What this report finds: Boosting income growth for the bottom 90 percent requires a policy agenda that explicitly aims to halt or reverse the rise in inequality in the United States in recent decades. The economic evidence shows no generalizable relationship between rising inequality and faster growth. This is important good news. It means that an agenda based on progressive redistribution can unambiguously raise living standards for the bottom 90 percent and even likely be better for overall growth than the agenda promoted by those who are opposed to strong efforts to check rising inequality and instead want to focus solely on spurring overall growth.
Why this matters: The lack of a general relationship between inequality and growth means that specifics matter in policy debates. And the specifics of the modern “growth only” agenda will fail. Policies such as cutting top tax rates, deregulating industries, and signing more trade agreements will both fail to appreciably boost growth rates and continue to send a disproportionate share of income gains to the top 10 and 1 percents. The “growth only” agenda has already been tried, and the results have been slower overall growth and sluggish income gains for the vast majority in recent decades.
How we can fix the problem: Income redistribution over the last few decades has been a zero-sum process, with gains at the top essentially coming straight out of the pockets of the bottom 90 percent of Americans. This zero-sum dynamic means that intelligent policies—including but going way beyond smarter and fairer taxing and spending—can convert these lost potential gains for the bottom and middle into actual income increases without harming overall economic growth. We should:
Use the levers of macroeconomic policy (monetary, fiscal, and exchange-rate policy) to target genuine full employment.
Make investments that markets are not making—in early childhood education, infrastructure, school construction, energy efficiency, and public health care.
Strengthen antitrust regulations and look for other opportunities to introduce competition to private markets, such as public options for health insurance and retirement savings.
Reregulate many activities of the financial sector to squeeze out the activities that don’t enhance productivity or create efficiency but simply enrich well-placed actors within finance. A financial transactions tax is the clearest example of a policy that can stop this income skimming.
Enact climate-change mitigation measures—realizing that policies beyond simply increasing the market price of greenhouse gas emissions can play large and useful roles.
Strengthen regulations and institutions that help shift bargaining leverage from capital-owners and corporate managers to low- and middle-income workers. Key examples include higher minimum wages and labor law reform that allows willing workers to join unions and bargain collectively.
Introduction and summary of findings
The decades-long rise in income inequality has finally become a front-burner political issue, dominating much of the debate in the 2016 presidential campaign. Predictably, those opposed to strong efforts to check (or even reverse) the rise in inequality have objected to this focus, and have argued instead that the simple pace of overall economic growth, and not how this growth is distributed, should be the prime concern of policymakers. Often this argument has a political edge; focusing on distribution is bad for candidates’ electoral prospects. Maybe this political argument is right (we are no experts on that), but regardless of whether it is a good short-term electoral strategy, a sustained policy effort to either arrest or reverse the rise in inequality is a necessary economic strategy if the goal is maximizing income growth for low- and middle-income American households.
To put it simply, the rise in inequality in recent decades has largely been zero-sum (or even worse). Many economists, analysts, and policymakers resist this zero-sum thinking, as it does not seem nuanced or subtle enough to describe a system as complex as an $18 trillion American economy. Yet the evidence is clear that it really is about this simple: the gains at the very top of the income distribution in recent decades have come essentially straight out of potential gains at the bottom and middle. This zero-sum dynamic means that intelligent policy changes aimed at progressive redistribution to stop (or even reverse) the steady rise in inequality would likely not harm overall economic growth, and would surely boost living standards at the bottom and middle.
Such policy changes are clearly needed. There is every reason to expect that income growth in the near future will continue to be unbalanced, providing significantly greater gains to those at the top than those in the middle or at the bottom, unless there is a significant reorientation of economic policy. Too often a policy stance of ignoring this radically unequal growth is described as “growth oriented” rather than (more accurately) as “regressive redistribution.” But the clear truth is that a progressive reorientation of policy is needed simply to ensure that growth going forward is not distributed as unequally as it has been.
This brief examines the trajectory of American living standards in recent decades and how they have been affected by rising inequality. It then assesses the likely effects of various policy recommendations on both income distribution and growth. Its key findings are:
Inequality has risen substantially in recent decades, regardless of how it is measured. This is true even when examining income trends that account for government transfers (such as Social Security, Medicare, Medicaid, food stamps, and unemployment insurance) and noncash employer-provided benefits such as contributions towards health insurance premiums.
Due to this inequality, incomes of the vast majority have grown much more slowly than the economy’s potential should have allowed. By simple arithmetic, inequality has placed a growing wedge between overall average income growth and income growth for the bottom 90 percent of households. This wedge between bottom 90 percent income growth and average income growth—call it the “inequality tax”— reduced incomes of the bottom 90 percent of households by roughly 20 percent between 1979 and 2007 (the last year before the Great Recession) relative to what incomes could have been absent the rise in inequality. This inequality tax fell during and immediately after the Great Recession, as a plunging stock market disproportionately reduced top incomes. But the stock market recovery in recent years has almost surely pushed this inequality tax back up to near prerecession levels.
Incomes for the vast majority post-1979 have been harmed by both slow growth and rising inequality. Compared with earlier economic eras, the period after 1979 has been characterized by both slower average economic growth and rising inequality. Both of these trends have hurt the income growth of the bottom 90 percent of American households. In short, the aggregate data show a clear association between regressive redistribution and slower growth.
Yet the rise in inequality—not the slowdown in overall economic growth—is the more important reason why living standards growth slowed so radically for the vast majority in recent decades. Contrary to the arguments of those looking to prioritize efforts to boost overall growth rather than focus on progressive redistribution, the rise in inequality after 1979 has done more than the slowdown in average growth to impede living standards gains for the bottom 90 percent of American households relative to previous historical periods.
