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Ryan’s Medicare hot air

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There’s a scary graph in Wisconsin Rep. Paul Ryan’s new budget blueprint that shows the federal government’s “unfunded promises” rising from $76.4 trillion in 2010 to $99.6 trillion in 2011.

That’s $23.2 trillion in just one year.

The entire U.S. economy produces about $15 trillion in gross domestic product each year. If it seems preposterous that the government’s “unfunded promises” grew by that much in just one year, that’s because it is.

Most of what the Wisconsin Republican calls “unfunded promises” are the future Medicare benefits that the government expects to have to pay through the late 2080s. To get a scare out of Medicare, you have look seven decades into the future.

But here’s the reality: Medicare has been a solid investment for 47 years. It’s also in good shape for the foreseeable future.

Of all the hot air in Washington, Ryan’s hackneyed Medicare scare is the hottest. The Medicare Trust Fund isn’t actually a trust fund; it isn’t really going bankrupt. Oh, and most of Medicare isn’t even connected to those funds anyway.

Here’s how it works.

As every senior citizen knows, Medicare is incredibly complicated. It has four parts. Part A covers hospital bills. Part B covers doctors’ bills. Part C is an optional private insurance plan. Part D is a private insurance plan for prescription drugs.

There are two Medicare “trust funds.” The Hospital Insurance (HI) trust fund supports Medicare Part A. The Supplementary Medical Insurance (SMI) trust fund supports Parts B and D. There is no trust fund for Part C.

The HI trust fund, which pays hospital bills, is the one Ryan is worried about. It is currently $238 billion in the black and takes in an annual income of $229 billion. Those are some pretty big figures, but Medicare is still running a multi-billion dollar deficit and is expected to run through its treasure chest in about 12 years.

The HI trust fund is supported by a 2.9-percent tax on wages, split evenly between wage earners and their employers.

On top of this, an additional 0.9-percent tax on wages over $200,000 for individuals ($250,000 for married couples filing jointly) will start flowing to the HI trust fund in 2013 under the Affordable Care Act.

Even with these extra revenues, the HI trust fund is projected to go bankrupt in 2024. But “bankrupt” doesn’t mean “bankrupt” in the sense of going out of business. It only means that the trust fund account will turn negative for the first time.

In other words, around the year 2024 — for the first time in its history — Medicare Part A will start to cost the federal government money. After 2025, the losses are expected to be in the range of $40-$60 billion per year.

By that time, the total federal budget is expected to be over $4.5 trillion, so we’re talking about a Medicare Part A deficit amounting to a little over 1 percent of the federal budget.

So what about those so-called “unfunded promises”? Extend a growing trend out long enough and you can make the number as big as you like. But projecting the future Medicare costs of people who have not yet been born is simply disingenuous.

There are plenty of real challenges facing America this election year. Three of the most important are jobs, jobs, and jobs. Potential problems in Medicare and Social Security 50 or 75 years from now just don’t measure up. It’s not time to hit the panic button just yet.

In corporate America, why greed’s never good

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In Corporate America, Why Greed’s Never Good

Why are corporate chief executive officers so highly paid?

Modern American Fortune 500 CEOs have incredibly demanding jobs leading large, complex organizations. They have to take big risks and at any minute face dismissal for underperformance.

At least, that’s one version of events.

The more accurate: The average CEO stays in office about six years and then retires, according to research published by the National Bureau of Economic Research and the Economist magazine.

Only about 20-25 percent of CEOs are fired. The rest either leave through planned retirements or as the result of mergers and acquisitions — in which departing CEOs usually receive handsome “golden parachutes.”

And those demanding, epic 100-hour work weeks? CEOs spend many of those “work” hours talking deals on the golf course, entertaining clients at lavish meals, and traveling by private corporate jet.

Academic research shows that executive pay is not mainly driven by job demands or pay for performance. High CEO pay is driven mainly by poor corporate governance resulting in a “Lake Wobegon effect.”

Corporate board compensation committees routinely determine CEO pay by comparing the compensation of their CEOs to the compensation of other, successful CEOs in the same industry. Of course, all boards think they have better than average CEOs. If they didn’t think their CEOs were above average, why would they keep them?

The Lake Wobegon effect is named for humorist Garrison Keillor’s fictional Minnesota town in which “all the women are strong, all the men are good looking, and all the children are above average.”

The Lake Wobegon effect runs especially strong in companies that hire pay consultants to benchmark their CEO salaries against others in their industries. Companies that use pay consultants pay their CEOs more and pay them more in stock, compensation that’s less visible in company accounts than cash, according to a 2009 report in the journal Academy of Management Perspectives by Martin Conyon, Simon Peck, and Graham Sadler. These effects appear even after appropriate statistical controls have been made for company performance and CEO experience.

The root cause of the Lake Wobegon effect is pay benchmarking. In a simulation study published in 2010 in the American Journal of Sociology, Thomas DiPrete, Gregory Eirich, and Matthew Pittinsky show how benchmarking practices result in a multimillion dollar game of leapfrog.

Each year corporate boards evaluate their CEOs. They only compare their CEOs to CEOs at “successful” companies, leaving out failed CEOs and bankrupt companies, and find their CEOs to be slightly better than these already better than average peers. As a result, they leapfrog their executives’ pay to the top third of the industry pack. The next year other boards leapfrog their executives, and so on, and so on.

As the leapfrogging process continues year after year, CEO pay grows at a faster and faster rate.

It wasn’t always this way. CEO pay hardly increased at all from the 1930s through the 1970s. Research published in 2010 in the Review of Financial Studies by Carola Frydman of MIT and Raven E. Saks of the Federal Reserve shows that the average American CEO in the 1970s earned about 4 percent more than the average CEO did in the 1930s, adjusted for inflation.

Frydman and Saks report that since the 1970s CEO pay has risen by 686 percent. Not coincidentally, contemporary CEO pay practices date to the late 1970s and early 1980s. Back when companies gave CEOs cash raises based on annual performance reviews, just like the rest of us, CEO pay grew modestly every year, just like pay for the rest of us, if at all.

