Income Inequality and Double Dip Recession
I have argued in these pages that the current recession is not a normal recession and that there would, therefore, be no normal recovery; that monetary (central bank) policy may bail out the banks, but would not succeed in stimulating an economic recovery except for stock, bond, derivatives, and other markets for speculators; similarly, fiscal policy (tax cuts and government spending) would prove insufficient for recovery as well. The result would be years of “bouncing along the bottom” at subpar economic growth, with some quarters growing, but below historic trends, and other quarters declining to zero growth or barely above it. Which is, in fact, what has happened since June 2009, the official end of the recession in GDP terms (see my Epic Recession: Prelude to Global Depression, 2010).
Reviewing that prediction, it is now apparent that most of the Eurozone economies are already in a second recession. The United Kingdom has not only experienced a double dip, but is approaching a possible triple dip. Japan is facing the same experience. The possibility of a double dip recession in the U.S. is growing and could happen by 2013-14, given certain conditions. These conditions include:
- The lack of real job, housing, and state-local government spending recoveries in 2012-13
- The emergence of a banking crisis and deepening recession in Europe
- A significant slowing of the Chinese-Indian-Brazilian economies as a consequence of slowing global manufacturing and world trade
Intensified deficit cutting by Congress after the November 2012 elections that would begin to have a real impact on the U.S. economy in 2013-14 (see Obama’s Economy, Jack Rasmus, 2011)
The first two points have materialized since late 2011. The U.S. jobless level appears stagnant at around 22-23 million, housing recovery is tepid at best, and state/local governments continue to lay off thousands every month and cut spending. Concerning the third point, the banking crisis is clearly emerging in Europe and austerity programs there continue to drive the Eurozone economies into deeper recession. Although not in recession, the growth rates in the big three emerging economies—China, India, Brazil—have slowed by almost half thus far. And now deficit cutting in the U.S. has begun in earnest and promises to have a major economic impact in 2013-14.
GDP Data: July-December 2012
U.S. GDP data released on January 30, 2013 for the fourth quarter 2012, showed a decline in GDP of -0.1 percent for the last three months of 2012. Government and business inventory spending led the decline. To the extent consumer spending played a positive role at all in the fourth quarter, it was largely driven by auto sales—stimulated by auto dealers offering buyers deep price discounts, virtually free credit with near zero percent auto loan interest rates, as well as new auto purchases in the northeast as a result of Hurricane Sandy’s destruction of existing auto stock.
The 2012 holiday season retail sales data, in contrast, were not particularly notable. Net export sales continued to sag in the last quarter, as the slowdown in world manu-facturing and trade continued globally. As others have noted, health care services began to slow as well, promising to continue into 2013.
In the first quarter 2013, a number of negative developments continued to prevail. First, more than $100 billion has been taken out of the economy with the end of the payroll tax cut last January 1. Second, consumer sentiment and spending showed a definite sharp decline in the early months of 2013. Deficit cutting will intensify with a deal on the sequestered $1.2 trillion agreement that occurs this month in Congress. Projected defense spending cuts will be reduced, but non-defense spending will occur and perhaps even rise. Consumer spending on autos, which has been a plus, cannot continue at the prior pace. Health care spending will likely continue to slow, as health insurance premiums of 10-20 percent are to be imposed by price gouging health insurance companies looking to maximize their returns in anticipation of Obamacare taking effect in 2014. Business spending in the fourth quarter—to take advantage of tax laws—will almost certainly slow in the first quarter of 2013. Industrial production and manufacturing will add little, if anything, to the economy and housing will contribute to growth through apartment construction only.
It is not the deficit that faces a cliff, it is the U.S. economy. Should Congress proceed with continued spending cuts in 2013, should the Euro economies, UK, and Japan continue to weaken and should China-India-Brazil fail to reverse their economic slowdowns significantly—then the odds of a double dip in the U.S. will rise still further in 2013-14.
The strategic question is, why is the U.S. economy so fragile and weak? Why has it been unable to generate a sustained economic recovery? The answers are not all that difficult to understand. First, despite $13 trillion in free, no interest money given to banks, investors, and speculators by the U.S. federal reserve for 5 years now, the banks continue to dribble out lending to small/medium U.S. businesses. No loans mean no investment mean no hiring mean no income growth for consumption, which is 70 percent of the economy. Similarly, large non-bank corporations continue to sit on more than $2 trillion in cash. Like the banks, they refuse to invest in the U.S. to create jobs, preferring to hold the cash or use it to buy back stock and pay shareholders more dividends or to invest it offshore or in speculating with financial instruments like derivatives, foreign exchange, commodities futures, and the like.
