Narrowing the Income Gap, Without Another Bust

Jared Bernstein is a senior fellow at the Center on Budget and Policy Priorities in Washington and a former chief economist to Vice President Joseph R. Biden Jr.

There are two opposing views out there right now regarding the economic prospects for 2014.  There are those making the case that this will be the year the economy finally escapes the residual gravitation pull of the great recession and hits escape velocity, i.e., gross domestic product and job growth accelerate, households â€" with their balance sheets back in the black, and with home prices rising â€" pick up their consumption, and businesses respond to this newfound activity by bringing more of their investment capital off the sidelines and into the game.

The other view is embodied in a recent CNN/ORC poll result that finds that nearly 70 percent said the economy “is generally in poor shape,” while “just over half expected the economy to remain in poor shape a year from now.”

Most readers of this blog will have no problem aligning these two disparate viewpoints.  There is no single United States economy that’s either doing well or poorly.  When someone asks “how’s the economy doing?” the correct response is (preferably with a Jersey accent), “Whose economy you talkin’ about?”

Comparative Indicators for the Recovery

Sources: Real gross domestic product and corporate profits, Bureau of Economic Analysis (Q2 2009 to Q3 2013); Standard & Poor’s 500-stock index, S.&P. Dow Jones Indices (June 2009 to November 2013); median household income, Sentier Research (June 2009 to October 2013).

In our era of historically high levels of income inequality, growth is of course necessary, but it’s not sufficient to lift the living standards of the bottom half.  The chart above gives a rough look at the problem, showing the growth over the expansion thus far in G.D.P. (up 10 percent), corporate profits (up 50 percent), the Standard & Poor’s 500-stock index (up 77 percent), and median household income (down 4 percent), all adjusted for inflation.

A more detailed look at the problem of growth’s failure to reach most households comes from comprehensive Congressional Budget Office data on household income.  Compared to the chart above, these data are less up to date â€" the last data point is 2010 â€" but they not only track income across the full income scale, they also include the impact of taxes, government benefits, and capital gains and losses.

The latter is an essential driver of inequality, as large gains and losses in the asset values of the wealthiest households have been a fixture of the bubble/boom/bust cycle that has characterized the nation’s last few business cycles.  This makes inequality “procyclical” â€" it goes down when the economy does, and vice versa â€" around a rising trend.

According to the Congressional Budget Office data, the downturn solidly whacked the incomes of all income classes, including that of the top 1 percent.  It would be a mistake to conclude that their wealth insulates them from impact of financial-market-driven recessions (though, of course, their wealth insulates them from the associated hardships experienced by those with few resources).

It is also the case that in the worst of the downturn, the safety net helped low- and middle-income families much more than wealthy families.  Our system of taxes and transfers (like unemployment insurance and nutritional assistance) is still progressive, though it’s becoming less so over time.

But now that the downturn’s behind us and the economy is steadily, if moderately, expanding, we have the tale of two economies I introduced above.  The Congressional Budget Office data show, for example, that in 2010, the real after-tax-and-transfer income of middle-income families was unchanged over the previous year, sticking at about $58,000.  The income of the top 1 percent, on the other hand, went up 15 percent, or $133,000, to about $1 million.  The 2010 increase in the income of the top 1 percent was more than twice that of the average income of the middle class.

That’s just one year, but it’s indicative of the pattern that’s prevailed after each of the last two recessions.  Inequality takes a big hit when asset bubbles burst and the safety net kicks in to offset some of the damage.  Then, as the recovery gets underway and the safety net fades â€" both SNAP (food stamps) and unemployment benefits were recently cut â€" asset values start to appreciate again, and inequality is back on the rise.

Which of course raises the question: What can be done to break this pattern?  Here are a few ideas:

-Don’t reduce safety net supports too soon.  The expiration of long-term unemployment benefits was precipitous given the still-elevated levels of overall unemployment and especially long-term unemployment.  Congress will return to a bill to extend the program for three months.  That would help … a little.

-A small financial transaction tax. A very small tax on financial transactions â€" a few basis points (hundredths of a percent) â€" would both dampen noisy trading and raise some needed revenue to pursue measures like the ones suggested here.  There’s a bill in Congress for a financial transaction tax of three measly basis points (meaning three cents on a $100 trade) that has been scored as raising $350 billion over 10 years.  There’s also some research suggesting that such a tax would help to reduce some financial-sector activities associated with the economic shampoo cycle (bubble, bust, repeat).

-A higher minimum wage. Think of this policy as a mechanism that would at least partly connect the pay of low-wage workers to the broader recovery.  An expanded earned-income tax credit would help here as well, especially for childless adults.

-Full employment: I’ve discussed this one many time in past columns recently suggesting five ways to get there.  The point is that the last three recoveries have started out “jobless,” meaning G.D.P. growth got going well before jobs.  Yes, the unemployment rate has been coming down lately, but part of that is because former job seekers are giving up the search.  An aggressive full-employment program, including direct job creation â€" I’d scale up a subsidized jobs program that proved quite effective during the last downturn â€" would help in many important ways.  By tightening the labor market, it would provide workers with some of the bargaining power they lack to claim their fair share of th growth they’re helping to create.  On the macro level, as I warned about in my last post, full employment would offset and reverse the part of the labor-force decline unrelated to retirement, thus helping to increase the economy’s eroding potential growth rate.

And dig this: of the two ideas above that invoke budgetary costs, my back-of-the-envelope estimate finds that they could be handily financed by the proceeds from the financial transaction tax.

Is it just me, or is there something particularly just about that arrangement?