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Economists Discover Inequality

The Origins of Inequity

by JACK RASMUS

Much has been written over the past year about the growing income inequality in America, and how the wealthiest 1% households have accrued 95% of all the national income gains in the US economy since the June 2009 so-called economic ‘recovery’ officially began.

Liberal economists like Paul Krugman, Robert Reich, James Galbraith and others have writing numerous books and countless newspaper columns on the subject over the past year. They have finally discovered in recent years the sad fact of accelerating income inequality in America, a developing trend that has been in progress for decades, at least since the early 1980s. Actually, theirs has been less a ‘discovery’ than a re-reporting of work on the subject done by others.

While liberal economists have been reporting on income inequality, they have yet to explain why and how the growing concentration of income, and consequently wealth, in the hands of the 1% has been occurring and, indeed, why that inequality has been accelerating now after more than three decades. As the data conclusively show, the 95% of all income growth accruing to the wealthiest 1% households since 2009,noted above, represents an acceleration, from 65% of all income gains accruing to the 1% during the Bush years, 2001-08, and 45% during the Clinton years, 1993-2000.

While no doubt of value in itself, it is one thing to cite data that shows the irrefutable trend of income and wealth concentration; it is another to explain how and why that concentration has occurred and who is responsible for it—a responsibility that lies not with mystical categories like ‘the market’ or ‘globalization’ but with real individuals and policymakers in both business and government for the past 30 years.

The Emmanuel Saez Connection

The discovery of inequality was initially given its major boost more than a decade ago in the then pioneering work of Emmanual Saez, a French economist transplanted more than a decade ago to the University of California, Berkeley. Saez back in 2002 was the first to begin reporting the facts about growing income inequality in the U.S. since the early 1980s, based on previously unavailable data from the Internal Revenue Service. Prior to Saez’s work, other official sources of government data from the Bureau of Labor Statistics, Commerce Dept., Federal Reserve and Congressional Budget Office were, and still remain, notoriously limited and incomplete with regard to accurately estimating capital incomes. Of course, with regard to Krugman and others, better late than never to have ‘discovered’ inequality. But Saez is the real economist hero—not Krugman, Reich & company—having revealed for more than a decade now the more accurate (although in some ways still limited) facts about growing income inequality in America.

While having made a major contribution by more accurately describing the true dimensions of income inequality, Saez’s work has been weaker on identifying the fundamental causes of that growing income and wealth inequality. A professor of Public Finance (i.e. government spending and fiscal policy in general), Saez has focused his explanation of the causes mostly on the growing inequities of the tax system in the USA and other capitalist economies. To a lesser extent, he has also focused on the trend of senior executive pay in business, pointing out that in the last decade alone CEOs and senior corporate management have roughly doubled their share of total corporate profits—a not insignificant shift of income when ‘senior’ management is defined typically as the top half dozen to a dozen managers in a typical corporation.

But Executive Pay trends represent more an internal transfer of potential capital income’s rising share from stockholders and bondholders of a corporation to active CEO and senior management. What’s of more interest is how the overall share of incomes from Capital in general is rising at the expense of workers’ earned incomes, i.e. wages and salary incomes—and especially the sub-category of hourly wages and weekly earnings for the roughly 110 million production and non-supervisory workers in the U.S.

By addressing the role of the restructuring of the tax system that has been occurring for three decades in the US, shifting in favor of corporations and their wealthy 1% stock & bond holders in turn, Saez addresses an important element in the general explanation of growing income inequality. But in so doing, he omits the even more fundamental origins of income and wealthy inequality. The tax system changes are but one of a ‘three legged stool’ of income inequality forces at work. The tax system changes ensure that income generated at its source flows through the corporation to the owners of capital without being seriously diverted, or siphoned off, by the State and the tax system for other purposes. The ‘tax connection’ is thus strategic for understanding the income inequality trend, but it is not the whole story. It is more an enabling force than a fundamental causative force of income inequality.

Changing the tax system may therefore slow the process of income concentration, but does not address the origins of the problem at its source. The tax system is but one of three important elements of the income trend issue. For Saez to focus on it almost exclusively, providing an important contribution to understanding the trend, is not yet to provide a more complete explanation and understanding of the problem.

Thomas Picketty’s New Book

Working with Saez at the beginning of his work a decade ago on income and wealth concentration in the 20th century, Saez’s economics partner has been his collaborator, another French economist, Thomas Picketty, who recently published a major book called, Capital in the 21st Century. The book is getting a lot of traction and promotion from other liberal economists, like Krugman, from the liberal news media, as well as from the US business press, the latter of which is more interested in trying to debunk Picketty’s data.