At the same time, the bottom 80 percent of households, more than 110 million, are confronted with 5 years of real disposable income stagnation or decline. This income stagnation and decline translates into insufficient income to stimulate consumption spending, which makes up 71 percent of the U.S. economy. What spending exists is fundamentally credit driven, not income driven. Thus, car loans, student loans, credit cards, and installment loans rise—and along with it household debt. The problem with the U.S. economy, therefore, is not only insufficient income, but growing household debt. Together they result in consumption becoming increasingly fragile (an income to debt ratio term) and, therefore, unable to generate a sustained economic recovery.
This deepening reliance on credit/debt and declining real income in the U.S. is the consequence of decades of an accelerating redistribution of income in the U.S. from the bottom 80 percent households to the wealthiest 10 percent, 5 percent, and especially 1 percent households.
The Wealthiest Historic Income Gains
With average annual incomes of $593,000 a year today, the wealthiest 1 percent of households in the U.S.—approximately 750,000 out of a total of more than 150 million families in the U.S.—receives about 24 percent of all income generated in the U.S. every year, according to Nobel Prize winning economist Joseph Stiglitz. That’s up from only 8 percent of total income in 1979. That’s a tripling of the wealthiest 1 percent’s annual share of total income since Ronald Reagan took office in the early 1980s. Not since 1928, when the wealthiest 1 percent share of income reached 22 percent, has income inequality been as extreme—and income inequality continues to grow.
According to studies of IRS data by University of California economist Emmanuel Saez and others, during the Clinton years, 1993-2000, the wealthiest 1 percent households captured 45 percent of all the increase in U.S. income growth. During the George W. Bush years, 2000-2008, they captured 65 percent. And in the latest year of available data, 2010, they captured 93 percent. So the top 1 percent recovered quickly from the recession. So did their corporations, from which the same 1 percent households obtain more than 90 percent of their income in the form of capital gains, dividends, interest, rents, and other forms of capital incomes.
Corporate Profits and the 1 percent
Averaging an annual rate of increase of about 10 percent from 1948-2007, Pre-Tax Corporate profits virtually doubled from their recession 2008 low-point of $971 billion to $1.876 trillion by March 2011 less than a year and a half later—i.e. a level 28 percent higher than even their 2007 pre-recession record high of $1.460 trillion.
A subset of the $1.876 trillion—i.e. profits of the 500 largest U.S. corporations—rose 243 percent in 2009-10 according to the Wall Street Journal. That’s 243 percent after averaging 10 percent a year during 1998-2007. Moreover, that 243 percent does not include profits of multinational U.S. corporations hidden and sheltered in their offshore subsidiaries, which in 2012 were estimated at more than $1.4 trillion.
This record gain in pre-tax corporate profits since the onset of the economic crisis in 2007-08 was achieved not from the increased sale of goods and services, but by cutting jobs, reducing wages, benefits, and hours of work, and by productivity gains pocketed by management and not shared with the workers. Profit margins since 2008—i.e. profits as a percent of operating costs—by 2011 has attained the highest levels in more than 80 years.
Just as there is cost-cutting at the direct expense of workers, so too have Corporate After-Tax profits surged as a consequence of massive corporate tax cutting by governments at all levels, federal as well as state and local. Major corporate tax cut legislation in 2004-05, allowing faster depreciation write-offs (a form of tax cut) and disregard of enforcing the foreign profits tax under George W. Bush, all resulted in a further surge in corporate after-tax profits in Bush’s second term, 2004-08. That was followed by hundreds of billions more in business tax cuts at the Federal level under Bush and Obama from 2008 through 2012.
State and local government taxes on business since 2008 have been falling especially fast, as a December 1, 2012 feature article by Louis Story in the New York Times pointed out. That article estimated the cost of business tax cuts by state and local governments at no less than an additional $70 billion a year, not represented in the above profits figures.