The average S&P 500 CEO now makes over $10 million a year, according to the annual Executive Excess report from the Institute for Policy Studies. The AFL-CIO reckons that the ratio of chief executive pay to median worker pay rose from 42-1 in 1980 to 343-1 in 2010.

Over in the UK they’re taking this problem seriously. The final report of the UK High Pay Commission concluded that “top pay is a symptom of market failure based on a misunderstanding of how markets work at their best.”

“It is through looking at executive remuneration that we see the classic problems of corporate governance laid bare,” the Commission said. In other words, the Commission found that corporate pay practices — not the demands placed on executives — are responsible for high executive pay.

Executive pay is now seen to be so ridiculously high that even investors are unhappy. According to the Wall Street Journal, a recent survey by executive consultants Towers Watson shows that “companies that give their CEOs high pay opportunities are more likely to receive lower levels of shareholder support.” You don’t have to be a socialist to be angry over CEO pay.

The money at stake is enormous, but in the end the problem for shareholders isn’t the pay itself. A company with a billion dollars in profits can afford a $10 million CEO. The problem is what CEOs will do for the money. If history is any guide, they’ll do anything. It’s worth rolling the dice and risking bankruptcy for your company if the potential payoff is a multi-million dollar bonus.

Executives involved in many of the largest corporate collapses in American history were extraordinarily well-paid. Richard Fuld (Lehman Brothers), Bernie Ebbers (Worldcom), Kerry Killinger (Washington Mutual), Kenneth Lay (Enron), and Stanley O’Neal (Merrill Lynch) all had seven-digit annual pay packages.

Moving beyond specific cases, CEO greed has been shown to be related to a host of negative outcomes. One way to measure greed is to ask how much CEOs pay themselves compared to what they pay their top management team. This is called the “CEO pay slice.”

The CEO pay slice reached a historical minimum in the 1960s and has been growing ever since. As I have reported elsewhere, between 1993 and 2006 CEOs at America’s top 1500 public companies received average annual raises of 8.8 per year, while their corporate seconds-in-command received annual raises averaging 5.4 per year, thirds-in-command 5.2%, fourths-in-command 5.0 per year, and fifths-in-command 4.6 per year.

That’s greed at its most transparent.

The CEO pay slice is associated with lower profitability, lower stock returns, and a range of other negative outcomes. All this is true even after appropriate statistical controls have been made, according to a 2011 paper in the Journal of Financial Economics by Lucian Bebchuk, Martijn Cremers, and Urs Peyer. Greed is not good.

George Washington University Law School Professor Lawrence A. Cunningham suggests a remedy for the most egregious cases of CEO greed. Writing in May 2011 in the Iowa Law Review, he suggests shareholders take advantage of a little-used principle of the common law of contracts: contractual unconscienability.

Contractual unconscienability arises in “pay contracts that are the product of managerial domination of the process and formed on terms massively favoring the executive.” Professor Cunningham writes that “for those outraged by lopsided corporate executive compensation, this … offers an appealing new legal theory … to police them.” I agree.

Austerity is not the answer; Employment is the answer

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In Greece the unemployment rate is 20%.  In Spain it’s 23%.  In Portugal and Ireland the unemployment rate is 15%.  Things in Europe are starting to look as bad as in the United States.

Actually the official European unemployment rate is 10.1% versus 8.3% in the United States.  But unemployment benefits in Europe are much more generous than in the United States.

As a result, many people are counted as “unemployed” in Europe who would be forced to take part-time work just to stay alive in the United States — or would give up looking for work entirely.

Whether in Europe or in the United States, unemployment anywhere at anytime is a waste of valuable human capital.

In the United States as in Greece and Spain governments are cutting teachers, road workers, and even tax collectors in an effort to balance budgets.  This is folly bordering on lunacy.

What good does it do a country for a teacher to stay home unemployed while children are squeezed into crowded classrooms?  The teacher suffers the ravages of unemployment and poverty.  The children suffer a second-rate education.  Who gains?

Well, taxpayers gain and bondholders gain.  Taxpayers are spared the burden of higher taxes.  Since the rich pay the most in taxes, they gain the most from keeping taxes low — or lower than they would otherwise be.

Bondholders gain because any reduction in government spending improves a country’s credit-worthiness.  That lowers the interest rates — and raises the prices — on government bonds.  When bonds go up in price, bondholders make a profit.

The immediate result of firing a teacher is thus to sacrifice the interests of teachers and children in order to promote the interests of wealthier people and bondholders (mainly banks and hedge funds).

A second result of austerity is to reduce the productivity of the economy as a whole as human resources go unused or are used in less productive ways (as when an experienced teacher turns to manual labor to make ends meet).

A third result of austerity is to move the long-term trajectory of society from a more progressive to a less progressive track as long-term investments in society’s future are sacrificed for short-term savings in government spending.

The answer is that in a downturn those who can pay should pay to keep society functioning at full productivity and full employment.  That means increasing top tax rates in progressive income tax systems.

In a society with a progressive income tax, only people with high incomes pay high taxes.  It is mathematically certain that the burden of government spending will fall on those who can most afford it.

Only people with income pay income taxes and only corporations with profits pay corporate profit taxes.

Increases in property, sales, and value-added taxes are much less effective.  Everyone pays these taxes, even the unemployed.  It’s a poorly-targeted policy that raises revenue by increasing taxes on those least able to pay.

In an extreme case where top incomes taxes can’t be raised quickly enough to generate sufficient income to pay the bills, bondholders will have to suffer.

This is what has happened in Greece: bondholders are sharing the burden of supporting the Greek government budget.  Bond restructuring is a good first step, but it has to be complemented by increases in progressive income taxes.

By following bond restructuring with massive budget cuts and an austerity budget, the Greek government is just perpetuating a cycle that will result in further bond restructuring down the road.

Austerity is never the answer.  Austerity is about making society’s weakest and most vulnerable members pay for the budgeting errors of the ruling class.  It never improves productivity, and it never improves an economy.  It only improves the budget situation — temporarily.

Employment is the answer.  Everyone should be employed.  With productivity always rising due to technological change, employment and wages should never have to go down.  That may sound Pollyannaish, but it’s nonetheless true.