The rise in inequality is the predictable outcome of policy changes enacted in the post-1979 period. Over the last few decades a large portfolio of policy changes has had the predictable effect of redistributing the benefits of economic growth to households at the top of the income distribution. These policy changes include the near-abandonment of full employment as a policy goal, cuts in top tax rates, the deregulation of finance, and a host of measures that eroded labor standards and institutions that buttressed bargaining power of low- and middle-wage workers.
Many of the policy decisions that increased inequality in recent decades also deeply damaged overall growth. For example, the failure to aggressively target full employment and the effort to deregulate the financial sector both clearly led to slower overall growth and redistributed income toward the highest-income households. In short, the aggregate data show a clear association between regressive redistribution and slower growth.
Many items on the modern progressive economic agenda would boost growth and halt the rise in inequality. Despite much handwringing by those arguing against it, the broad distribution-focused agenda of progressives elevates many policy changes that would unambiguously boost overall growth rates as well as stop the rise of inequality. For example, investments in infrastructure and early childhood education would provide faster average growth and would distribute benefits more widely. In short, the modern progressive agenda is both pro-growth and explicitly aimed at progressive redistribution.
The modern “growth first” agenda that is commonly promoted would have trivial effects on overall growth but would regressively redistribute income. Key items on the agenda of those claiming to focus on growth over redistribution, such as signing more trade agreements, cutting tax rates, and reversing federal regulations, would provide at best trivial overall growth payoffs. Worse, the regressive redistribution that would result from these policies would have a net negative effect on living standards for the vast majority of American households.
Some items on the modern progressive agenda would progressively redistribute income without harming overall growth and these items are crucial to do. A substantial body of research indicates that many policy interventions that would lead to a progressive redistribution of income are essentially irrelevant to overall growth rates. This is important good news; it means that the zero-sum nature of income redistribution can be put to use to increase, not just suppress, growth for the bottom 90 percent.
Policies that are growth-neutral overall but strongly progressive in distribution generally work by increasing the economic leverage and bargaining power of low- and moderate-wage workers in the labor market. This largely means either rebuilding labor standards that have eroded or adopting modern labor standards that America has largely ignored for too long. Examples include raising minimum wages, restoring rights to collective bargaining, ensuring overtime rights for a broad class of salaried workers (as just accomplished with a new rule from the U.S. Department of Labor), adopting more-generous unemployment insurance, and instituting new paid leave rights. All of these measures—which are part of EPI’s Raising America’s Pay (RAP) agenda, can help shift bargaining power in the labor market away from capital-owners and corporate managers and back to low- and moderate-wage workers. The research on this (from EPI’s RAP research and other sources) shows that there is little to nothing to fear about the growth and efficiency consequences of such policies, but that they hold great promise in restoring the share of income claimed by the bottom 90 percent. There are even some reasons to believe that these efficiency-neutral progressive policies may help ameliorate a key growth problem: the chronically slow growth of aggregate demand (“secular stagnation,” in the jargon) that has plagued advanced economies in recent decades.
Background
The rise in inequality in recent decades has been essentially zero-sum, at best. The evidence strongly indicates that overall growth rates in recent decades were not buoyed by the large regressive redistribution of income that occurred during that time. Consequently, gains at the top were not financed by faster overall growth, instead they were achieved at the expense of decent living standards growth at the bottom and middle of the income distribution.
To put it simply, the rise in inequality has easily been the biggest factor driving underperformance of income growth for the bottom and middle. We define this underperformance in two ways in this paper. The first is essentially definitional—income growth for the bottom 90 percent of households that significantly lags economy-wide average growth (that is, slower growth than what the economy could have delivered to all households). That is, any increase in inequality should be seen as a potential economic policy failure. The second definition of underperformance is simply income growth for the bottom 90 percent that is significantly slower than what these households experienced in earlier economic eras.
In this paper we label the entire bottom 90 percent of American households the “vast majority” and examine trends in their living standards over time. We often compare their economic outcomes to average outcomes—outcomes buoyed by large gains in the top 10, 5, or 1 percent of the income distribution. We will also occasionally (and more depressingly) compare outcomes for the bottom 90 percent directly with outcomes achieved by the top 10, 5, or 1 percent.
The bottom 90 percent is obviously a heterogeneous group in a lot of ways: households in the bottom 10 percent of the income distribution are obviously poor in any reasonable sense of the term while households at the 90th percentile are awfully privileged relative to many others in this group. But we still think it’s a useful group to examine. One point in favor of using this “vast majority” concept is data availability: it allows us to use a dataset from Thomas Piketty and Emmanuel Saez that does not differentiate between households in the bottom 90 percent to make comparisons over time. It is also worth pointing out that average income growth for the entire bottom 90 percent of American households has lagged lag far behind the economy-wide average in recent decades. And the difference between growth rates at the 20th percentile and 90th percentile is much smaller than the difference between growth rates at, say, the 90th percentile and the 99th percentile. In short, while this bottom 90 percent is a very expansive group, its members have experienced a pretty common trajectory in income growth in recent decades, so we think it makes sense to examine their experience as a group.
Since the rise of inequality has been the biggest cause of disappointing income growth for the vast majority, reversing (or at least stopping) this rise in inequality is obviously key to accelerating future living standards’ growth for this group. In short, an economic strategy that does not aim to explicitly confront inequality would severely shortchange the living standards of the vast majority. Given this, it is bizarre indeed to argue that policymakers should not make it a priority to reverse (or at least stop) recent decades’ trends toward greater inequality.
