Income Inequality: Way High by Historical Standards

The Washington Post's economics columnist Steven Pearlstein has an article and graph in today's newspaper showing how high income inequality has gotten in America.

Here's his "Percentage of Americans' pretax income going to top 10% of households" graph:

Before the recent economic downturn, fully 50% of the (pretax) income received from private (non-governmental) sources went to the top "decile" (10 percent) of earners. The bottom nine deciles (90 percent) of earners were left to split the remaining half of total pretax income.

SInce the downturn, the share of the top 10 percent has edged downward. But it still receives fully 48 percent of private pretax income!

The last time the slice of the pie going to the richest 10 percent was in the same high range as it is today was around 1929 — just about the time a stock market crash led to the Great Depression!

From the end of World War II until about 1976, according to the graph, the top 10 percent took home only about one-third of private pretax income. Pearlstein calls these "the 'golden years' for the U.S. economy."

As you go higher up the income ladder, things get more and more skewed. "By 2007, the top 1 percent of households took home 23 percent of the national income," writes Pearlstein. That's almost a quarter of national income, going to just 1 out of 100 American households.

That figure was attained after "a 15-year run in which [the top 1 percent] captured more than half — yes, you read that right, more than half — of the country's economic growth." Translation: from 1992 to 2007, as gross domestic product and national income rose mightily, the bottom 99 percent of households took home less than half of the overall increase.

Here's a chart showing the inequailty in income in a different way:

(It's from this web page. Scroll down about halfway to the "August 3, 2008--Growing Inequality in Income" entry.)

In this second chart we see that as of 2006, the bottom 90 percent of earners had an income level that was, on average, $30,173 — down from $31,437 in 2000. Meanwhile, the average family in the "top 10% to 5%" range of incomes took home $117,688 in '06. There were almost 7.5 million such families, compared with over 133 million in the bottom 90 percent.

Then, once you get into the "top 5% to 1%" range and above, the income disparity grows by leaps and bounds. There were, for example, fewer than 15,000 families in the "top 0.01%" in 2006, each taking home an average income of over $17 million dollars!

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Pearlstein adds:

Because so much of the nation's income is siphoned off to the super-rich ... a struggling middle class trying to maintain its standard of living [must] take on more and more debt. ... [Meanwhile,] in order to respond to the stagnant incomes of their constituents, politicians took a number of steps to keep the "American Dream" within reach, including subsidization of home mortgages and college loans [and] politicians also were quick to cut taxes for the middle class even when it meant running up the national debt to pay for popular entitlement programs and government services.

See the common thread? When income inequality is high, there are irresistable pressures both at the national and at the family level to take on huge amounts of debt.

In an earlier post, I showed this graph:


It illustrates the fact that the percentage of our gross domestic product represented by the size of our national debt (i.e., the total amount of debt owed by the federal government to those holding its bonds and other debt instruments) has never been higher in our nation's history ... with the single exception of the years immediately following World War II.

The national debt represents the accumulation over time of our annual federal budgetary deficits. Unless we quickly rein our annual federal deficit in by means of a series of difficult political choices, this ratio of national debt to GDP will (according to the Congressional Budget Office's "alternative baseline scenario") soar way past the sky-high post-WWII level, sometime during the 2020s.

Even if we make the tough political choices now, the CBO's rosiest scenario — the "extended baseline scenario" — has the debt-to-GDP ratio increasing from today's already high-by-historical-standards level.

Pearlstein also points out that the "polarization of income distribution in the United States coincides with a polarization of the political process. Just as income inequality has eroded any sense that we are all in this together, it has also eroded the political consensus necessary for effective government."

Translation: don't hold your breath until the politics-as-usual we see in Washington and around the country today steps up to the tough political choices that will make the CBO's disturbing "extended baseline scenario" come true, as opposed to the truly scary "alternative baseline scenario."

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We await with bated breath, meanwhile, the report forthcoming by December 1 from the National Commission on Fiscal Responsibility and Reform. Appointed in early 2010 by President Obama and headed by Alan K. Simpson, a former Republican senator from Wyoming, and Erskine Bowles, White House chief of staff under our last Democratic president, Bill Clinton, this commission (see its website) is ...

... charged with identifying policies to improve the fiscal situation in the medium term and to achieve fiscal sustainability over the long run. Specifically, the Commission shall propose recommendations designed to balance the budget, excluding interest payments on the debt, by 2015. In addition, the Commission shall propose recommendations that meaningfully improve the long-run fiscal outlook, including changes to address the growth of entitlement spending and the gap between the projected revenues and expenditures of the Federal Government.

The recommendations of the commission will be non-binding on Congress or the president. It is just barely possible, however, that they would be submitted to Congress for an up-or-down vote, without allowing Congress the ability to pick and choose among the recommendations. If that even succeeds, it's unclear how the package would be translated into actual legislation and passed as such, with the president's eventual signature.

Even so, the commission approach may be our best hope to rein in deficits and balance the federal budget any time soon. Doing so is the only way to get the debt-to-GDP ratio back under control, barring stunning GDP growth which is not likely to happen.