Austerity is a political decision, not an economic one.  It benefits the few at the expense of the many.  It is as inappropriate as it is immoral.  People should work, not sit home to save tax money and boost bond prices.  Employment beats austerity every time.

Corporate campaign spending: They get what they pay for

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Will corporate spending determine the outcomes of the 2012 elections? Academic research shows that when companies spend money on politics, they earn a significant financial return. For America’s corporations, it pays to play politics.

How high corporate political spending will go in 2012 is anyone’s guess. According to the Supreme Court, the sky’s the limit.

In 2010, the US Supreme Court ruled unconstitutional most of the legal limitations on how corporations can spend money to influence elections. As a result, companies can now spend unlimited amounts of money on political causes.

They can contribute directly or indirectly, publicly or anonymously, as much money as they want. So can unions and other social groups, but let’s face facts. No union can match the spending power of America’s biggest corporations.

This ruling is known as Citizens United because it upheld the right of conservative campaign group Citizens United to air a documentary that was critical of Hillary Clinton during the 2008 election season.

The ruling came too late for the 2008 elections, but the January 2010 decision came just in time for the November 2010 midterm elections.

Political watchdog group Public Citizen found in a January 2011 report that outside (non-candidate) spending by “independent” groups like Citizens United rose from $68.9 million in the 2006 midterm elections to $294.2 million in the 2010 midterm elections.

They attributed this fourfold increase to the Supreme Court’s Citizen United decision.

Because of the threat of bad publicity, most corporations choose to fund political advertisements anonymously through so-called “Section 501(c)” front organizations rather than publicly in their own names.

Section 501(c) groups are nonprofit associations that can operate as anonymous fronts for corporations and other organizations. They differ from long-standing Section 527 groups, which are regular political action committees that must disclose their donors.

The Citizens United decision opened up Section 527 groups to unlimited corporate contributions (with disclosure). More nefariously, it opened up Section 501(c) groups to unlimited anonymous corporate contributions.

A December 2010 report by Bill de Blasio, the public advocate for the City of New York, found that over 75 percent of the political advertisements aired by the newly deregulated Section 501(c) groups were negative in tone. In contrast, only 54 percent of ads run by the more regulated Section 527 groups were negative.

Why would corporations want to influence elections? The answer is simple. It pays.

In a January 2011 article in the Journal of Management, University of Tennessee Business Professor Russell Crook found that corporate political activity has a significantly positive effect on company performance measured using return on investment, return on assets and government-derived revenues.

In their study, Professor Crook and his colleagues reanalyzed the results of dozens of studies of corporate political activity. Not surprisingly, they found that companies that are highly regulated and/or do business with the government spend the most on corporate political activity.

Overall, Professor Crook and his colleagues found that corporate political activity had as large an impact on company performance as did access to strategic resources or high levels of human capital.

Big companies have the most money to spend, and the research shows that they spend much more on political activities than small firms. But it turns out that the impact of corporate political activity on company performance is even stronger for small companies than it is for large ones.

In a March 2011 article in the journal Accounting & Finance, finance professors Ike Mathur and Manohar Singh found that the economic value added by lobbying is roughly three times as high for small companies as it is for large companies, once appropriate statistical controls have been made.

This is probably because small firms tailor their lobbying efforts very closely to specific legislation that affects them, while large firms lobby on more general pro-business issues like reduced corporate tax rates.

According to news reports following the 2010 elections, some of the biggest anonymous contributors to unregulated Section 501(c) groups were hedge funds and private equity firms.

These companies and their ultra-high-income executives spent large sums to defeat Congressional Democrats who supported higher taxes on investment income. So much for the fabled Tea Party election. Reports suggest that it was more of a Bankers’ Ball.

The impact of corporate spending on the 2010 Congressional races points to the real danger posed by the Supreme Court’s Citizens United ruling.

The danger isn’t that the 2012 presidential elections will be bought by powerful corporate interests. In the 2008 campaigns, Barrack Obama and John McCain each raised over $1 billion. It takes a lot of money to have an impact at the presidential level.

The real danger is that unlimited corporate spending will buy hundreds or even thousands of less-publicized elections for state and local offices.

Casino operators will attempt to influence gambling ballot measures. Gas drillers and coal companies will seek to place their preferred candidates on county commissions. For-profit school operators will seek to sway school board elections.

Wherever there are elected judges, local businesses with cases before the courts will try to have their preferred candidates elected – and none of them will have to disclose the fact that they are doing so.

Simply put, corporate campaign spending is a bad idea, but it’s a bad idea whose time has come. The Supreme Court has opened the floodgates, and the research shows that the money will come pouring in, secretly and anonymously. It’s just good business.

But it’s bad politics.

Why have levels of income inequality risen so much?

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The recession has been tough on many Americans.  But the recession only started in 2008, and the statisticians at the National Bureau of Economic Research figure it ended in 2009.  The recession was pretty short.

No, the problems in America’s realonomy have been a long time in the making.  Median incomes in America have been stagnant since 1973.  You can’t blame that on the recession.

Total US national income per person has more than doubled over the past forty years (adjusting for inflation).  Why then have incomes for most Americans been stagnant or falling?  Why do American families now need two incomes to have the standard of living they used to have with just one?

Why aren’t today’s young adults making twice as much as their parents did were when they first entered the labor market thirty years before?

The answer is that all of the growth in the American economy over the past forty years has gone to the top 50% of American households.  Most of it has gone to the top 20%.  In recent years, it’s gone to the top 1% only.

In other words, the US income distribution has become much less equal.

If the US income distribution today had remained unchanged over the past thirty years, the average American household would have a total income over $85,000.  Instead it’s around $50,000.

If the US income distribution had become more equal in the four decades after 1970 — as it did in the four decades before 1970 — the average American household would be doing even better.

The fact that the average American household today has an income of $50,000 instead of $100,000 can be attributed entirely to the fact that inequality has risen over the past four decades instead of declining.  America has far greater income than ever before in its history, but that income is concentrated in fewer and fewer hands.  Rising inequality is killing middle America.