As a result of the continuing corporate tax cuts since 2008 at all levels of government, Corporate After-Tax profits recovered even faster during the recent recession than did pre-tax corporate profits. From a 2008 low-point of $746 billion, in less than 18 months from the recession low, after tax profits rose to $1.454 trillion—i.e., a level of 47 percent higher than even their 2007 pre-recession record of $989 billion. In other words, after tax profits recovered twice as fast as pre-tax profits as a direct consequence of government business tax cutting during the recent recession. The reductions in the Personal Income Tax have occurred in various forms:
- the lowering of the top marginal tax rates
- the raising of the income threshold at which the top marginal rates would apply
- the reducing of capital gains and dividends tax rates even faster than for other forms of income of the wealthiest 1 percent
- the introduction of new forms of interest income taxed at lowest rates (e.g. carried interest)
the IRS’ benign neglect of offshore tax sheltering by the wealthy and the proliferation of countless income tax loopholes benefiting the wealthy too numerous to recount.
Tax System Contribution to Income Inequality
In the 1970s, the top federal income tax rate on the wealthiest individuals ranged from 50 to 70 percent. But the top 1 percent paid an actual average tax rate—after loopholes, deductions, and exemptions—of about 45 percent. By 2011, however, this 45 percent actual rate had declined further to 22.5 percent, according to a 2012 study in the Tax Justice journal—i.e. very much lower than the official 35 percent top personal income tax rate typically mentioned by the press, the government, and in current debates about the fiscal cliff.
Under Ronald Reagan, the nominal top tax rate was reduced from 70 percent in 1980 to as low as 28 percent in 1988. With ballooning budget deficits due to tax cuts, defense spending, and the bailout of mortgage banks and corporate junk bond holders under Reagan, the 28 percent top rate was raised temporarily in 1991 to 31 percent under George H.W. Bush, and in 1993 to 39.6 percent under Clinton. However, the income threshold level at which the 39.6 percent top rate took effect was raised from $82,000 a year to $250,000, which minimized significantly the tax cut hit for the top 1 percent. Other loopholes were simultaneously introduced, reducing the hit even further.
The Clinton tax cuts were followed by a new round of massive tax cuts for the top 1 percent and corporations under George W. Bush, from 2001 through 2005. The top tax rate was reduced to 35 percent and the income threshold was raised even further to $312,000. In addition, capital gains and dividends taxable rates plummeted to 15 percent and billionaire hedge fund managers were able to claim their personal income—called carried interest—and therefore taxable also at the 15 percent top rate.
The Bush Personal Income Tax cuts of 2001-04 amounted to more than $3 trillion over the subsequent decade, 80 percent of which went to the wealthiest households. Hundreds of billions more in corporate tax cuts were added in 2004-05, including reducing the 35 percent corporate tax rate to 5.25 percent for multinational corporations offshore earnings.
An additional $1.3 trillion in mostly business tax cuts were further added as part of the Bush-Obama fiscal stimulus programs introduced from 2008-12, which included a two-year extra extension of the Bush tax cuts by Obama in 2010. As a consequence of the more than $4 trillion in Bush-Obama tax cuts from 2001-2012, Federal government taxes as a percent of Gross Domestic Product fell from 20.6 percent of GDP in 2000 to only 14.4 percent—i.e. the lowest on record since 1950.
If Federal tax revenues were restored to the pre-2000 level of 20.6 percent of GDP, they would produce an annual increase in Federal government revenues of $458 billion a year. That’s more than $4.5 trillion in additional revenue over the coming decade—a number which is about the same as that proposed by Republican and Democrat politicians in fiscal cliff negotiations as the target to reduce the U.S. deficits and debt. Congress and Obama could have solved the deficit problem for another decade just by letting the Bush tax cuts expire on December 31, 2012.
Alternatively, the $4.5 trillion could be achieved by means of one simple tax measure: raise the effective, actual tax rate on the wealthiest 1 percent households to a 45 percent actual effective top marginal rate. That measure alone raises Federal tax revenue by $458 billion a year and restores Federal tax revenues from the current 14.4 percent low to the prior long-term average of 20.6 percent of GDP.
That single measure would eliminate any and all need to cut Social Security, Medicare, Medicaid, education, or any other spending, including even defense, or to raise any taxes on the middle class.
In fact, the latter social programs could even be expanded, funded by the introduction of other equity-oriented tax policies. For example, introducing a moderate financial transaction tax of $1 per stock trade, $100 per $10,000 bond trade, and 2 percent on all derivatives trades could produce tax revenues of another $150 billion a year. Requiring multinational corporations to pay taxes on their profits diverted to offshore subsidiaries could raise additional hundreds of billions a year. And requiring both individual and corporate investors to repatriate their $4 trillion in offshore tax shelters could raise hundreds of billions more a year. And that is just a short list.