Those arguing for ignoring distribution and focusing only on growth often claim (at least implicitly) that progressive redistribution and growth conflict, and that strategies aimed explicitly at progressively redistributing income will hamstring overall growth. In fact, recent economic history in the U.S. strongly indicates that it is regressive redistribution and growth that are in conflict; the package of policy changes that led to the rise in inequality did nothing to boost overall growth of the economy. Instead, as inequality rose, overall growth rates fell. In short, equity and efficiency are often not in conflict. And an ambitious agenda that restores economic power to the vast majority can make the economy grow both fairer and faster.
Inequality is sharply up in all high-quality datasets
Recent trends in income inequality and concentration are summed up in Table 1. In recent speeches, Senator Elizabeth Warren has cited a statistic indicating that between 1980 and 2014, the bottom 90 percent of American households (our “vast majority”) have seen no income growth, while the top 1 percent have accounted for nearly two-thirds of the rise in average incomes. For an advanced economy, this is a stunningly poor performance in generating income growth for the vast majority, and is also a marked change relative to earlier periods that Warren highlights. For example, between 1935 and 1980, the bottom 90 percent accounted for roughly 70 percent of average income growth.
Senator Warren’s numbers are based on the groundbreaking inequality research of Thomas Piketty and Emmanuel Saez. The Piketty-Saez data are based on analysis of cash, market-based incomes tracked by individual income tax returns—basically wages and salaries, interest, rental payments, dividends, business income, and capital gains.
While the Piketty-Saez dataset is universally considered high quality, some have criticized using it to infer trends in living standards on the grounds that it fails to account for government transfers (both cash and noncash) and noncash market-based income (mostly employer-provided health insurance premiums) that have boosted incomes for the vast majority over recent decades.
Is there anything to this critique? A little. It is clearly true that incomes for the bottom 90 percent are higher and rise faster post-1979 if one includes growth in government transfers and nonwage employment benefits. But it is also clearly true that the enormous rise in inequality in recent decades is entirely driven by the cash, market-based income tracked by the Piketty-Saez data, and that this rise in cash, market-based income inequality leads to a sharp rise in overall income inequality as well.
Table 1 displays some Piketty-Saez data as well as data on comprehensive income (including government transfers and employer-provided benefits) for various periods. These data on comprehensive income come from the Congressional Budget Office (CBO). The table calculates the average annual income growth rate as well as the share of average income growth accounted for by the income growth of top 1, top 5, top 10, and bottom 90 percent households over various periods.
Table 1
While the Piketty-Saez data show a more extreme rise in inequality in the post-1979 era than do the CBO data, the top 1, 5, and 10 percent of households still account for extremely disproportionate shares of overall growth even in this comprehensive income data. For example, the bottom 90 percent account for just 8.6 percent of average income growth in the Piketty-Saez data between 1979 and 2007—the last year before the Great Recession hit. Over this same period the bottom 90 percent accounted for a bit over a third (36.3 percent) of average income growth in the comprehensive income data—but still less than the 38.5 percent accounted for by just the top 1 percent. It is odd to claim that comprehensive income data fundamentally disprove the idea that rising inequality has kept average income growth from fully reaching the bottom 90 percent; even using these data, the bottom 90 percent accounts for less income growth than the top 1 percent.
The Piketty-Saez data (which, unlike the CBO data, extend back before 1979) show that growth rates were much more equal between income groups in the pre-1979 era, and that average income growth was much more broadly based, with the bottom 90 percent accounting for almost two-thirds (65.9 percent) of average growth from 1947 to 1979.1
Two benchmarks to measure the underperformance of income growth for the vast majority
Much political rhetoric takes as given the disappointing economic trajectory of the bottom 90 percent of American households in recent years. We think that the economic facts support this political rhetoric, and suggest two benchmarks to assess income growth for the vast majority.
The first benchmark compares the income growth of the bottom 90 percent with average income growth. This average growth can be (and indeed has been) buoyed significantly by very fast growth rates at the top of the income distribution. Yet the fact that the top 1 percent of households saw cumulative comprehensive income growth of a staggering 245 percent (4.5 percent annual growth compounded over 28 years) between 1979 and 2007 tells us very little about how the bottom 90 percent fared.
The second benchmark compares income growth for the vast majority between 1979 and 2007 with such growth in an earlier economic epoch, specifically growth between 1947 and 1979. This is a key comparison often made in the debate between those arguing that overall growth should be policymakers’ key priority versus those arguing for progressive redistribution. Knowing the facts of the income slowdown for the vast majority that occurred in the second period will be useful in that regard.
Why do we highlight trends until 2007 even though data are available after that year? Because income trends for all groups post-2007 are dominated by the effects of the Great Recession. It is no puzzle why income growth was been weak since then—the degree and length of income weakness may be surprising, but it is easily explainable. In this paper we are more interested in longer-run changes in the policy environment that have steadily redistributed income upwards over the years. In years to come, the income weakness that can be attributed to the effects of the Great Recession will have (hopefully) faded, and these longer-run determinants will reassert themselves, but for now we think ending the data analysis in 2007 still provides a cleaner snapshot of their effects.
Benchmark one: vast majority versus overall average growth, or, the rising “inequality tax”
Figure A provides the clearest look at our first benchmark. Using the CBO comprehensive income measure, it shows the average income of the bottom 90 percent. It also shows what incomes of the bottom 90 percent of households would have been in each year since 1979 if they had grown at the same rate as average household income. In short, this tells us what income growth the vast majority could have seen had inequality not increased since 1979. We should be clear that the United States was an unequal country in 1979, with average incomes of the top 1 percent 11.8 times as large as average incomes of the bottom 90 percent. The benchmark being proposed here is not some platonic ideal of perfect equality. Instead, the benchmark is simply a stable level of already considerable inequality.
