Economists Discover Inequality (But Have Yet To Explain It)


Rasmus-2Much has been written over the past year about the growing income inequality in America and how the wealthiest 1 percent households have accrued 95 percent of all the national income gains in the U.S. economy. Liberal economists like Paul Krugman, Robert Reich, and James Galbraith have been reporting on income inequality, but have yet to explain why and how the growing concentration of income in the hands of the 1 percent has been accelerating, from 65 percent of all income gains during the Bush years and 45 percent during the Clinton years.

The Emmanuel Saez Connection

The discovery of inequality was initially given its major boost more than a decade ago by the pioneering work of Emmanual Saez, a French economist transplanted to the University of California, Berkeley. Saez was the first to begin reporting the facts about growing income inequality in the U.S., based on previously unavailable data from the Internal Revenue Service. Prior to Saez’s work, other official sources of government data from the Bureau of Labor Statistics, Commerce Dept., Federal Reserve, and Congressional Budget Office were, and still remain, notoriously limited and incomplete with regard to accurately estimating capital incomes.

While having made a major contribution by more accurately describing the true dimensions of income inequality, Saez’s work has been weaker on identifying the fundamental causes of that growing income and wealth inequality. A professor of Public Finance (i.e. government spending and fiscal policy in general), Saez has focused his explanation mostly on the growing inequities of the tax system in the U.S. and other capitalist economies. To a lesser extent, he has also focused on the trend of senior executive pay in business, pointing out that in the last decade alone, CEOs and senior corporate management have roughly doubled their share of total corporate profits—a significant shift of income when senior management is defined as the top half-dozen to a dozen managers in a typical corporation.

What’s of more interest is how the overall share of incomes from Capital in general, is rising at the expense of workers’ earned incomes—i.e., wages and salary—and especially the sub-category of hourly wages and weekly earnings for roughly 110 million production and non-supervisory workers in the U.S.

By addressing the restructuring of the tax system, Saez provides an important element in the general explanation of growing income inequality. But in so doing, he omits that the tax system changes are but one of a three legged stool of income inequality forces at work. The tax system changes ensure that income generated at its source flows through the corporation to the owners of capital without being seriously diverted or siphoned off by the State and the tax system for other purposes. The tax connection is thus strategic for understanding the income inequality trend, but it is not the whole story.

Thomas Picketty’s New Book

rasmus-1Working with Saez a decade ago on income and wealth concen- tration in the 20th century is another French economist, Thomas Picketty, who published a major book, Capital in the 21st Century. The book is getting a lot of promotion from other liberal economists, like Krugman, from the liberal news media, as well as from the U.S. business press—the latter of which is more interested in trying to debunk Picketty’s data. The title of the book is somewhat misleading as the Picketty book is less about the changing nature  global Capitalist Reproduction in its various forms in the 21st century and more about the consequences of those changes, specifically the accelerating of capital incomes and the concentration of wealth accruing to capital owners. Picketty’s book is best understood as a deeper and more historical representation of Saez’s work on income inequality that proceeded it, but we are still talking about the appearances of inequality, not its essential origins.

In the book, Picketty reveals that the wealthiest households, com- posed of those whose incomes are earned almost exclusively on returns from capital, have been increasing their wealth steadily at 5 to 8 percent on average every year over the long term. And that’s been the case, whether in good economic times or bad. Moreover, the half dozen or so recessions in the U.S. since 1980, including the recent great one that began in 2007, seem to have had little long-run impact on the accelerating concentration of income and wealth to the top 1 percent households. In stark contrast, Picketty’s book argues working families—recipients of what is called earned incomes from wages and salaries—have barely maintained their incomes and standard of living during the best of times, while experiencing a reduction in income during recessions.

What the income inequality trends revealed by both Saez and Picketty suggest, is not just that the wealthiest are accruing more of the national income and wealth for themselves, but that the remaining 80 percent of working class households are stagnating or declining in terms of real wages, real earnings, and real disposable income. The income inequality in America now means not only that the rich are getting richer, but that the middle and below are simultaneously  getting poorer over the longer term.

What the Saez-Picketty work suggests is that income inequality occurs when the rich get richer in absolute (capital income) terms or when both occur simultaneously, which has been the case in the past three decades, at least.

Dual Origins of Rising Capital Incomes

Their accelerating income and wealth is generated  from the manipulation of global financial assets and speculative financial trading—from returns on capital from global stock and bond trading, foreign exchange speculation, interest, real estate, commodity futures, structured finance, and derivatives in myriad proliferating forms, rents, and so forth—to mention just a short list. This is money making money and doesn’t involve shifting income from workers by reducing their real wages, cutting their health care and retirement benefits, stealing all their productivity gains, and the many other ways corporations shift income from the the working class to themselves.