It’s no mystery why inequality has been rising in America.  As a recent 11-country comparative study concluded, the main factors that determine whether a country is equal or unequal in its income distribution are “union density, the strictness of employment protection law, unemployment benefit duration, unemployment benefit generosity, and the size of the minimum wage.”  (Winfried Koeniger et al “Labor Market Institutions and Wage Inequality,” Industrial and Labor Relations Review, Vol. 60, pp. 340-356.)

By far the most important of these factors is union density, the percentage of workers who are covered by a union contract or collective bargaining agreement.

Around the world, wherever workers have unions, they get better pay.   The most recent estimates suggest that unionization increases an individual worker’s pay by about 17%,  but some argue that the effect on total pay (including benefits) could be as high as 43%.

The key issue is bargaining power.  Obviously, workers who bargain as part of a union are in a better bargaining position than workers who don’t have a union.  But it’s not just a matter of unions.

Where unemployment benefits are generous, workers can bargain harder, since it’s not catastrophic if they lose their jobs.  And having a good minimum wage means that when unemployed workers run out of insurance payments they can be sure of earning at least a living wage when they do go back to work.

One way to reduce inequality is to tax the rich and give to the poor.  Another is to make the poor more powerful so they can negotiate better deals from the rich.  Both are necessary.  For forty years, America has done neither.

And so the average American family lives on $50,000 a year instead of $100,000, while a few not-very-average American families garner huge wealth that goes largely untaxed.

That’s why US levels of income inequality have risen so much for so long.  We’ve let them.  If we reversed the pro-rich policies of the past forty years, income inequality would fall — rapidly.

The problem is not a failure of our economy to support the American people.  The problem is a failure of our democracy to support the American people.  We have only ourselves to blame.

The problem isn’t growth – The problem is inequality

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Commentators still talk about the Great Recession as if we’re still in it.  But according to semi-official statistics from the National Bureau of Economic Research (NBER) the recession ended in June 2009.

In fact, the “official” recession lasted only 19 months.  Over that period, US economic output declined by around 5%.  But the economy has been growing for 32 months now, and has now surpassed its 2008 peak.

In the realonomy where most Americans live it sure doesn’t feel that way.

Why not?  Because while the economy has taken off, the realonomy has been left behind.  Jobs and wages are still below 2008 levels.  Economic growth is feeding into corporate profits and CEO pay, not into ordinary people’s paychecks.

It’s also not going into government budgets — and government is where the money is needed most.  You may feel like you’re struggling, but America’s state and local governments are struggling too.

The obvious solution is for state and local governments to tax the windfall profits and pay that are right now going to the richest people and corporations in America.

America has to take the attitude that “we’re all in this together.”  To see what things look like when people don’t help each other out, just look at Europe.  It’s obvious that most Greeks and Germans, Portuguese and French just don’t feel like they’re all in it together.  Some Europeans would rather see “other” Europeans on the street than see “their” bankers not get paid.  The result is chaos — and suffering.

In America, there’s no “us” versus “them.”  There’s just us.  Our bankers, our CEOs, our unemployed and our poor.  It’s our children who need teachers and our elderly who need carers.  When Americans resist taxes on the rich to pay for schools for the poor, what they’re saying is: “why should one person have to pay for another person’s children?”

Why?  Because in America, there’s no “us” versus “them.”  There’s just us.

Or at least that’s the idea.  But over the last forty years in America — and more than ever over the last four years — the rewards of the American economy have been diverted more and more to a small segment of society.

How they’ve done that is a long story.  It involves the intentional destruction of unions, the use of free trade treaties to undermine workers, aggressive lobbying of government to change the rules of the game in favor of big business, and the dramatic expansion of international tax havens.  In any case, however it’s been done, it’s been done, and it has resulted in a dramatic rise in inequality in America.

Those who have benefited from dramatic income gains over the past forty years can’t be blamed for seizing their opportunities.  On the other hand, they can be blamed for being so aggressive in protecting their expanded fortunes.

The simple truth is that America needs higher taxes on higher incomes, more government providing more services, and jobs — lots of jobs.  If the private sector won’t provide those jobs, the public sector should.  We certainly need more people to work in schools and nursing homes, and there certainly are lots of people willing and able to work.  Put two and two together and we might just mend our broken economy.

The death of the great American middle class

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The American economy has done well over the past forty years.  America’s national income per person has almost exactly doubled since 1970.[1]  The United States has been the richest major country in the world for over 100 years now, and it remains the richest major country in the world today.[2]  The American economy in 2010 generated $47,436 for every man, woman, and child living in the country.[3]  On current projections, this figure will rise by a further $1000 per year for the next several years.[4]

That’s a lot of money for a lot of people.  Unfortunately, all of that money doesn’t go directly into ordinary Americans’ paychecks.  Some of it goes into corporate profits, payroll taxes, and other expenses.  The remaining personal income actually paid out to Americans through their paychecks and profits came to $40,094 per person in 2010.[5]  That’s still over $40,000 for every man, woman, and child living in America.

Of course, that doesn’t mean that a family of two adults with eight children will make $400,000 a year.  Most children don’t work, and when they do work they don’t earn very much.  Spreading total US personal income out among just the adult population[6] would give an average of income of $52,952 for every American adult.

In other words, if America’s total personal income were evenly distributed, the typical married couple would be making over $100,000 a year.

If the typical single person in America were making $52,952 a year and the typical married couple were making $105,904 a year, the United States really would be a very rich country.  The problem is that most people actually make much less than this.  The typical American adult makes just $26,134.[7]  Half of all Americans make less than this.

How can it be that the typical American adult makes just $26,134 when America is the richest nation on Earth?  The answer is that a few high-income Americans gain the lion’s share of America’s national income.  As illustrated in the figure below, the top 5% of American households made as much money in 2009 as the entire bottom 50% combined.[8]  That’s amazing.  Out of about 120 million households in America today, the richest 6 million make as much money as the poorest 60 million.

 

 

Put a slightly different way, the same data show that the richest 20% of households take home more income than the other 80% combined.  There really are two Americas: the top 20%, and everybody else.  By definition, most Americans fall into the category of “everybody else.”