Figure A
As the figure shows, had inequality not increased after 1979, the bottom 90 percent would have had incomes roughly 20 percent higher in 2007, the year before the Great Recession struck. This translates to more than $14,000 lost to inequality in that year alone. This can be thought of as an “inequality tax”—an annual chunk of money that could be, but is not, boosting the living standards of the vast majority simply because of the rise in inequality. It is important to note that the incomes of the bottom 90 percent between 1979 and 2007 were buoyed by strong growth in government transfers. It is far from certain that the pace of growth in these social insurance and income support policies will be maintained going forward.
The most common objection to the claim that growing inequality imposed a tax on incomes of the vast majority is that this rise in inequality was somehow necessary to generate any rise at all in average income growth, and that efforts to progressively redistribute income going forward will cause a reduction in this average growth rate. That is, while efforts to brake or reverse the increase in inequality may allow the bottom 90 percent to take a larger share of the overall pie, these same efforts will shrink the overall size of the pie enough to make this group worse off in absolute terms. There is no serious evidence to support this claim, as we’ll show in a later section. But for now, it is unambiguously true that as a matter of arithmetic, the economy in 2007 could have delivered 20 percent higher incomes to the bottom 90 percent of households but for the effect of rising inequality over the previous three decades.
Benchmark two: bottom 90 percent income growth in previous periods
Our second benchmark looks at the slowdown in income growth for the bottom 90 percent between 1979 and 2007 relative to the three decades before 1979 (as shown in the bottom portion of Table 1). This growth slowdown for the vast majority is driven by two factors: a sharp reduction in overall (average) income growth post-1979 and a rise in inequality that drove a large wedge between overall income growth and growth for the bottom 90 percent.
Participants in the debate over whether policymakers should focus on overall growth versus checking or reversing the rise in inequality often point to comparisons between these periods as a way of privileging the importance of growth. For example, in the latest Economic Report of the President (for the year 2015), the Council of Economic Advisers (CEA) wrote a chapter, “Middle-Class Economics,” that seemed to say that the impact of declining overall growth dwarfed that of regressive redistribution on stunting middle-class income growth. This is not true. For household income, the role of redistribution is at least as important as the overall slowdown in growth in restraining income growth for the bottom 90 percent.
Our first cut at the issue looks at growth rates using the Piketty-Saez data, which let us calculate average annual growth rates of cash, market-based incomes of the bottom 90 percent since 1947. The results are striking: annual income growth slows from 2.1 percent in the 1947–1979 period to 0.2 percent in the 1979–2007 period.
But the objection noted above about the Piketty-Saez data remains: by not counting government transfers and employer-provided benefits the data understate the rise in incomes for the vast majority. This is certainly true: the average growth rate of income of the bottom 90 percent is substantially higher after 1979 in the comprehensive income data—0.9 percent annually between 1979 and 2007. But this begs the question of how much transfers and employer-provided benefits contributed to growth in the earlier period. If the rate of growth of transfers and employer-provided benefits was similar in the two periods, then the slowdown in income growth for the vast majority identified in the Piketty-Saez data will be just as extreme.2
And in fact the overall growth of transfers and employer-provided benefits was significantly more rapid between 1947 and 1979 than thereafter. Hence, by our second benchmark, it is clear that income growth for the bottom 90 percent absolutely decelerated radically after 1979. As we detail in the next section, the role of inequality looms large in this slowdown in growth for the vast majority.
Have the bottom 90 percent been hurt more by rising inequality or slower growth?
The slowdown in income growth for the vast majority is well-recognized. A common diagnosis for why income growth for the bottom 90 percent has slowed so significantly is that overall economic growth has slowed in the U.S. beginning in the 1970s. There is a lot of truth to this: overall economic growth in the U.S. was indeed slower after 1979 relative to the decades before. For example, dividing total personal income as tracked by the National Income and Product Accounts (NIPA) by the total number of households in the U.S. produces an annual average rate of growth of 1.9 percent between 1947 and 1979, and 1.6 percent between 1979 and 2007. This overall growth slowdown was driven both by a slowdown in the growth of productivity (income produced in an average hour of work in the economy) as well as a slowdown in the growth of the labor force.
This slowdown in productivity growth starting in the 1970s looms very large indeed in the minds of economists; it is perhaps the most-studied event in American economic history. However, even relative to this average growth slowdown, the rise in inequality has played a huge role in the income slowdown for the vast majority. In fact, the rise in inequality is responsible for roughly two-thirds of the slowdown in income growth for the bottom 90 percent between 1979 and 2007.3 That is, the rise of inequality has played an even bigger role in the slowdown of incomes for the bottom 90 percent than the overall slowdown in economic growth.
Figure B shows trends in comprehensive income growth for the bottom 90 percent of the household income distribution. The highest line in the figure shows how much bottom 90 percent income would have grown had overall income growth maintained its pre-1979 pace and inequality had not widened in the post-1979 period. This is calculated by taking the post-1979 pace of average growth (in the CBO data) that excludes capital gains (1.4 percent) and multiplying it by 1.2 to get 1.7 percent growth. This 1.2 is the ratio between average growth rates of NIPA personal income divided by total households in the 1947–1979 and 1979–2007 periods referenced above. We think this ratio is a useful proxy for what growth in CBO-measured comprehensive income would have been in earlier periods. We exclude capital gains because they are not included in the NIPA data and so might have different trends. This exclusion of capital gains makes our inequality measure quite conservative, as capital gains are extraordinarily concentrated in the top 10 percent of the income distribution.
