer. Former Chief Economist of the International Monetary Fund Raghuram Rajan argues that, instead of attacking the root causes of rising income inequality in the U.S., policymakers made access to credit much easier for low‐income households in order to support their spending.”

The conceptual leaps here should be obvious. When Raghuram Rajan made his case in Fault Lines, he offered a subtler, more plausible take. My Economics 21 colleague Arpit Gupta offered a critique of Rajan in this post:

Rajan begins by observing that unequal access to education led to stagnant wages. His new and controversial spin is that politicians in turn responded to stagnant wages through an unprecedented period of populist credit expansion. By loosening the credit spigot at the government-backed mortgage agencies Fannie Mac and Freddie Mae, politicians of both parties were able to ensure that their constituents—though they did not see rising wages—could at least purchase larger homes.

This is a plausible and consistent narrative, and undeniably has an element of truth to it. Political efforts to extend the supply of credit have a long pedigree in American politics, from the deregulation of banking in the early 20th century, to the surge in thrift lending, to the present day. Yet it is exactly the omnipresence of populist lending which calls into doubt the causal role of inequality in this story. In the 1996 election, Dole ran on a platform of capital gains cuts, and Clinton ultimately drastically increased the exemption for capital gains tax for housing investment (a reform Vernon Smith blames for part of the subsequent housing bubble). As Rajan notes, Clinton also increased the share of government agency loans going to low-income borrowers. Yet this growth in populist lending happened during the most durable period of income growth in the last thirty years. Even if stagnant wages may drive politicians decisions on populist lending to an extent; it’s not clear that these populist pressures would suddenly disappear in the presence of rising wages. [Emphasis added.]

As Arpit goes on to note, however, stagnant wage incomes do seem to have had a relationship to consumer indebtedness:

As the above graph shows, growth in consumption was actually far lower in this period than in the past. The difference is that this decade saw a large drop in the growth of wage income, to the point that growth in consumption outpaced income. Rising levels of consumer debt accounted for this difference.

But again, galloping increases in the value of non-cash compensation is undoubtedly an important part of this picture, and arguably a case for market-oriented reform of health insurance. By focusing on stagnant wage income rather than increasing overall compensation, the JEC staffers create a potentially misleading impression. 

That said, it does seem clear that we could have used capital and leverage requirements, and this was a failure of both the Clinton and Bush administrations. But the robust growth of the Clinton years rested in no small part on a tech bubble and financial bubbles that swelled government revenues, and temporarily reduced the pressure to reform entitlement spending. The banking deregulation of the Clinton era appeared to be wise course of action. This was clearly a serious bipartisan policy failure, and it should be acknowledged as such. Yet the JEC staffers don’t dwell on the failure of the Clinton administration, for reasons that should be obvious and that should encourage us to take their analysis with a grain of salt.

Annie excerpts a chart that tracks changes in the top marginal income tax rate and increases in “the wealthiest American’s share of total income,” i.e., the top 0.1 percent. Wealthy Americans have been earning more as marginal tax rates have declined. This is hardly surprising. Indeed, that was the intention of the high-income rate reductions. It’s also important to note that tax rates have an impact on reported income.

The underlying problem isn’t the rise in income inequality per se. Rather, it is the fact that we haven’t seen sufficiently robust wage growth for middle-earners and low-earners. Reducing cost inflation in medical care is one good strategy for addressing this problem. But how would encouraging high-earners to earn less address this problem? Indeed, it is at least possible that it would make the problem worse, as high-earners consume high-touch personal services that employ large numbers of middle-earners and low-earners. 

This, of course, doesn’t address the “Keeping Up with the Joneses” concept. It is at least possible that bringing high-earners down a peg or two would alleviate the psychological burdens borne by middle-earners engaged in positional competition. The trouble is that in the long-run the United States might find itself surpassed by countries that are less susceptible to status anxieties of this kind, thus undermining wealth-creating talent agglomerations that are a driver of growth. One wonders if there are more constructive ways to address status anxiety than pursuing growth-dampening tax policies, e.g., school choice could reduce positional competition for access to high-quality public school districts.  

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