It wasn’t always like this, and it doesn’t have to be like this.  America used to be one of the most equal countries in the free world, a place where anybody could make a decent living, support a family, and retire well.  Such simple dreams are increasingly out of reach for ordinary Americans who fall in the middle of the country’s income distribution.

Forty years of stagnation for American workers

The figure below shows the median male income for American men since the end of the Civil War in 1865.[9]  The median income is the income of the average or typical person.  Men’s incomes are used because the proportion of women working outside the home has changed dramatically over the years.  Where data are available for women, they tell a similar story.

 

 

It’s obvious from this figure that typical male incomes rose continuously from the 1860s through the 1960s.  Between 1865 to 1973 typical male incomes rose by a factor of 10, from $3425 a year to $34,762 a year.  Male incomes rose in every single decade for more than a century.

It’s also obvious that this growth ended in the 1970s.  Since the 1970s there has been no increase in male median incomes — at all.  None.  In fact, since 1973 typical male incomes have fallen by 7.4%, from $34,762 a year to $32,184 a year.  Typical male incomes fell slightly in the 1970s, rose slightly in the 1980s and 1990s, then fell again in the 2000s.

That’s remarkable, considering that American national income per person has doubled over the same period.  But it gets worse.  For American men of any given age, incomes have fallen dramatically since 1973.  For American men aged 45-54 years old incomes have fallen by 11.1%; for men 35-44 years old incomes have fallen by 18.7% since 1973, and for men aged 25-34 years old incomes have dropped by an astounding 26.7%.[10]

Yes, the average American young man in 2009 makes one-quarter less than the average American young man did in 1973.  American men today are — literally — worse off than their fathers were.  The typical young male Americans made $43,530 in 1973, compared with just $31,914 today.[11]  No wonder young adults can’t afford to move out on their own these days.

How it is possible that the US economy has doubled in size without helping the average working man at all?  The answer can be divided into three parts.  First, more and more women work outside the home.  This boosts the overall size of the economy without boosting the wages paid by any particular job.  Second, the population is getting older as baby boomers mature.  Older people are more experienced and thus earn more (on average), even though incomes for people of any particular age haven’t changed.

The third part, however, is the biggest.  It’s rising inequality.  Pretty much all of the economic gains of the past forty years have gone to the top half of American workers.  Most of those gains have gone to the top 1%.  It has been estimated that 58% of all the income growth in the US economy between 1976 and 2007 went to the top 1% of households in America.[12]  To get into that top 1% a household has to be bringing in over $405,000 a year.[13]

For the 99% of Americans whose household incomes are well under $400,000 a year, there has been very little improvement since the 1970s.  For individual Americans in the middle of the income distribution, there has been no improvement at all.[14]  For Americans at the bottom, things have actually gotten worse since the 1970s.[15]

It sounds like the same old story: the rich get richer and the poor get poorer.  But as shown in the figure above, that’s not really true.  For at least a century from 1870 to 1970 it was the people in the middle — or at least the working men in the middle — who got richer.

The middle sixty at home and abroad

According to a recent survey, 91% of American adults identify themselves as “middle class.”[16]  Of these, 53% identify themselves as falling in the middle of the middle class, 18% in the upper middle, and 18% in the lower middle class.  Taking the middle of the middle as a benchmark, over half of all Americans seem to feel like they live pretty typical lives.  They’re probably right.

On surveys and in actual incomes there’s a bulge of Americans who fall somewhere in the middle of the distribution.  They’re more than half the population, but far short of the whole population.  They’re the Middle Sixty.  Above them are the Top Twenty — lawyers, doctors, investment bankers, and business executives.  Below them are the Bottom Twenty — the poor.  The Middle Sixty, Top Twenty, and Bottom Twenty roughly correspond to normative ideas of well-off, middle-class, and poor.

The “Middle Sixty” are the roughly 60% of Americans who live lives of plenty, but not lives of luxury.  They never go hungry, but they can’t afford to hire kitchen help.  They’re not homeless, but they have one home, not two or three.  Their kids don’t go to private prep schools, but their kids can go to college if they work hard and get the grades.  The Middle Sixty live ordinary, typical American lives.

A good way to think about what it means to be a member of the Middle Sixty is to think about owning a car.  Most Americans own a car.  It might be a Hyundai or it might be a Hummer, but either way it’s one car for each adult driver.  Only poor Americans can’t afford their own cars.  Only rich Americans can afford to have collections of cars.  For the vast majority of Americans in the middle, one car per driver is enough.

People at the high end of the Middle Sixty might drive expensive new cars while people at the low end of the Middle Sixty drive cheap used cars, but life is pretty similar either way.  They all drive their cars on the same roads and park in the same spaces at the same supermarkets.  They all have kids in carseats and pump their own gas.  When the car needs service, they have to get up early and drop it off before work.  Some of the Middle Sixty have nicer lifestyles than others, but they all have pretty much the same lifestyle.

A good indicator of the strength of the middle class in a country is the proportion of all the income in that country that goes to the Middle Sixty.  For example, one problem in Mexico is the lack of a strong middle class.  In Mexico, the Middle Sixty take home just 46.6% of Mexico’s income, even though they make up 60% of Mexico’s households.[17]  In Mexico, so much of the nation’s income goes to the Top Twenty that there’s very little left for the Middle Sixty, or for the poor.

The amazing thing is, by this measure even Mexico has a stronger middle class than the United States.  The Middle Sixty in America take home just 46.3% of America’s income.[18]  This is by far the lowest figure of any major developed country.  The figure below shows Middle Sixty income levels for the United States, Mexico, and four other countries.[19]  The United States scores at the rock bottom of the league for the economic strength of its middle class.