This top-line number represents a best-case scenario in which overall growth does not slow and inequality does not rise. The middle line shows what bottom 90 percent income growth would have been if it matched actual average income growth post-1979. The gap between the top two lines isolates the impact of the slowdown in overall growth. Finally, the bottom line shows cumulative income growth for the bottom 90 percent. The gap between the bottom and middle lines is simply the measure of the “inequality tax” we identified before, and it shows the contribution of rising inequality to keeping bottom 90 percent income growth below average growth.
Figure B
The growth slowdown certainly matters. If growth had kept its pre-1979 pace, cumulative income growth for the bottom 90 percent would have been roughly 10 percentage points higher by 2007 even had inequality followed the same path it took in those decades. But rising inequality stunted income growth even more—cumulative income growth for the bottom 90 percent would have been nearly 20 percentage points higher had pre-1979 average growth not persisted but also had inequality not risen. This isolates the effect of rising inequality on the income slowdown for the bottom 90 percent between 1979 and 2007. In short, rising inequality accounts for roughly two-thirds of the income growth slowdown for the bottom 90 percent between 1979 and 2007. This is an awfully large portion of the problem to ignore, which is implicitly what the “growth first” proponents are suggesting.
The previous section has demonstrated that ignoring questions of distribution will radically blunt what can be done to boost income growth for the vast majority, simply as a matter of arithmetic. Further, as we will show later, it is much easier and more certain to potentially affect distribution through policy levers than it is to use these levers to boost the economy-wide growth rate. Yet this has not stopped many pundits and policymakers from insisting (with very little evidence) that sidelining distributional concerns in favor of (usually unspecified) measures meant to promote growth should be the strategy of those concerned with the income growth of the bottom 90 percent.
The crucial and strange role of increased health spending—particularly transfers—on personal income
The large difference between the Piketty-Saez and CBO reports of income growth for the bottom 90 percent is attributable primarily to the CBO’s inclusion of government transfers and nonwage employer benefits. Health care spending dominates both of these income flows, and the per capita cost of health care has risen extraordinarily rapidly in recent generations. Transfer payments and employer contributions to health insurance premiums would need to rise rapidly just to keep living standards constant.
There are a number of conceptual hurdles to properly accounting for the value of health care transfers in calculating changes in household income.
One hurdle is figuring out how to interpret large increases in nominal income dedicated to purchasing health care. Determining how much of that nominal increase translates into an increase in real (inflation-adjusted) household income depends on the deflator applied. Official health care price indices (such as those constructed by the Bureau of Labor Statistics and Bureau of Economic Analysis) indicate that there has been very little gain in real health care spending in recent decades. But this is hard to believe: given the technological improvements, few Americans believe that the health care available to them today is not better and more valuable than what was available to people in 1979.
Of course, there is a related question of whether American households in 2016 would be willing to trade their bundle of health care goods and services—including their costs—for what is available to French (or Canadian or British or Japanese) households in 2016. Given that health care prices in America are substantially higher than health care prices in other advanced countries, and yet many measures of utilization and health care effectiveness are higher in our peer countries, this might well be a trade many would find worth doing.
Another hurdle, particularly in the case of transfers, is figuring out how to allocate the benefits of increased spending on health care goods and services. For example, poor households that do not receive Medicaid surely are able to consume less health care on average then poor households that do receive Medicaid, but is it true that the full benefits of the dollar value of average Medicaid spending flows only to recipients and not simply to higher incomes for medical providers? Take instances when uncompensated health care is provided to poor families in the absence of Medicaid. In those cases, the Medicaid benefits will (at least in part) serve to compensate providers for providing the care they would have provided anyway. A recent paper by Finkelstein, Hendren, and Lutter (2015) estimates that each dollar spent on Medicaid by federal and state governments boosts the consumption of health care by recipient families by only $.20 to $.40, with the remainder accruing to higher incomes for health care providers.
A final hurdle is the issue of how much non–health care consumption is made possible through a transfer of Medicaid benefits to low-income families. Say that a family has zero non-Medicaid income but then qualifies for Medicaid, which spends an average of $10,000 per year on beneficiaries. Does this Medicaid transfer really benefit this family’s income by a full $10,000? For years the Congressional Budget Office only counted the “fungible value” of Medicaid and Medicare as additions to comprehensive income. The fungible value is the smaller of (1) the average value of Medicaid benefits and (2) the difference between a household’s non–health care income and what it needs to spend on basic food and housing needs. The intuition behind this fungible measure of Medicaid’s value is that only income boosts that provide purchasing power over and above the basic needs of food and housing should be counted as additions to household income. The difference between the fungible value of Medicaid and Medicare and the full-value approach currently used by the CBO can be substantial.
Given all of these conceptual hurdles to properly accounting for the value of health care transfers in calculating household income, an obvious solution is to simply stop trying to account for this value and instead report non–health care related incomes and health care related incomes separately. Non–health care related incomes can be deflated with the CPI-U-RS, as before, while health care income growth can be compared not just with official price indices, but with health outcomes to gauge the effectiveness of higher nominal spending in creating welfare. Figure C shows the trajectory of non–health care related incomes and health care incomes for the bottom 90 percent of households. Segregating health care related incomes significantly slows the growth of non-health care related incomes, which rose a third slower (18.8 percent versus 27.5 percent) between 1979 and 2007, and about half as rapidly (11.2 percent versus 21.2 percent) between 1979 and 2011.
Figure C
Does progressive redistribution necessarily hurt growth?