The title of the book is somewhat misleading. The Picketty book is less about the changing nature and processes of global Capitalist Reproduction in its various forms in the 21st century—a work that is long overdue but not yet written. The book is more about the consequences of those changes; specifically the accelerating of capital incomes and the concentration of wealth accruing to capital owners. PIcketty’s book is best understood as a deeper and more historical representation of Saez’s work on in come inequality that proceeded it. We are still talking about the appearances of inequality; not its essentially origins.

In the book Picketty reveals that the wealthiest households, composed of those whose incomes are earned almost exclusively consisting of returns from capital, have in recent decades been increasing their wealth steadily at 5%-8% on average over the long term every year. And that’s been the case, whether in good economic times or bad. Moreover, the half dozen or so recessions in the US since 1980, including the recent ‘great’ one that began in 2007, seem to have had little long run impact on the accelerating concentration of income and wealth to the top 1% households. In stark contrast, Picketty’s book argues working families—recipients of what is called ‘earned incomes’ from wages and salaries—have barely maintained their incomes and standard of living during the best of times, while experience a reduction in income during recessions and not so good times.

What the income inequality trends revealed by both Saez and Picketty suggest, therefore, is not just that the wealthiest are accruing ever more percentage of the national income and wealth for themselves, but that the remaining bottom 80% working class households are stagnating at best, or actually declining in terms of real wages, real earnings, and real disposable income. The income inequality in America now means not only that the rich are getting richer; but that the middle and below are simultaneously getting poorer over the longer term.

What the Saez-Picketty work together suggests is that Income inequality is a two-headed monster. It occurs when the rich get richer in absolute (capital income) terms, as well as when middle class and below households experience a decline in their (earned wage & salary) incomes; or when both occur simultaneously which of course has been the case in the past three decades at least. However, while identifying wage stagnation or decline, neither Picketty or Saez offer much explanation as to why or how this decline has been occurring. It is one thing to identify wage stagnation and decline; it is another to explain why and how it is occurring—and accelerating of late.

So how are the wealthiest 1% households becoming not merely ‘very rich’ but ‘super-rich’ and ‘mega-rich’? What are the fundamental causes behind the trend? How is their income being generated at the source—thereafter ensuring it is ‘passed through’ by an ever-generous treatment of corporate and personal capital incomes by a restructuring tax system?

The Dual Origins of Rising Capital Incomes

Their accelerating income and wealth is generated, in increasing part, from the manipulation of global financial assets and speculative financial trading, on the one hand. That is, from returns on capital from global stock & bond trading, foreign exchange speculation, interest, real estate, commodity futures, structured finance and derivatives in myriad proliferating forms, rents, and so forth—to mention just a short list. This is just ‘money making money’ and doesn’t involve shifting income from workers by reducing their real wages, cutting their health care and retirement benefits, stealing all their productivity gains, and the many other ways their corporations shift income from the working class to themselves.

This second of the twofold process, i.e. reducing of labor costs across the board, are therefore a second major way in which income has been growing for the wealthiest 1%. Income and wealth is not only generated from financial speculation, but from the transfer of income from workers through the conduit of their corporations to them in the form of capital gains, dividends, interest and rent. One of the hallmarks of the past decade globally is that Corporate ‘profit margins’ (i.e. profits from reducing operating costs) are at consistent, record annual levels. Corporate income taxes are then in turn reduced by governments to increase the ‘pass through’ of these growing corporate net income gains to their major stockholders, the wealthy 1% households who are almost exclusively ‘investor’ households and not earners of wages & salaries. Governments then further reduce their personal income taxes as well, in order to ensure they can keep an ever growing percentage of the profits that their corporations pass through to them.

As both Saez and Picketty have understood, Capitalist tax systems are central to both of the more basic processes of income creation noted above. Tax cuts on corporate and personal investor income taxes both result in more income accruing to the wealthiest 1%. But the underlying processes are different. One involves the increase in transfer of share of national income from workers to owners of capital; the other involves owners of capital manipulating the financial system and financial asset prices for gain. One involves increasing the exploitation of labor, and the other involves the manipulation of asset prices and exchange.

Both Saez and Picketty focus on the tax system as central to the growing concentration of income in favor of the wealthiest 1%. However, neither examine the more fundamental processes at play—i.e. the growing relative weight of financial speculation in global Capitalism or the simultaneous growing intensification of labor exploitation and income transfer between classes that is occurring in the U.S. and globally as well.

Saez and Picketty’s lesser economist colleagues—the Krugmans, Reichs, et. al.—provide little explanation of the strategically central fundamental processes (financial speculation income generation & earned income transfer from workers to owners of capital), focusing only empirically and sporadically on ‘this or that’ surface manifestation of the problem: noting a problem of real minimum wage decline here, a particular corporate tax cut there, rising cost (and shift) of health services today, coming crisis in retirement incomes tomorrow, and so on. That is, an eclectic empiricism with no theoretical foundation, and therefore no real analysis and therefore no possibility of effective solutions for ending the growing concentration of incomes in the end.