Income Decline for the Bottom 80 percent
But income inequality is a consequence not only of income shifting to the wealthiest households and their corporations, it is also the consequence of conditions and policies which have simultaneously reduced the real incomes of the bottom 80 percent households—i.e. those 110 million earning less than $118,000 annual income and most of whom earn less than $50,000. A short list of the major causes include:
- De-unionization of much of the labor force and a consequent collapse in the union-nonunion wage differential
- Free trade policies that have lowered wages for new export companies by 20 percent compared to higher paid jobs lost to imports
- Millions of jobs permanently lost to free trade from NAFTA, CAFTA, and others
- Offshoring of high paying jobs by multinational corporations to Asia and beyond
- Creation of a 40 million 2-tier workforce of part time and temp workers, with 60 percent wages and virtually no benefits
- Elimination of health care benefits for tens of millions, and reduction in benefit coverage and higher cost sharing for those remaining with benefits
- Longer duration between adjustments of minimum wage legislation, and smaller progressive adjustments when they occur
- Rising base level of unemployed as recessions occur more frequently and are deeper and longer in duration, resulting in job recovery longer and at lower pay
- Management hoarding of all productivity gains without sharing, in part, with wages
- Elimination of defined benefit pensions and replacement with minimal 401k plans
- Exemption by government rule changes of millions of workers from eligibility for overtime pay
- Rise in property tax, sales taxes, and other local government fees and charges as local government grants more and more tax cuts to corporations and businesses
- Indexation and rise in payroll tax contributions by workers
- Reduction in paid leave time for vacations, holidays, sick leave, etc.
According to the PEW Institute’s 2012 study, the share of total income for those households in that annual income range of $39,000 to $118,000 a year declined from 58 percent in 1983 to 45 percent in 2011. So what the top 1 percent households gained (16 percent share increase, from 8 percent to 24 percent), the middle class largely lost (13 percent share decline from 58 percent to 45 percent). In terms of wealth estimates, the middle class has lost 28 percent of its wealth in just the last 2 decades. The size of the middle class itself has declined, shrinking from 61 percent of adults in the U.S. population at its peak to only 51 percent today.
The decline in income and wealth has been long term, increasing noticeably since 1980. Since 2008, households without a 4-year college education have been especially hard hit, with a significant -9.3 percent income decline at the median in less than 4 years. Older workers, age 55-64, and younger workers, age 25-34, have been similarly hard hit—the former a -9.7 percent drop and latter a -8.9 percent drop. Even college degreed workers income has fallen by -5.9 percent since the so-called end of the recent recession in June 2009.
While some of the income decline is due to wage and benefit reductions by those who did still had their jobs during the recent recession, much more of the relative income decline has been due to massive loss of jobs since 2007, which reached a level of 27 million at one point and still remains at 22 million after 4 years of so-called recovery. While more than 15 million jobs were lost, no more than 5 million has been recovered since the recession began. Moreover, the jobs added during the recession have paid significantly less than the jobs lost. According to a National Employment Law Project survey published in August 2012, 60 percent of the jobs lost during the recession were higher paying construction, manufacturing, and tech jobs, ranging between $13.84-$21.13 per hour. But only 22 percent of the jobs added since 2008 were in this range. In contrast, 21 percent of the jobs lost after 2008 were low paying, $7.69-$13.84, but the latter have been 58 percent of the jobs added during the recession. And the problem is not only short term and recession related. Since 2001, low wage jobs have grown 8.7 percent while higher wage jobs have declined -7.3 percent.
Major Reconstruction Needed
A rebalancing of the increasingly skewed distribution of income in the U.S. must include a major restructuring of the tax system which is a central enabling factor behind the growing inequality, although not the only cause, as we have seen.
In a somewhat historic irony, the current deficit cutting negotiations between the two parties in Congress and the Obama administration will inevitably produce an outcome that will only further reduce disposable income by the middle and working class in America, in order to continue tax cuts for the wealthy and reduce still further the tax rates for their corporations. The consequence is that income inequality trends will inevitably worsen further in the U.S. in the coming years, holding back full economic recovery and continuing the U.S. economy on a trajectory toward another recession.
Jack Rasmus is author of Obama’s Economy: Recovery for the Few and host of Alternative Visions on Progressive Radio. His blog is jackrasmus.com and his twitter handle is #drjackrasmus.