Meanwhile, we need to address income inequality. There's no way we will be able to rein in the federal largesse aimed by politicans at "keeping the American Dream within reach" of the broad middle class if a fairer distribution of income is not somehow brought about, thus reducing the pressure on the politicians to keep the federal money tap flowing, deficits be damned.

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The figures I gave earlier were for pretax income. We use a "progressive" income tax in the U.S. to charge the well-to-do a higher percentage of their income, based on their tax bracket. Hence, after-tax income distribution is not quite as skewed as pretax income.

You can check out an easy-to-use tax calculator here to see how tax brackets work. Try it! Enter your filing status (single, married filing jointly, etc.) and the tax year you are curious about to see what the tax brackets looked like in that year.

Now set the filing status to married filing jointly, the most common status for the proverbial "family of four." Advance the tax year in successive steps from 2000 through 2003. Notice how the tax rates for the top three brackets suddenly dropped in 2003.

By 2003, taxpayers in the third bracket from the top — with taxable incomes of at least $114,650 — were taxed at 28 percent of the taxable income above the lower edge of their bracket. The same bracket was taxed at 30 percent the previous year. Meanwhile, the two top brackets went from 35 percent and 38.6 percent to 33 and 35 percent, respectively. Those changes reflected the "Bush tax cuts."

According to Steven Pearlstein's article, households that take home more than $110,000 a year (in today's dollars) constitute the top 10 percent of our population income-wise. But in the 2010 tax year, as the tax brackets worksheet shows, the bottom edge of tax bracket #3 is fully $137,300. That means that a huge slice of America's top 10 percent income-wise currently gets taxed in the fourth bracket down, at a maximum rate of only 25 percent!

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The Bush tax cuts will expire at the beginning of 2011 unless Congress steps in. It is not entirely clear which earlier year's brackets would be reverted to, or whether the dollar amounts associated with those reverted brackets would be raised to offset inflation. Yet if one assumes the 2001 brackets would come back into force, possibly with inflation-adjusted dollar amounts, the worksheet suggests that the three (no longer four) tax brackets embracing roughly the top decile of incomes would have to pay taxes at maximum rates of 30.5, 35.5, and 39.1 percent. Thus, everyone in the top decile would pay taxes at higher maximum rates than now.

We hear that Democrats want to let the Bush cuts expire for the most well-off while keeping them in force for the vast middle class. But we also hear that they would raise taxes (by letting cuts lapse) on only the top two brackets, not the top three, as would be needed to pull in extra tax dollars from the over 13 million households in the top decile but below (roughly) the top 1 percent.

In my opinion, we will instead need to raise taxes on the entirety of the top decile if we want to be able to afford not raising them on those in the bottom 9 deciles!

Why doesn't it feel like an economic recovery?

Today's The Washington Post features "Why it doesn't feel like a recovery," a revealing graph accompanied by a short article. They are presented interactively here.

Here's the crucial graph itself:



You'll need to view the online presentation for full details. Here's a summary:

Our economy's "size" is given by its gross domestic product: how much valuable "stuff" gets produced by Americans each year. The potential GDP grows as the potential size of the workforce does. Meanwhile, improved techniques of production are usually expected to increase the "productivity" of workers, so they can make ever more "stuff" per hour on the job than they otherwise could. That's why there is an almost straight diagonal line in the graph that steadily ascends as the years roll by, reflecting a GDP that potentially grows at a nearly constant rate.

But the actual GDP is currently under — less than — that potential GDP. That's the area shown in red on the graph.

Actual GDP can sometimes exceed the line shown as potential GDP, during short, unsustainable bursts of economic activity. The areas shown in blue — the bigger of the two that are shown comes around the years 2000-2001 — reflect that.

The key point is that the vast shortfall between actual and potential GDP that we see today is what is wrong with the economy. Too many people without jobs, too much industrial machinery idle, too many office buildings under full capacity — it all adds up to a woefully underperforming economy.

This is so even though actual GDP stopped dropping and began heading upward in the middle of last year, 2009. The graph shows that fact ... and it is what economists mean when they say that the recession officially ended then. We are no longer in recession because we have positive GDP growth now; that's all that means. It does not mean the economy is in good shape.

What would it take to get the economy back to the level where actual GDP matches potential GDP, so that everyone who is not simply "between jobs" actually has a job, factories are all humming, office buildings are full, retail stores are not empty, etc.?

As the graph shows, we can get back to that point as soon as 2012 — in time for the next presidential election — if only actual GDP could rise at the rate of 6 percent per year between now and then. 6 percent growth would so far outstrip the more modest expected rise in potential GDP, that all but the roughly 5 percent of workers who are typically "between jobs" at any given moment are actually working.

However, if actual GDP growth takes place at a more modest rate of 3 percent a year, it will take us until 2020 to squeeze all the red out of the graph.

And it gets worse. If the rate of actual GDP growth tops out at only 2 percent a year into the foreseeable future, we will never squeeze all the red out. In fact, in that scenario the unemployment rate, which is now at an unacceptable 9.7 percent, would rise to fully 11.9 percent by 2020 if GDP grows at a scant 2 percent between now and that year.

In short, this graph gives us all valuable insight into why words like "the recession ended in mid-2009" are meaningless from a practical — and political — perspective today.