The diagnosis that the slowdown in overall growth is the chief problem confronting the vast majority of American households has led to prescriptions claiming to focus on boosting this overall growth. Those making these recommendations often claim (at least implicitly) that policies distributing growth more broadly are always and everywhere inimical to faster overall growth. That is, they claim that one must choose either faster overall growth or progressive redistribution, and that choosing to pursue one of these goals will mechanically make the other goal harder to achieve.
“Growth only” voices in the ‘redistribution’ versus growth debate
If you talk to leading progressives these days, you’ll be sure to hear this message: The Democratic Party should embrace the economic populism of New York Mayor-elect Bill de Blasio and Massachusetts Sen. Elizabeth Warren. Such economic populism, they argue, should be the guiding star for Democrats heading into 2016. Nothing would be more disastrous for Democrats. … The political problems of liberal populism are bad enough. Worse are the actual policies proposed by left-wing populists. The movement relies on a potent “we can have it all” fantasy that goes something like this: If we force the wealthy to pay higher taxes (there are 300,000 tax filers who earn more than $1 million), close a few corporate tax loopholes, and break up some big banks then—presto!—we can pay for, and even expand, existing entitlements. Meanwhile, we can invest more deeply in K-12 education, infrastructure, health research, clean energy and more. (Cowan and Kessler 2013)
For many years, Democratic efforts to reduce inequality and lift middle-class wages were based on the theory that the key is to improve the skills of workers. … But a growing number of populist progressives have been arguing that inequality is not mainly about education levels. They argue that trying to lift wages by improving skills is an “evasion.” It’s “whistling past the graveyard.” The real problem, some of them say, is concentrated political power. The oligarchs have rigged the game so that workers get squeezed. … Or it’s about corporate power. Without stronger unions shareholders reap all the gains. … The implication? … Put redistribution first. … Unfortunately, this rising theory is wrong on substance and damaging in its effects. (Brooks 2015)
The economic debate is now sharply focused on the issue of income inequality. That may not be the debate Democrats want to have, however. It’s negative and divisive. Democrats would be better off talking about growth—a hopeful and unifying agenda. (Schneider 2014).
A Better Campaign Theme Than Inequality: Income disparity doesn’t much worry America. Advocating for growth holds more promise. (Galston 2015)
But there is nothing in the economic research that suggests a generalized tension between progressive redistribution and growth. Further, many measures that are often considered exercises in progressive redistribution actually have strong, positive impacts on overall growth. And many measures that are considered first and foremost as growth-promoting also have progressive distributional impacts. And other measures put forward as growth-promoting actually produce very little overall growth and instead serve primarily to redistribute income upward. Finally, many measures really do seem to just operate on distribution without affecting overall growth. This means that if implemented they can indeed boost incomes of the bottom 90 percent without slowing average growth. Again, the zero-sum logic of past decades’ regressive redistribution can be reversed to favor the bottom 90 percent.
Economic research on general relationships between growth and inequality
The links between growth and inequality are extraordinarily well-studied. But much too often policymakers and researchers set the bar for redistributive policies far too high by looking for unambiguously positive impacts on average growth rates. While some studies have indeed found a statistically significant positive relationship between increased equality and increased growth, this is not a robust generalized finding. Most common is research showing an insignificant relationship between growth and progressive redistribution.
However, for those concerned with boosting the income of the vast majority, the burden is not on those calling for progressive redistribution to prove that such measures will boost overall growth. Instead, the burden is on those seeking to block such redistribution to show that such measures unambiguously hurt overall growth (specifically, a statistically significant generalized negative relationship between increased equality and growth). And fewer studies have shown a negative relationship between progressive redistribution and growth than have shown a positive relationship.
The large majority of studies have found no conclusive, generalized relationship between inequality and overall growth. What this means is that efforts to progressively redistribute economic power and income have no predictable effect on growth rates. And if overall growth is unaffected by redistributing income downward to the vast majority, then progressive redistribution unambiguously boosts incomes for those households.
Redistribution and inequality in the United States have had the following broad historical pattern: a strong association between stable income shares (i.e., no increase in inequality) and rapid overall growth right after World War II followed by rising inequality and notably slower growth in the three decades before the Great Recession. That is, rising inequality is associated with slower growth. This broad association remains even when researchers undertake more systematic attempts to establish a link between rising inequality and aggregate economic performance, and it remains when researchers examine international or state-level data.
For example, Piketty, Saez, and Stantcheva (2011) examine the relationship between top marginal tax rates, top income shares, and aggregate economic performance, both in U.S time-series data as well as using data from an international panel of 18 Organization for Economic Cooperation and Development (OECD) countries. They find strong evidence that falling top marginal tax rates are associated with higher pretax top income shares (rising inequality). However, they do not find a strong association between either falling top marginal tax rates and rising economic growth or (for the U.S. data) rising top income shares and faster economic growth. They also find significant evidence that falling top marginal tax rates are associated with slower income growth for the bottom 99 percent of households. They take this constellation of evidence as supporting a “bargaining model where gains at the top have come at the expense of the bottom.”
Andrews, Jencks, and Leigh (2011) find slightly mixed evidence on the larger issue of top income shares and subsequent growth, with increases in the share of income accruing to the top 10 percent positively (and generally with statistical significance across regression specifications) related to subsequent overall growth in their preferred regression models. They note the modest economic impact implied by their results: “But at the very least, the 95 percent confidence intervals for our preferred estimates appear to rule out the claim that a rise in top income shares causes a large short-term increase or decrease in economic growth. The claim that inequality at the top of the distribution either benefits or harms everyone therefore depends on long-term effects that we cannot estimate very precisely even with these data.” Most importantly for the question at hand, these results are driven by what is happening between the 90th and 99th percentiles. They note: “The top 1 percent’s share is never both positively and significantly related to the growth rate.”