 

 

It might be even worse than this.  The data used to calculate the official US Census Bureau income statistics don’t accurately measure incomes over about $100,000.  As a result, they don’t adequately capture the recent rise in the incomes of the super-wealthy.  To address this gap, the Federal Reserve conducts a survey every three years that is specifically designed to measure the incomes of people earning over $100,000 a year.[20]

The latest data available from that Federal Reserve study are for 2007.  The results suggest that the income share of the Middle Sixty is actually just 35.8%.[21]  To put that number in context, a 35.8% income share is literally “off the chart” of the figure above.  Using that same Federal Reserve data, the Middle Sixty income share was 44.6% in 1982, the first year that the survey was conducted.[22]

For those who don’t remember 1982, it was a tough year for the middle class.  Since then, though, the income share of the Middle Sixty has dropped to nearly 11 points below Mexican levels.  And that was in 2007, which was a good year for most Americans.  The latest Federal Reserve survey was conducted in 2010, but the data have not yet been released.  Considering the state of the economy in 2010, it’s likely to be a bloodbath for the Middle Sixty.

The United States didn’t always have the world’s weakest middle class.  Back in 1968 the US Middle Sixty took home 52.3% of all the nation’s income (based on the official statistics).[23]  That implies that in 1968 the US middle class was stronger than any middle class in the world is today.  The US Middle Sixty might have been even stronger in the 1950s, but unfortunately data are not available to tell.  The data start in 1968, and it’s been all downhill from there.

The reasons behind the trends

Total US national income per person rose by 99.3% over the 30 years from 1969 to 2009.[24]  Why then have incomes for most Americans been stagnant or falling?  Why do American families now need two incomes to have the standard of living they used to have with just one?  Why aren’t today’s young adults making twice as much as their parents did were when they first entered the labor market thirty years before?

The answer is that all of the growth in the American economy over the past forty years has gone to the top half of Americans.  Most of it has gone to the Top Twenty.  If the US income distribution today had remained unchanged from 1969, by 2009 the average American household would have had an income of $86,479 instead of $49,777.[25]  If the US income distribution had become more equal in the four decades after 1969 — as it did in the four decades before 1969 — the average American household would be doing even better.

The fact that the average American household today has an income of $50,000 instead of $100,000 can be attributed entirely to rising instead of declining inequality over the past four decades.  America has far greater income than ever before in its history, but that income is concentrated in fewer and fewer hands.  Rising inequality is killing middle America.

Sociologists and economists have been conducting detailed quantitative analyses of rising inequality for more than a quarter century now.  It’s no mystery why inequality has been rising in America.  As a recent 11-country comparative study concluded, the main factors that determine whether a country is equal or unequal in its income distribution are “union density, the strictness of employment protection law, unemployment benefit duration, unemployment benefit generosity, and the size of the minimum wage.”[26]

By far the most important of these is union density: the percentage of workers who are covered by a union contract or collective bargaining agreement.[27]  Around the world, wherever workers have unions, they get better pay.[28]  The most recent estimates suggest that unionization increases an individual worker’s pay by about 17%,[29] but some argue that the effect on total pay (including benefits) could be as high as 43%.[30]  Though researchers argue over the exact figure, research consistently shows that unions increase workers’ wages.

In the end the key issue is bargaining power.  Obviously, workers who bargain as part of a union are in a better bargaining position than workers who don’t have a union.  But it’s not just a matter of unions.  Where unemployment benefits are generous, workers can bargain harder, since it’s not catastrophic if they lose their jobs.  And having a good minimum wage means that when unemployed workers run out of insurance payments they can be sure of earning at least a living wage when they do go back to work.

So how does America compare on union coverage?  As the figure below makes clear, the United States has just about the lowest level of union coverage in the world.[31]  This figure compares the proportion of workers who are covered by union-type collective bargaining contracts across the United States and 11 western European countries.  Union coverage in the United States is now lower (by far) than anywhere in western Europe.  Even at its height in 1953, US union coverage was low by European standards.  Today it is absolutely in the basement.

 

 

At the union peak in 1953 well over 40% of American workers were covered by collective bargaining agreements.  Considering that union workers were never very poor and never very rich, that 40% accounts for the majority of the Middle Sixty.  In other words, it used to be normal for Americans to be in a union.  Ralph Kramden, Archie Bunker, and Fred Flintstone were all union members.  Ronald Reagan was a six-term union president before he became a politician.  In 1960 he even called his union out on strike!

Of course, the decline of unions isn’t the only reason why inequality is rising in America.  There is some evidence that America is pulling apart along regional lines, with New York and Los Angeles pulling away from the rest of the country.[32]  There’s also some evidence that technological change is creating situations in which the top-ranked people in any industry (like sports and movie stars) end up taking home more and more of the available pay.[33]  After-tax inequality is also affected by changes in the tax system.

To some degree the decline in union membership is also just a symptom of a much broader trend: the decline of society and the rise of individualism.  This trend is associated with increased consumerism and free market economics.  People place their own interests above the common good.  In particular, American businesspeople increasingly ask not what’s good for their employees, their customers, or their coworkers, but what’s good for themselves.  Nowhere is this better illustrated than when looking at executive pay.

The chief Executive Officer (CEO) is the top employee, the commander-in-chief, of any public company.  In the United States, CEOs run their companies with very few constraints.  Technically they are supervised by boards of directors, but most American CEOs serve as chairmen of their own boards of directors — and even select their own board members.  Shareholders are the legal owners of a public company, but if shareholders are unhappy it’s much easier for them to sell their shares than to fire their CEOs.

It’s been widely reported that CEOs now receive enormous salaries, hundreds of times as much as their own workers.  The average annual pay of a Fortune 500 CEO was over $8,000,000 in 2009.[34]  That’s about 200 times the earnings of the average American adult who works full-time.[35]

 

 

Much less widely reported has been the growing gap between how much companies pay their CEOs and how much they pay the small number of top executives who work directly under the CEO.  Between 1993 and 2006 CEOs at America’s top 1500 public companies received average annual raises of 8.8% per year.[36]  Corporate seconds-in-command received annual raises averaging 5.4%, thirds-in-command 5.2%, fourths-in-command 5.0%, and fifths-in-command 4.6%.[37]

In other words, inequality is rising even within the boardroom.  It is rising everywhere we look.  The rising pay gap between corporate fourths- and fifths-in-command has nothing to do with union coverage, unemployment insurance, technological change, or the premiumization of life in New York and Los Angeles.  It can only be traced to changing norms of what’s considered acceptable behavior in setting pay.  Forty years ago, executives might have felt some pressure to take care of their employees before taking care of themselves.  They certainly don’t anymore.