Explaining—Not Reporting—Income Inequality

What is necessary to explain fully the growing income-wealth inequality trends is a threefold task:

First, it is necessary to explain the processes by which the rate of increase in workers’ compensation (wages & benefits) is being reduced on a class-wide basis—that is, for both the employed, unemployed, and underemployed—and especially for the ‘core’ 110 million non-supervisory & production workers in the US.

The unemployed experience a total wage cut. That needs to be factored into the overall average for wage reduction for the working class as a whole. Unfortunately, current government statistics report wages and compensation only for those still employed, which underestimates the total wage reduction since the unemployed total loss of wage income is not included. Moreover, that official data reports wages only for those who are full time employed. It thus underestimates the overall wage reduction for the class as a whole for those millions of workers in recent years that have been forced from full time into part time and temp jobs. The growth in underemployed part time and temp jobs represents a further reduction in the overall working class wage and benefit estimation, since on average these ‘contingent’ jobs pay 50%-55% of the average full time job.

It is important also to consider the roughly 110 million non-supervisory workers’ wages and compensation. Government data reporting on ‘wages and compensation’ in general include salaries and benefits for CEOs and senior managers, whose ‘wage’ and salary increases may be significant and thus ‘bias upward’ the total average for wages and benefits in general. The trend in income inequality in favor of the top 1% is consequently worse than reported, when the trend compares the 1% to the roughly ‘bottom 80%’ of households in the US where the ‘non-supervisory’ 110 million reside.

The preceding adjustments that more accurately estimate wages and compensation on a class-wide basis that includes the unemployed, underemployed, and excludes CEOs and senior management, are only the beginning of the necessary task, however.

To obtain a more accurate summary of wage and income reduction for workers today, still further estimation adjustments are necessary. It is necessary to adjust not only for current nominal wage cuts and reductions that may have occurred, but also for deferred wages previously paid in the form of workers’ pensions and healthcare contributions that are reclaimed and taken back. When defined benefit pensions are converted to 401ks personal pensions by a company, or when a company declares bankruptcy and turns over its pension to the government’s Pension Benefit Guaranty Corp, to restructure, pension benefits are reduced. Pension payments are reduced. In effect, the company takes back in part the worker contributions that were previously paid into the pension fund. The same occurs when prior worker contributions to a health insurance fund are offset when a company increases the share of monthly premiums workers’ must pay for employer provided health insurance coverage, or when the coverage provided by that insurance is reduced. The result is an increase in payment by the worker for both cases. But estimating reductions in nominal and deferred wages is still not the entire story.

There is the reduction of future wages yet to be paid. Future wages are reduced by means of issuance of credit and debt to workers. The interest paid on that debt currently and over the life of the loan represents a reduction in future wages not yet paid.

There is also a fourth category of wage that must be calculated in order to accurately estimate the overall reduction in workers’ income and inequality. That is the ‘social wage’. That is the contribution to social security and medicare paid by workers in the payroll tax. It too is a form of wage that is deferred. Workers pay into the social security fund in expectation of a claim on that payment when retired. A reduction in social security monthly benefits and/or a rise in co-pays by retirees for Physician or Prescription drug coverage represents a reclaiming of part of the social wage previous paid.

All the above forms of wages are further reduced by inflation, so that adjustments for the real wage paid to workers are necessary as well. This leads to what inflation index is used to adjust wages and benefits in their nominal form to their real, purchasing power form. US government inflation indices have been ‘smoothed out’ over recent decades by introducing statistical estimation techniques that reduce the volatility of price inflation. The different techniques are too numerous (and boringly arcane) to recount here. But they add up to the effect of underestimating the true inflation in the typical goods and services bought by the ‘bottom 80%’ households and the 110 million nonsupervisory core working class. That means that true inflation is higher, and therefore real wages are actually lower than reported by the government.

What all the above in effect means is that working class incomes in the US have actually slowed, and fallen in many cases, even more than has been reported. Were that more accurate wage and compensation reduction been used to track the growing income inequality in the US, that inequality would be significantly greater than even reported today—whether by the government or by the Saez-Picketty studies as well.

Explaining inequality—not just reporting it—requires an analysis of how these various ‘forms of wages’ have been reduced in recent decades and especially since 2009. That deeper analysis leads to explanations of trends of destruction of unions and thus the higher union wage, the growing trend of outright ‘wage theft’ by businesses, the avoidance of paying overtime pay by reclassifying millions of workers as ‘exempt’ instead of hourly paid, the atrophying of the real minimum wage, the wage reduction effects of free trade, the shift to contingent labor, and all the reasons why the total unemployed (in and out of the labor force) are rising steadily and are chronically longer term jobless. Add to this the analyses of the many government policies introduced in recent years and decades that reduce the deferred, social, and future wage and underestimate the real wage.