Thompson and Leight (2012) have recently used a different sort of panel to examine the relationship between top income shares and growth—a panel looking at the top 1 percent within individual U.S. states. Their analysis finds that a rising share of income accounted for by the top 1 percent is associated with falling subsequent growth in incomes and earnings for households in the middle of the distribution, while having no significant effect on growth at the bottom of the distribution. Further, their finding on the statistical significance of the depressing effects of rising top shares on middle incomes is fairly robust and survives the inclusion of a range of covariates (though its economic impact is relatively modest).
We should end by repeating something important about where the burden of proof needs to lie in the debate over the effect of inequality on growth. If one is seeking to maximize the incomes of low- and moderate-income households, the burden of proof is clearly on the side claiming that increased inequality significantly boosts growth. If that side is wrong and inequality instead restricts growth, then clearly low- and moderate-income households will gain from a move toward a more equal distribution. Importantly, even if distribution is completely neutral with respect to growth, the incomes of low- and moderate-income households can be boosted by redistributing from the top. Our claim here is modest: the empirical research that has directly examined the effect of rising inequality on overall economic growth certainly does not suggest that inequality strongly boosts growth. And as long as the shift of income to the top of the distribution is not associated with improved overall growth, then the rest of the income distribution is harmed. Again, the zero-sum character of much of the regressive redistribution of income towards the top we have seen in past decades can be put to work in reverse to progressively redistribute toward the bottom 90 percent without harming overall growth rates. This makes reversing this upward redistribution a key policy priority, and one unlikely to come at the cost of slowing overall economic growth.
The importance of moving from general to specific when debating redistribution and growth
In one sense it is not surprising that there is no durable generalized relationship between progressive redistribution and overall growth rates. Progressive redistribution could occur in a number of ways. Some of these ways could indeed harm overall growth. The forcible expropriation of private-sector assets, for example, is unlikely to be growth-enhancing. Other measures aimed at progressive redistribution could have powerful growth-promoting effects: for example, providing income to families with children in the form of paying for high-quality universal prekindergarten education.
This means that the debate over distribution versus growth really needs to move quickly away from generalities and to specifics to be of any use. A number of items that have emerged on the progressive economic agenda in recent years would clearly have strongly positive effects on both growth and equity.
Policies that boost both overall growth and progressive redistribution
Today’s progressive economic agenda essentially involves three major planks. First, use the tools of macroeconomic stabilization to ensure that the economy reaches genuine full employment so that it is not leaving money on the table in the form of unemployed workers and unused productive capacity. Second, boost investment where the market is not doing enough—both in “core infrastructure” projects as well as in “noncore” public investments with the potential to pay large returns, as identified by independent research. Third, use either legislation or regulatory tools to blunt the impact of market failures and to ensure competition.
All three of these planks require effective public structures and well-run government. But they are not just limited to a government that taxes and spends. To be clear: smarter and fairer taxing and spending needs to be a key part of the progressive agenda. But too often the fiscal tax-and-transfer system becomes the only policy response to rising inequality. We can do better than this through a range of policy changes that affect pre–tax-and-transfer distribution to make economic growth both fairer and faster.
Testing the true limits of full employment
A core plank of progressive economic strategy is to use the levers of macroeconomic policy (monetary, fiscal, and exchange-rate policy) to target genuine full employment One of these major levers—fiscal policy—has been redirected to actually impede recovery from the Great Recession in recent years through unnecessary austerity. This has led advocates for targeting full employment to more recently focus on trying to convince the Federal Reserve to hold off on interest rate increases (or to at least adopt a very slow pace of increases) until unemployment is low enough to actually spur across-the-board wage growth.4
Using macroeconomic policy to boost demand and target genuine full employment would clearly be good for overall economic growth. An economy with 4 percent unemployment generates more income than one with 5 percent unemployment. Further, tight labor markets spur wage increases which can in turn spur firms to invest in labor-saving technologies that spur productivity growth. But this policy also has strongly progressive effects. The wage growth of low- and moderate-wage workers benefits more from lower rates of unemployment than wage growth of workers at the top of the wage distribution. More than their high-wage peers, these low- and moderate-wage workers need high pressure labor markets to give them bargaining power to demand wage increases .
Yes, there is a limit to how much growth can be wrung out of the system by supporting demand growth through more expansionary fiscal, monetary, and exchange-rate policy. But we are not at this limit yet, and it is clear that we should be absolutely sure the economy is at this limit before we stop using these tools.
Making investments that the private sector is not
Productivity growth has been decelerating for the last decade. This is driven in part by sluggish growth in business investment in plants and equipment. When businesses do not want to invest even during times of historically low interest rates, we do not have to throw up our hands in despair. We can instead mobilize capital and invest it productively through the public sector. A solid base of research indicates that there are plenty of high-return public investments out there to make.
Investing in early childhood education
Probably the most popular item on the progressive economic agenda is an expanded investment to make high-quality prekindergarten education available to all children. The economic benefits of high-quality early-childhood education are enormous and extraordinarily well-documented.5 These benefits are so large that over the course of decades such an investment will be fully self-financing even in narrow fiscal terms.6
And these benefits come in part in the form of a higher quality labor force that will boost future growth. This investment is also strongly progressive. Currently, spending on children’s enrichment is much higher for high-income families. Measures to make high-quality early-childhood education universally affordable will hence constitute large transfers directly to poor and moderate-income households (for more on the benefits of an ambitious investment in early child care and education, see Bivens et al. (2016).