Closing thoughts

Ronald Reagan, the conquering hero of American conservative mythology, was born in 1911.  He came of age during the Great Depression.  People of his generation had it tough.  They worked hard to make ends meet, but their hard work was rewarded with ever-increasing standards of living.  For Americans of their generation, things started out hard but got better and better as time went on.  They were perpetual optimists, because living in America they could always be sure of one thing: life would be better for their children than it was for them.

That’s simply not true anymore.

Today, American confidence in the future has reached an all-time low.  Americans are optimists by nature, and optimists still outnumber pessimists by 54% to 42%, but the gap is narrower than ever before.[38]  By a small margin of 38% to 37%, more Americans actually think life was better in the 1960s than it is today.[39]  Among those who are old enough to actually remember adult life in the 1960s, the ratio is 49% to 30% in favor of the sixties.[40]

That’s not just nostalgia.  Life really was better in the late 1960s for many Americans, and certainly for most white Americans.  Perhaps more importantly, the United States of forty years ago had much more of an ethic that they were all in it together.  In the 1960s and 1970s, American CEOs paid themselves roughly 40 times as much as an ordinary worker.[41]  That’s not exactly slumming it, but it seems positively frugal by today’s standards.

What’s incredible is not that so many people are no better off than their parents were forty years ago.  What’s incredible is that so many people are no better off than their parents were forty years ago despite the fact that American economic output per person has doubled in that period.  The problem isn’t that the economy is stagnant.  It’s not stagnant.  It’s growing.  The problem is that the rewards of that growth are all going to a very small number of people — ironically, to the people who need them least.

There’s both good news and bad news to be read in this benchmarking of the great American middle.  The good news is that there are plenty of resources in America for everyone to live a very good life.  There’s so much income generated every year in America that if we distributed it evenly the average household could be living on $100,000 a year.  Even allowing for the kinds of inequality found in America in the 1960s and 1970s — CEOs making 40 times their workers’ salaries instead of 200 times — the average household could be bringing in $80,000 a year.  That’s not too bad.

The bad news is that there’s no sign that Americans are prepared to take it into their own hands to reduce inequality.  Fewer than half of Americans have a favorable view of unions; even after a major recession, slightly more Americans have a positive view of businesses than of unions.[42]  Americans are not going to the polls to demand that their political leaders implement policies that are known to reduce inequality.  Perhaps most importantly, Americans are not moving away form the divisive beggar-thy-neighbor individualism that caused inequality to rise in the first place.  Instead, they seem to be embracing it.

Notes

[1] Based on figures from the 2010 National Income and Product Accounts from the US Bureau of Economic Analysis, Table 7-1.

[2] Based on real national income per capita estimates from Angus Maddison (2010), Statistics on World Population, GDP and Per Capita GDP, 1-2008 AD, Table 3.

[3] Based on 2010 US GDP estimates from US Bureau of Economic Analysis release BEA 11-02, Table 3, divided by 2010 US population estimates from US Census Bureau release NST-PEST2010-01, Table 1.

[4] Based on 2011 and 2012 US growth projections from the International Monetary Fund’s World Economic Outlook Update, January 2011.

[5] Based on 2010 US personal income estimates from US Bureau of Economic Analysis release BEA 11-02, Table 10, divided by 2010 US population estimates from US Census Bureau release NST-PEST2010, Table 1.

[6] Based on the age structure of the US population in 2009 from US Census Bureau release NC-EST2009, Table 2.

[7] Based on 2009 figures from US Census Bureau release PINC-01, Part 1.

[8] Based on an analysis of 2009 figures from US Census Bureau Income Inequality Historical Table H-2.

[9] Data for 1865-1946 based on E.H. Phelps Brown and Margaret H. Phelps Brown (1968), A Century of Pay: The Course of Pay and Production in France, Germany, Sweden, the United Kingdom, and the United States of America, 1860-1960, Appendix 3.  Data for 1947-2009 are based on figures from US Census Bureau Historical Income Statistics Table P-8.  The three separate inflation-adjusted Phelps Brown and Phelps Brown indices have been spliced together at their overlap points, then spliced to the Census Bureau 2009 dollar series using the average conversion rate between the two sources for the years 1947-1960 ($72.87 in 2009 dollars per Phelps Brown and Phelps Brown index point).  Linear interpolations have been used to fill the gaps in the series due to World War I (1914-1919) and World War II (1942-1944).

[10] Based on figures from US Census Bureau Historical Income Statistics Table P-8.

[11] Based on figures from US Census Bureau Historical Income Statistics Table P-8.

[12] Anthony B. Atkinson, Thomas Piketty, and Emmanuel Saez.  2009.  “Top Incomes in the Long Run of History,” NBER Working Paper 15408; the authors include single-person households as “families,” making their definition of a family near-identical to the US Census Bureau definition of a household.

[13] Based on Atkinson et al’s figures for the top 1% extrapolated using top 5% income growth rates since 2007 from US Census Bureau Historical Income Statistics Table H-1.

[14] Based on figures from US Census Bureau Historical Income Statistics Table P-8.

[15] Based on the application of income ratios from US Census Bureau Historical Income Statistics Table IE-2 to data from US Census Bureau Historical Income Statistics Table P-8.

[16] Pew Research Center (2008), Inside the Middle Class: Bad Times Hit the Good Life.

[17] Based on 2002 figures (the most recent available) from Matthew Hammill (2005), Income Inequality in Central America, Dominican Republic and Mexico: Assessing the Importance of Individual and Household Characteristics, Table 3.

[18] Based on 2009 figures from US Census Bureau Historical Income Statistics Table H-2.

[19] All figures are the most recent available.  Canadian figures are for 2008 and come from Statistics Canada CANSIM Table 202-0405.  United Kingdom figures are for 2008-2009 and come from UK Office for National Statistics report on Effects of Taxes and Benefits on Household Income Table 2.  French figures are for 2008 and come from INSEE Revenus et Niveaux de Vie Mass des Niveaux de Vie Détenue par les x% les Plus Riches.  Australian figures are for 2007-2008 and come from Australian Bureau of Statistics Document 6523.0 Table S1.

