It’s been five years since the financial crisis reached critical meltdown. The dominoes began to fall with the demise of Lehman Brothers, followed by the shotgun sale of Merrill Lynch to Bank of America, Fannie Mae and Freddie Mac taken into federal conservatorship and the Federal Reserve backstopping insurance giant AIG in exchange for a super-majority equity stake.
Last month also marked the two-year anniversary of the Occupy Wall Street (OWS) movement. Together, those events planted the issue of staggering U.S. income inequality into public awareness and discourse.
Today, the financial sector has largely recovered — thanks in no small part to extraordinary policy actions by the Federal Reserve — and major U.S. stock indexes are near record highs, reflecting a rise in productivity and a strong rebound in corporate profits since the Great Recession. Meanwhile, the U.S. labor market is only about one-fifth the way to a full recovery; and as long as the jobs crisis festers, inflation-adjusted wages will stagnate or fall for the vast majority of workers.
While the tumult of the Great Recession brought deserved attention to societal inequities and an economic model that has been failing far too many, this disparate recovery (or lack of recovery) is itself further exacerbating income inequality.
A WIDENING GAP
Recent U.S. income inequality data published by economists Emmanuel Saez and Thomas Piketty show that the top 1 percent of households by income has captured a staggering 95 percent of total income gains between 2009 and 2012, compared with 68 percent of gains between 1993 and 2012. Rather than sharing in the gains, the bottom 90 percent of households have seen income fall steeply – by an amount equivalent to 16 percent of all the income gains between 2009 and 2012. By comparison, between 1993 and 2012, the bottom 90 percent lost income equivalent to 5 percent of gains.
In other words, the vast majority of households have been falling behind even faster than before. Income gains have accrued almost exclusively to the very top of the income distribution, while the broad middle class and lower-income households are losing ground.
At the broadest level, rising income inequality essentially reflects an increase in compensation going to the top 1 percent, coming at the expense of other worker’s paychecks. A large part of the story is the rise in investment income (capital gains, dividends and business income) as a share of national income, as productivity gains and profits are increasingly passed on to shareholders. And shareholders’ gains come at the expense of workers—a declining share of income has been going to labor (wages and salaries). Investment income accrues overwhelmingly to households at the very top of the income distribution, while the vast majority of households overwhelmingly derive their income from labor.
Between 1979 and 2007, wages and salaries as a share of overall income fell from 70 percent to 60 percent. Over this period, the income going to the top 1 percent of households has more than doubled, from 9 percent to 19 percent. And if unaltered by public policy, income inequality — already having surpassed Gilded Age levels of inequity — will remain on an upward trajectory for the foreseeable future.
FISCAL POLICY ISN’T HELPING
This growing inequality is being exacerbated by policy failures – more specifically, by decreasingly progressive tax, transfer, regulatory, and full-employment policies in recent decades.
Financial deregulation has contributed to the rising share of national income going to investment income and compensation of financial professionals — with the latter being a significant driver of rising income share of the top 1 percent, as analyzed in a recent paper by Larry Mishel and Josh Bivens of the Economic Policy Institute.
There is also compelling evidence that reductions in top marginal tax have exacerbated the growth in market-based income inequality. Essentially, a lower top tax rate makes efforts by executives to demand greater compensation more rewarding. Successful such efforts will come out of workers’ paychecks, not shareholders’ portfolios.
Political inaction, or “political drift,” on the minimum wage — allowing the real minimum wage to be eroded by inflation — or unionization policy is certainly part of the story. Globalization and international trade have exerted downward domestic wage pressure while increasing returns to wealth, with pressures on inequality growth stemming both from irreversible market forces and certain trade policy choices.
Inequality would have risen sharply absent these influences of budget policy. But while market-based income inequality, as measured by the “Gini” index, rose 23 percent between 1979 and 2007, post-tax, post-transfer inequality rose 33 percent. This means that roughly a third of the rise in post-tax, post-transfer inequality is attributable to erosions in the redistributive nature of tax and budget policy.
There are limits to how much redistributive policies can temper inequality (though we are far from those limits), but tax and budget policy should have been serving as a tempering influence rather than exacerbating market-based inequality growth. Beyond these better-understood forces and policy levers, the disparate nature of the recovery from the Great Recession is both fueling inequality and is squarely in the hands of U.S. policymakers.
When aggregate demand is depressed below supply, slack in the labor market makes it easier for firms to cut employee compensation, thereby increasing profits and capital income as a share of total income. In the three years since the Great Recession officially ended, non-financial sector corporate profits have jumped 62 percent per unit of output, while employee compensation has fallen more than 1 percent per unit of output. Domestic corporate profits as a share of gross domestic product have jumped from 7 percent to 10 percent since the fourth quarter of 2007 (the eve of the recession). And as a share of corporate income, both pre-tax and after-tax corporate profits recently reached post-war highs.
Lower-income workers also suffer disproportionately, as they lose already scant bargaining power to oppose nominal wage cuts or reduced hours. We’ve seen this play out in the Great Recession and its aftermath, with changes in real household income taking a bigger fall as you move down the income distribution.
MONETARY POLICY IS NO PANACEA
The Federal Reserve can’t solve the jobs crisis by itself. It is tasked with maintaining both full employment and price stability, but its main policy tool, lowering interest rates, currently has very limited ability to address the severe shortfall in aggregate demand that is responsible for the jobs crisis. The main policy lever of setting short-term interest rates has been maxed out since December 2008, and its program of purchasing assets to lower long-term interest rates is a poor substitute for direct demand.
Fiscal policy — particularly deficit-financed government spending — would be the most effective policy lever to restore full employment and arrest the wage deflation that is making inequality worse. Instead, continued government austerity is slowing economic growth and preventing recovery, to the vocal dismay of the Fed.
If, however, expansionary fiscal policy were used to restore full employment, greater demand for workers would begin exerting upward domestic inflationary pressures from wage growth — easing pressure on the Federal Reserve to promote its dual mandate with loose monetary policy. Essentially, expansionary fiscal policy would eventually be met with the Federal Reserve easing off asset purchases and eventually raising policy interest rates. An economic recovery for capital and economic stagnation for labor would gradually converge toward more broadly shared gains from productivity growth.
Anyone professing concerns about income inequality should be deeply concerned with the status quo in the labor market and government austerity programs precluding full economic recovery. The mostly timely policy action to curb exorbitant inequality growth of late would be restoring full employment as soon as possible.
Seriously turning the dial on income inequality growth using tax, transfer and regulatory policy is a tall order, but policy failures that have the economy stagnating more than five years after the financial crisis are digging a much deeper hole of societal inequities.