Investing in infrastructure
Even before the Great Recession there were calls to restore public investment levels that had fallen dramatically in recent decades. In the early 1990s, a substantial body of literature identified the slowdown in public investment as a key driver of the slowdown in productivity growth that began in the early 1970s. The productivity acceleration that began in the late 1990s—driven largely by investment in information and communication technology equipment—took the issue of slow productivity growth off of the policy radar for a number of years.
However, productivity growth began decelerating before the Great Recession and since 2007 (the last business cycle peak) productivity has grown as slowly as it did from 1973 to 1995. In short, sluggish productivity growth is clearly back on the policy radar. Aside from a short burst associated with the American Recovery and Reinvestment Act (ARRA) of 2009, public investment has also continued to decline as a share of the overall economy in recent years.7
Bivens (2012a) notes that a new wave of research on the productivity impacts of public investments strongly indicates large returns from greater public investment. In fact no other policy is as likely to reliably boost productivity growth in coming years as an expansion of the public capital stock.
Nontraditional public investments
The evidence surveyed in Bivens (2012a) applied mostly to “core” public investments: infrastructure, roads, highways, and sewer systems. However, Bivens (2012b) points to several noncore areas of public investment shown by independent research to be strongly productivity-enhancing. Early childhood education, “green investments,” school construction, and public health care financing all provide large economic benefits.
Further, a growing body of research indicates that many programs considered first and foremost as income-support programs—such as the Supplemental Nutritional Assistance Program (SNAP, or food stamps) and Medicaid—have a strong investment component to them as well. This investment function is in the form of the improved prospects for a healthy and productive life that they provide their beneficiaries (particularly children).8
Policies to ensure that markets are competitive and efficient
For too many people pontificating about the need to make overall growth the top priority, regulation is a bogeyman. This shows a deep misunderstanding of basic economics. While regulations sometime seek to target non-economic goals or to redistribute economic gains, more often they aim to provide a correction to obvious market failures. These market failures can include a tendency for certain industries to become concentrated and noncompetitive, the existence of “externalities” (economic costs of a given activity that do not have to be paid by those undertaking the activity), or asymmetric information in key markets such as finance. The role of government in ensuring that markets remain competitive and efficient is one that not just makes the economy fairer, it also makes it more efficient.
Policies to ensure that markets remain competitive and to restrain monopoly power
Recently, many have argued that the progressive economic agenda should include measures to check monopoly power and ensure that markets remain competitive. For example, it is now widely recognized that a key driver in the rapid growth of American health care costs in recent decades has been the rapid growth in the prices of pharmaceuticals and medical devices—both industries are granted monopoly protection through patents. This monopoly power provides market power and shields these industries’ profits from competition, and skews incentives in other ways. For example, the benefits of patenting a new drug lead to clear incentives to cut corners in the testing process.
The large increase in the share of overall national income claimed by capital-owners instead of employees suggests that growing market concentration across the entire economy may be happening, providing firms with excess profits and reducing households’ living standards by raising prices above competitive levels.9
The effort to ensure that markets are competitive does not have to rely just on antitrust regulation, however. There are many opportunities to introduce competition to private markets by offering consumers a public option. The most famous public option was the proposal in early versions of the Affordable Care Act (ACA) to allow people to buy health care from a government-run insurance plan. This remains a good idea that should be a key focus of efforts to continue the valuable reform started by the ACA.
Further, the public option logic—simply offering a choice to consumers when private markets become concentrated or dysfunctional—applies to many other markets. For example, American housing finance should include a truly public option instead of the destructive public/private hybrid that the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac were before the 2008 crisis. That is, housing finance should be run by public employees who are paid well but not with the obscenely large salaries earned by the GSE directors before the crisis. And if private-sector financial institutions want to compete on price and service with the public GSEs, they should feel free.
A public option for retirement savings would also be an excellent idea. As recent regulations promulgated by the Department of Labor make clear, Americans are too often ill-served by the financial advice they get from private planners. They are frequently steered into high-turnover retirement plans that generate large fees, which eat into their net returns. Having a government savings plan that pooled savings and managed them with very low fees (by putting the money in mostly passive index funds) would provide a huge service to American savers. By checking monopoly power, all of these efforts would boost both economic efficiency and growth as well as direct a large share of economic growth to workers and households instead of just owners of capital.
Finally, the same logic that argues for expanding public options for health insurance and retirement savings argues for expanding the existing public options we already have in those areas: Social Security, Medicare, and Medicaid.
Squeezing out wasteful rents in the financial sector
Another item high on the agenda of progressive economic reformers is to reregulate many of the activities of the financial sector. Much of the argument surrounding this need for reregulating finance highlights the role that this sector played in amplifying the economic shocks that led to the Great Recession.
However, an even more compelling reason to consider financial regulation a crucial part of the progressive growth agenda is simply that much of what finance does—manage risk and allocate capital—could be done for a lot less money. Finance has grown from 2.8 percent of overall gross domestic product (GDP) in 1950 to 4.9 percent in 1980 to 8.3 percent in 2006, its pre–Great Recession peak (Greenwood and Scharfstein 2013). Despite this growth in total income claimed by finance, a large body of research notes that productivity growth in finance has been stagnant over long periods of time, and that much of what the sector has been paid to do in recent decades is to hide, rather than manage, risk.10 Further, the fees and commissions that have played an outsized role in boosting the financial sector’s share of overall income arguably have not played an efficiency-creating role for the economy at large, and have served instead to simply enrich well-placed actors within finance.
The simplest part of the financial reform agenda that could squeeze out this kind of wasteful rent-seeking from finance would be the provision of a broad-based financial transactions tax (FTT). 11 A