Reducing labor costs across the board is a second major way in which income has been growing for the wealthiest 1 percent. Income and wealth is not only generated from financial speculation, but from the transfer of income from workers through the conduit of their corporations in the form of capital gains, dividends, interest, and rent. One of the hallmarks, globally, is that corporate profit margins are at consistent, record annual levels. Corporate income taxes are then reduced by governments to increase the pass through of these growing corporate net income gains to their major stockholders, who are almost exclusively investor households and not earners of wages and salaries. Governments then further reduce their personal income taxes as well, in order to ensure they can keep an ever-growing percentage of the profits that their corporations pass through to them. As both Saez and Picketty have understood, Capitalist tax systems are central to both of the more basic processes of income creation noted above. Tax cuts on corporate and personal investor income taxes both result in more income accruing to the wealthiest 1 percent.

But the underlying processes are different. One involves the increase in transfer of share of national income from workers to owners of capital. The other involves owners of capital manipulating the financial system and financial asset prices for gain. One involves increasing the exploitation of labor and the other involves the manipulation of asset prices and exchange.

rasmus-4Both Saez and Picketty focus on the tax system as central to the growing concentration of income in favor of the wealthiest 1 percent. However, neither examine the more fundamental processes at play—i.e. the growing relative weight of financial speculation in global capitalism or the simultaneous growing intensification of labor exploitation and income transfer between classes that is occurring in the U.S.-and globally as well.

Saez and Picketty’s lesser economist colleagues—the Krugmans, Reichs, et. al—provide little explanation of the strategically fundamental processes of (financial speculation income generation and earned income transfer from workers to owners of capital),. They focused only sporadically on this or that surface manifestation of the problem: noting a problem of real minimum wage decline here, a particular corporate tax cut there, rising cost (and shift) of health services today, coming crisis in retirement incomes tomorrow, and so on. That is, an eclectic empiricism with no theoretical foundation and, therefore, no real analysis and no possibility of effective solutions for ending the growing concentration of incomes in the end. What is necessary to explain the growing income-wealth inequality trends is a threefold task. First, it is necessary to explain the processes by which the rate of increase in workers’ compensation (wages and benefits) is being reduced on a class-wide basis—that is, for both the employed, unemployed, and underemployed—and especially for the core 110 million non-supervisory and production workers in the U.S.  The unemployed experience a total wage cut, which needs to be factored into the overall average for wage reduction for the working class as a whole. Unfortunately, current government statistics report wages and compensation only for those still employed, which underestimates the total wage reduction since the unemployed total loss of wage income is not included.

Moreover, that official data reports wages only for those who are employed full time . It thus underestimates the overall wage reduction for the class as a whole for the millions of workers in recent years that have been forced from full time into part time and temp jobs. The growth in underemployed part time and temp jobs represents a further reduction in the overall working class wage and benefit estimation, since, on average, these contingent jobs pay 50 to 75 percent of the average full time job.

It is important also to consider the roughly 110 million non-supervisory workers wages and compensation Government data reporting on wages and compensation, in general, include salaries and benefits for CEOs and senior managers, whose wage and salary increases may be significant and thus bias upward the total average for wages and benefits in general. The trend in income inequality in favor of the top 1 percent is consequently worse than reported, when the trend compares the 1 percent to the roughly bottom 80 percent of households in the U.S. where the non-supervisory 110 million reside.

The preceding adjustments that more accurately estimate wages and compensation on a class-wide basis that includes the unemployed, underemployed, and excludes CEOs and senior management, are only the beginning of the necessary task, however.

To obtain a more accurate summary of wage and income reduction for workers today. It is further necessary to adjust not only for current nominal wage cuts and reductions that may have occurred, but also for deferred wages previously paid in the form of workers pensions and healthcare contributions that are reclaimed and taken back. When defined benefit pensions are converted to 401k personal pensions by a company or when a company declares bankruptcy and turns over its pension to the government’s Pension Benefit Guaranty Corp. In effect, the company takes back, in part, the worker contributions that were previously paid into the pension fund. The same occurs when prior worker contributions to a health insurance fund are offset when a company increases the share of monthly premiums workers must pay for employer-provided health insurance coverage or when the coverage provided by that insurance is reduced. The result is an increase in payment by the worker for both cases. But estimating reductions in nominal and deferred wages is still not the entire story.  There is the reduction of future wages yet to be paid. Future wages are reduced by means of issuance of credit and debt to workers. The interest paid on that debt currently and over the life of the loan represents a reduction in future wages not yet paid.

