Income inequality, debt, crisis and depressions

The recent award of the Bates medal to Emmanual Saez led us to his home page where we encountered this amazing graph of income inequality as measured by the share of income going to the top 10 percent:

 

Source:  Emmanual Saez’ home page.  The income measure is personal tax return based, so is roughly based on household income, as I understand it. 

We know that, based on the unemployment rate at least, Roosevelt’s policies did not end the Great Depression.  Unemployment remained on average in the high teens through 1940 (BLS source).  With adjustments for measurement differences it was probably higher.  Two things happened simultaneously to end the Depression.  There was the apparently miraculous reduction of income inequality in 1942, 1943, and 1944 that coincided with the end of the depression as measured by unemployment rate.  And there was the huge fiscal stimulus of the war.

We know that high income people save more of their income.  So, other things equal, there will be less production and consumption with an unequal income distribution.

To those who say “we need the rich because they save and fund investment,” I say, “You think they’re going to invest in the United States, when the big growth is all abroad?  There’s nothing keeping their money here (except fear, right now).”

Now I am not a “Keynesian,” or a “monetarist” or a Republican or a Democrat.  All those positions are far too cartoonish for your sophisticated interlocutor. 

But I have concluded in a non-academic way but upon I think sufficient amounts of empirical observation and common sense, the cause of the last depression and the cause of this nascent one to be severe income inequality and the distortions of aggregate demand that result—namely the lower income classes accumulating more debt than they can handle as they try to maintain relative position with the upper crust, as all wealth and poverty are ultimately relative (as Jesus knew).  The debt explosion may also result from everyone taking on debt to counter slowing growth in the economy due to said demand distortions, to keep getting the same relative kick from growing consumption.  Here’s the picture of debt load then and now—note the similarity to income inequality:

Source:  Credit Suisse

Nota bene: The real GDP growth rate has fallen from about 4 percent to about 2 percent over the postwar period during the run-up to our current indebtedness.

So how do you make an income distribution more equal without a world war with an enemy everyone bands together to fight?  I really don’t understand what happened in an economic sense during the war to equalize outcomes so much, and invite references in comments.

One possibility, with a remote chance of happening so long as Congress is bought and paid for by moneyed interests, would be to raise marginal tax rates on incomes over, say, $1 million to 75 or 90 percent.  Why?  Because our moneyed elite has come to believe they are above the law—managements have made it a practice to loot public corporations, with the full complicity of their accountants; financial service firms largely in New York have perpetrated multiple massive frauds upon the world’s financial markets (and to think that these people didn’t know it was fraud is to give them too little credit for intelligence—after all, many of the biggest winners also got Nobel Prizes).  Anytime one party walks away from a deal with a huge wad of cash and leaves all the risk with someone else, the alarum should sound.  But these people were good, slick beyond disbelief; and anyway, their friends (the rating agencies, insurance companies selling CDSs, wealthy clients of hedge funds, etc.) were getting rich too, so why spoil the party?

American marginal tax rates were highest in the 1950s, 90 percent frequently, at the time of the country’s greatest postwar growth rates.  So the argument that high marginal tax rates kill growth does not pass the sniff test.  In fact, top marginal tax rates have moved inversely over the postwar period with economic growth.  It’s almost as if in the early postwar years when the country was paying off its war debt that people actually believed that, from those to whom much has been given, much is expected.  Imagine that.

Source: Matt Yglesias

Raising marginal tax rates on these people might bring them down to earth and make them realize we’re all in the same boat.  America, love it or leave it!  Especially the hedge fund managers, who, as Warren Buffet points out, pay a lower percentage of income in taxes than their administrative assistants.

But this is not what we see happening.  Instead we see massive amounts of federal debt being piled on the tax-paying stressed-out middle classes, who are trying to deleverage and save, further reducing consumption demand. 

What’s the Benign Brodwicz program?  A poverty level dole and free health care for the unemployed or bankrupt while they look for another job while continuing to support domestic consumption and investment demand and safeguarding the health of the next generation.  Take care of the people, lose the macroeconomists who can never agree on anything anyway.  Academic economists are ideological cheerleaders not useful for practical work.  Obama’s deficits are insane given our position as world’s greatest debtor nation.  Lower business taxes.  Take care of the people and get the budget on a pay-go basis.  We’re a fabulously rich country, there’s plenty to go around.  The planet is groaning under the demands for ever-increasing consumption (see Sornette and Johansen for the really big picture).

It’s time for a new paradigm.  Keynesians, you’re firing your blanks at the wrong bogey-man.  Pumping up aggregate demand without addressing income inequality will just put more money in the pockets of the New York slicksters—as has happened with the banking bailouts—and the upper crust across the land, and sink everyone else in debt or indentured servitude to taxes.  And they’ll take the money and invest it where they can get the highest rate of return, which won’t be here.

Note the sequence: there’s an inequality increase and run-up of debt; then a collapse of effective demand, debt deflation and depression; households slowly deleverage; inequality vanishes in a crisis; growth takes off with a renewed social contract with the upper crust willing to bear their share of the burden. 

Massive fiscal stimulus applied to a country with a broken social contract invites massive corruption.  And our social contract is broken.

When will a sense of “democracy” return to the workplace? Here’s the picture of CEO pay relative to average worker pay.  These people must think they’re gods!  Any reader with experience of latter-day corporate America knows the feeling that one is expected to genuflect in the presence of top management.

Source:  New York Times

As a first step, our policies should be aimed at helping households to deleverage. 

The pension funds holding the assets of American workers might think about reining in executive pay.  (Fat chance, the money managers are part of the game.)

But to foster that sense of togetherness, I say tax the upper crust, knock ‘em off their pedestals.  Make ‘em remember what it means to be a member of the human race again. 

The two great tasks facing America now are to deleverage the households and to restore a sense of fairness to compensation and taxation.  Only then can massive fiscal stimulus be responsibly contemplated.

We will limp along, if we don’t commit fiscal suicide, until these problems are solved.  Massive debt-financed fiscal stimulus on a highly unequal, unfair, politically compromised economy will make the inequality—the root cause of depressions, in our view—worse.

IMHO.  Cheers.