Recently, a friend send me an opinion piece on the above-cited topic. Being a bit pressed for time, I typed up a relatively brief response and sent it off. Later, I decided that the matter needed a fuller treatment; hence this blog.
The presentation that follows has been heavily influenced by the thinking, research and documentation provided in two book; one by Joseph Stiglitz, a Nobel Prize winner in Economics (1), and Christia Freeland who has served as both reporter and editor for several financial publications including “The Financial Times”, “The Economist” and the “Washington Post ” (2).
Generally speaking, wealth can be distributed or redistributed across generations (e.g. inheritance) or across socio-economic strata (e.g. from rich to poor or vice versa). In this blog, the exclusive focus will be on the latter as it has become manifest in different objective metrics; for example, household income.
Going back 50 years to 1963, the country’s economic health and federal tax code were such that wealth and its growth (distribution) were occurring rather evenly for the working poor, the middle class and the upper five percent. The household incomes for these groups grew in parallel, with the growth curves for the three virtually sitting one on top of the other. This pattern persisted until 1984. In other words, throughout this 20 year period, everyone became better off, inflation notwithstanding, and any gaps in growth or distribution of wealth across households was statistically insignificant.
The election of Ronald Reagan in 1981 marked the beginning of a sea change in this history. The 40th president believed that he could unleash the power of the country’s economy by means of sweeping, across-the board tax cuts that disproportionately favored the wealthy who would then invest in new businesses and put their capital to work in other growth-inducing ways that would eventually “trickle down” to the less wealth. As Reagan famously promised “A rising tide lifts all boats”.
Now there is no question that Reagan’s economic policies elevated the country out of the stagflationary condition that existed when he took office. What is more, everyone prospered as household incomes grew. But, there began a striking acceleration in the growth of household incomes of the top five percent that left the middle and lower classes increasingly behind. Indeed, over the next 16 years, the gap between the household incomes of five percent and the rest of the population grew wider and wider, reaching its peak in 2000. Simply put, there was a massive redistribution of the nation’s wealth from the lower and middle classes to those above them. What is more, the peak disparity reached in 2000 remains in place today, in part because the nation’s tax policies have not changed, and the recession of 2008 has limited the growth of incomes in all households. None the less, from 1984 to the present, we have seen the rise of what Freeland has referred to as a “plutocracy”, and Stiglitz described as a “hollowing out” of the middle and lower classes.
Since the middle and lower classes comprise together, the single largest group of consumers, any reduction or leveling off of their purchasing power can only hurt the economy. Consumption slows because those people either have less to spend, or are economizing in the face of limited or no growth in their disposable incomes. Little wonder that over the last four years we have seen only paltry improvement in our gross national product (GDP) and weak job creation. Goods do not move off retailers’ shelves and showrooms so in the face of this low demand, there isn’t much incentive for manufacturers to hire more workers who would facilitate ramped up production.
Even before his election in 2008, President Obama was speaking of the need to “rebuild the middle class”. Contrary to claims by conservatives, the new president was not seeking to create equality across socio-economic classes (socialism), but to redistribute wealth in a way that reversed the “hollowing out” cited by Stiglitz. By adding to the disposable income of the middle class, their consumption should increase, driving production and hiring up in tandem. In turn, the newly employed (or re-employed) start to spend creating what economists call the “multiplier effect”. That is, a dollar spent on consumption finds its way back into the economy as a multiple of its original value.
With this 50 year history recounted, what does it tell us about the redistribution of wealth across socio-economic strata? In an economy like ours, any such transfer from bottom to top only works to everyone’s betterment if the recipients of the redistribution pump that largesse back into the economy in ways that promote the multiplier effect. If they use their added wealth to create more wealth only for themselves, then everyone else suffers. If the redistribution flows from the top down, then the goal should not be the equalization of wealth, but again, the stimulating of the multiplier effect. Putting more disposable income in the hands of a large consumer group like the combined middle and lower classes is a sure way to make that happen. That said, consider this slice of history that speaks well for the top-down approach: Back when Henry Ford was building his Model-T, he gave his assembly line workers a raise of .50 cents. He reasoned that by allowing them to make more, those employees would eventually be able to buy one of the cars they were putting together. The hoped for increase in Ford sales led to the construction of more gas stations to fuel those cars, to the construction of roads to accommodate them, and the placement of motels and other businesses along those thoroughfares. Ford was lauded as the creator of a “circle of virtue”. Later, economists renamed it “the multiplier effect”. This is perhaps the best example in our history of how top-down redistribution advanced by the private sector can put the engines of our economy into gear. The same thing can be done with a carefully calibrated federal tax policy that takes progressively more as one moves up the socio-economic ladder. The key is to leave everyone with sufficient money that can be pumped back into the economy in ways that set the multiplier effect into motion.
1. Stiglitz, Joseph; The Price of Inequality. New York: W.W. Norton, Co.; 2012.
2. Freeland, Christia; Plutocrats. New York: Penguin Press; 2012.