There is also a fourth category that must be calculated in order to accurately estimate the overall reduction in workers income and inequality—the social wage—that is, the contributions to social security and medicare paid by workers in the payroll tax. It, too, is a form of wage that is deferred. Workers pay into the social security fund in expectation of a claim on that payment when retired. A reduction in social security monthly benefits and/or a rise in co-pays by retirees for Physician or Prescription drug coverage represents a reclaiming of part of the social wage previously paid.

rasmus-3All the above are further reduced by inflation, so that adjustments for the real wage paid to workers are necessary as well. This leads to what inflation index is used to adjust wages and benefits in their nominal form to their real, purchasing power form. U.S. government inflation indices have been smoothed out over recent decades by introducing statistical estimation techniques that reduce the volatility of price inflation. The different techniques are too numerous (and boringly arcane) to recount here, but they add up to underestimating the true inflation in the typical goods and services bought by the bottom 80 percent households and the 110 million nonsupervisory core working class. That means that true inflation is higher and real wages are actually lower than reported by the government.

What all the above in effect means is that working class incomes in the U.S. have actually fallen in many cases, even more than has been reported. Had the accurate wage and compensation reduction been used to track the growing income inequality, it would be significantly greater than reported even today—whether by the government or by the Saez-Picketty studies.

Explaining inequality—not just reporting it—requires an analysis of how these various forms of wages have been reduced in recent decades and especially since 2009. That deeper analysis leads to explaining destruction of unions and thus the higher union wage, the growing trend of outright wage theft by businesses, the avoidance of paying overtime pay by reclassifying millions of workers as exempt instead of hourly paid, the atrophying of the real minimum wage, the wage reduction effects of free trade, the shift to contingent labor, and all the reasons why the total unemployed (in and out of the labor force) are rising steadily and are chronically longer-term jobless. Add to this the analyses of the many government policies introduced in recent years and decades that reduce the deferred, social, and future wage and underestimating the real wage.

The Three-Legged Stool

But explaining the true scope and magnitude of wage reduction is still just one of the three legs of the income inequality stool—in this case the declining income side of the coin of inequality. The other two legs are how more income is generated and claimed by the wealthiest households, especially the 1 percent, and how changes in the tax system are enabling an ever-greater pass through of income from the corporations of the wealthiest households to their personal bank accounts. To explain the other (non-wage) side of inequality therefore requires a second set of explanations and analyses: of how and why corporate profits have consistently risen in recent decades, accelerating especially in the past decade, and how that historic rise has been passed through at increasing rates, from the corporation to its major owners and investors—i.e. the wealthiest 1 percent of households.

Explaining the Rise In Corporate Profits

First, it requires an analysis of profits that are being generated increasingly by means of manipulation of financial asset prices by investors, by creating new forms of money and credit, and recycling money capital to create still more money capital where nothing is actually being produced except for money capital. This is the realm of finance capital, growing in relative weight and role in the 21st century.

But the other more traditional source of profits generation is, of course, profits from making goods and providing non-financial services. Here, profits grow by either selling more goods, raising prices of the goods sold, or reducing costs of producing those goods—especially labor costs. Since the June 2009 recession, the data shows profits from production quickly escalated to record levels in the U.S., exceeding the historic high pre-recession 2007 levels. Today’s record pre-tax corporate profits are primarily the outcome of the growth of profit margins, that is, profits generated from reduction of operating costs, in particular labor costs, and by raising productivity and/or reducing wages and compensation. The record profit growth for goods and services producing corporations is not the consequence of raising prices or selling significantly more product. It is the result of cost-reduction, which means largely wage and benefits cost containment or reduction. Explaining the income inequality trend must focus on the rise in profit margins for companies that produce goods and services, as well as profits from financial speculation. Moreover, the multiple connections between profits from finance capital and profits from real production by non-finance capital requires analysis and explanation.

How the income of corporations gets transferred to the  wealthiest households, is a critical element in the overall explanation and analysis of income inequality as a trend.  How the tax system has been restructured in favor of capital incomes—i.e. capital gains, dividends, interest, rent and other payments to the wealthy and investors—is a necessary focus of analysis, is how corporate taxes have been reduced as well. Reducing corporate taxes allows corporations to keep more income to potentially pass through to their investors. Reducing taxation on capital incomes after having been distributed by the corporation results in still more income gains by the wealthiest households in turn. Conversely, how the restructured tax system has in recent years raised the total tax burden and share (federal, state, and local) on the working class is a second essential focus of the general effect of the tax system on income inequality.

Saez, Picketty and a few others have contributed significantly to the analysis of the role of the tax system changes in recent years and decades to the growing income inequality trends in the U.S. But none of them have focused in any significant detail on the fundamental origins of income inequality—i.e., in the process of production, in the growth of credit, debt, and speculative finance, or how the working class is not only no longer sharing in the income generation, but is increasingly having to give back income it previously earned to the forces of Capital as well.

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Jack Rasmus is the author of the recent books, Epic Recession: Prelude to Global Recession and Obama’s Economy: Recovery for the Few, published by Pluto Press. He hosts the weekly radio show, Alternative Visions, on the Progressive Radio Network. His website is: www.kyklosproductions.com, and twitter handle, @drjackrasmus.