[20] The Survey of Consumer Finances, which contains a supplemental sample targeting high-income individuals.

[21] Based on figures from Edward N. Wolff (2010), Levy Economics Institute Working Paper 589: Recent Trends in Household Wealth in the United States: Rising Debt and the Middle-Class Squeeze — An Update to 2007, Table 2.  In this paper Wolff does not disaggregate figures for the lowest two quintiles.  To construct the Middle Sixty percentages, Wolff’s “bottom 40%” figures have been split out using the ratio between the bottom two quintiles observed for the relevant year in US Census Bureau Historical Income Statistics Table H-2 to arrive at a second quintile imputation, which was then added to Wolff’s third and fourth quintile figures.

[22] Again based on Wolff’s figures with an imputation for the second-to-bottom quintile.

[23] Based on 1968 figures from US Census Bureau Historical Income Statistics Table H-2.

[24] Based figures from the 2010 National Income and Product Accounts from the US Bureau of Economic Analysis, Table 7-1.

[25] Arrived at by applying US GDP growth between 1969 and 2009 to the US median household income level in 1969.

[26] Winfried Koeniger, Marco Leonardi, and Luca Nunziata (2007), “Labor Market Institutions and Wage Inequality, Industrial and Labor Relations Review, Vol. 60, pp. 340-356 (quote from p. 340).

[27] Koeniger et al (2007), Table 2.

[28] Alex Bryson (2007), “The Effect of Trade Unions on Wages,” Reflets et Perspectives de la Vie Économique, Vol. 46, pp. 33-45.

[29] David G. Blanchflower and Alex Bryson (2004), “What Effect Do Unions Have on Wages Now and Would Freeman and Medoff Be Surprised?” Journal of Labor Research, Vol. 25, pp. 383-414, Table 2.

[30] Lawrence Mishel, Jared Bernstein, and Sylvia Allegretto (2007), The State of Working America 2006/2007, Table 3.32.

[31] Based on figures from Barry Hirsch and David Macpherson, U.S. Historical Tables, accessed through the unionstats.com website.  The 1953 US figure is imputed from the 1953 private sector workers’ membership figure from Barry Hirsch (2008), “Sluggish Institutions in a Dynamic World: Can Unions and Industrial Competition Coexist?” Journal of Economic Perspectives, Vol. 22, pp. 153-176, adjusted upward by the historical average of 25% to account for government workers and workers who were covered by union contracts but who were not union members.  Figures for European countries are drawn from L. Fulton (2009), Worker Representation in Europe, Labour Research Department (London) and European Trade Union Institute, accessed through the worker-participation.eu website.

[32] Robert J. Gordon and Ian Dew-Becker (2008), Controversies about the Rise of American Inequality: A Survey, NBER Working Paper 13982.

[33] Robert H. Frank and Philip J. Cook (1995), The Winner-Take-All Society.

[34] Scott DeCarlo (2010), “What the Boss Makes,” Fortune Magazine online April 28, 2010.

[35] Based on data from US Census Bureau Historical Income Statistics Table P-38.

[36] Based on data from Changmin Lee and Woonam Seok (2009), “The Structure and Pay Distribution in the Executive Team,” working paper, Samsung Research Institute of Finance, Table 6.

[37] Again based on Lee and Seok (2009), Table 6.

[38] Based on data from the Pew Research Center for the People and the Press (2011), “Economy Dominates Public’s Agenda, Dims Hopes for the Future,” p. 2.

[39] Again based on Pew (2011), p.13.

[40] Again based on Pew (2011), p.14.

[41] Based on figures from G. William Domhoff (2011), “Power in America: Wealth, Income, and Power,” Who Rules America? website, University of California at Santa Cruz, Figure 8.

[42] Based on data from the Pew Research Center for the People and the Press (2011), ” Labor Unions Seen as Good for Workers, Not U.S. Competitiveness,” p. 2.

Should we reduce the corporate income tax?

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President Obama has opened an election-year debate on corporate taxation with his proposal to reduce the headline corporate income tax rate from 35% to 28%.  His idea is to give corporations an income tax cut while at the same time eliminating massive loopholes that corporations use to avoid paying taxes at all.

A corporate income tax with fewer loopholes would be a great thing.  Loopholes distort corporate behavior by encouraging them to behave in non-productive ways simply to reduce their tax bills.  Three cheers.

But why the reduction in the headline rate?  How much should corporations pay in taxes?

Well in Australia (where I live) the headline corporate income tax rate is 30%.  In Australia, there are essentially no loopholes or special provisions.  As a result, the effective corporate income tax rate is . . . 30%.

In the United States, the headline corporate income tax rate is 35%.  In the US, there are hundreds of loopholes and special provisions.  As a result, the effective corporate income tax rate is under 15%.

By the way, in Australia the unemployment rate is 5.1% and the minimum wage is over well over 20 US Dollars per hour.  And did I mention that everyone has government-sponsored health insurance?

Ah, but a high corporate tax rate will stifle innovation and investment — or so the story goes.  Let’s think about this a moment.

The corporate income tax is a tax on profits, not revenues.  Investment is deducted before profits are determined.  When a corporation invests in innovation, that money isn’t taxed.  It’s expensed against revenues to determine profits.

No dice.

No, what a high corporate income tax does is reduce the proportion of its profits that a corporation can pay out to shareholders, give to CEOs in massive bonuses, or use to buy up other companies.

What are the least productive, most damaging things that corporations do?  Pay out to shareholders, give to CEOs massive bonuses, and buy up other companies.

A high corporate income tax is sounding better all the time.

The real question, though, is not whether or not we should tax corporate income.  The government needs money to run, and we have to tax someone.  The real question is: what is the best way to use the nation’s resources?

To keep corporate income taxes low, either we have to keep individual income taxes high or we have to cut back on government services.  In other words, it’s corporations versus people.  In the grand scheme of things, I suspect that you and I need the money more than Apple or Google.

That’s not class warfare.  That’s simple arithmetic.

Yes, a high corporate income tax is sounding better all the time.