The Three-Legged Stool

But explaining true scope and magnitude of wage reduction is still just one of the three legs of the income inequality stool—in this case the declining income side of the coin of inequality. The other two legs are how more income is generated and claimed by the wealthiest households, especially the 1%, and how changes in the tax system are enabling an ever-greater pass through of income from the corporations of the wealthiest households to their personal bank accounts. To explain the ‘other (non-wage) side of inequality therefore requires a second set of explanations and analyses: i.e. how and why corporate profits have consistently risen in recent decades, accelerating especially in the past decade, and how that historic rise has been ‘passed through’ at increasing rates, from the corporation to its major owners and investors—i.e. the wealthiest 1% households.

Explaining the accelerating rise in corporate profits in turn requires two directions of analysis.

First, it requires an analysis of profits that are being generated increasingly by means of manipulation of financial asset prices by investors, by creating new forms of money and credit, and recycling money capital to create still more money capital where nothing is actually being produced except for money capital. This is the realm of finance capital, growing in relative weight and role in the 21st century. This is the realm of the now $71 trillion in investible assets held by global shadow banks—hedge funds, private equity firms, investment banks, asset management funds, etc. It is the realm of the growing numbers of ‘ultra- and very-high net worth’ individual investors who invest tens of millions each annually in highly liquid global markets through these institutions–in the proliferating forms of financial instruments in which they speculate and trade.

But profits are created not only by financial speculation, although the trend is toward a more rapid growth of profits from financial speculation relative to total profits growth. The other, more traditional source of profits generation is, of course, profits from making goods and providing non-financial services. Here profits grow by either selling more goods, raising prices of the goods sold, or reducing costs of producing those goods—especially labor costs. Since the June 2009 recession, the data show profits from production quickly escalated to record levels in the US, exceeding the historic high pre-recession 2007 levels. But this profits escalation has not primarily resulted from selling more output or at higher prices. Today’s record pre-tax corporate profits are primarily the outcome of the growth of ‘profit margins’; that is, profits generated from reduction of operating costs, in particular labor costs and therefore by raising productivity and/or reducing wages and compensation. The record profits growth for goods and services producing corporations is therefore not the consequence of raising prices or selling significantly more product. It is the result of cost-reduction—which means largely wage and benefits cost containment or reduction. Explaining the income inequality trend must therefore focus the rise in profit margins for companies that produce goods and services, as well as profits from financial speculation. Moreover, the multiple connections between profits from finance capital and profits from real production by non-finance capital requires analysis and explanation.

But profits represent income accruing to the institution of the corporation. Income inequality is typically a measurement of relative income shares between upper and mid-lower households. How the income of corporations gets transferred to the former, wealthiest households, is consequently a critical element in the overall explanation and analysis of income inequality as a trend. That is where and analysis of the third leg of the ‘three legged stool’ of inequality is required—i.e. the restructured tax system of recent decades.

How corporate income, generated from the first and second fundamental processes above, gets ‘passed through’ the corporation at increasing rates and volumes to the individual owners of capital is therefore the third level of explanation. This work has been the focus of Saez, Picketty and others. The tax system is a critical, strategic enabling factor in the growing income inequality trend in the US and globally. But it does not explain the origins of the inequality. Enabling and originating is not the same thing, although the former may be essential for the latter.

Here too, a dual analysis and explanation is required. How the tax system has been restructured in favor of capital incomes—i.e. capital gains, dividends, interest, rent and other payments to the wealthy and investors is a necessary focus of analysis, as is how corporate taxes have been reduced as well. Reducing corporate taxes allows corporations to keep more income to potentially ‘pass through’ to their investors. Reducing taxation on capital incomes after having been distributed by the corporation results in still more income gains by the wealthiest households in turn. Conversely, how the restructured tax system has in recent years raised the total tax burden and share (federal, state, and local) on the working class is a second essential focus of the general effect of the tax system on income inequality.

Saez, Picketty and a few others have contributed significantly to the analysis of the role of the tax system changes in recent years and decades to the growing income inequality trends in the US. Their work should be commended. Krugman and other notable liberal economists have publicized their work, especially of late. But none of them have focused in any significant detail on the fundamental origins of income inequality—i.e. in the process of production, in the growth of credit, debt, and speculative finance, or how the working class is not only no longer sharing in the income generation but is increasingly having to give back income it previously earned to the forces of Capital as well.