The Gini is Out of the Bottle

The GOP is Playing with Fire

In my previous post ( The Case of the Missing Capex ), I alluded to two lessons I expect Republicans to reap if they actually manage to pass the tax legislation they are presently pushing.  That is, unless the final bill changes considerably.  Actually, I don’t expect the GOP to learn anything, so I shouldn’t call them lessons.  Instead, they are the foreseeable outcomes to a political and economic policy mistake. Political error is the primary subject of this post.  I will mostly save the economic policy implications for later.

People (in this case, politicians) are prone to making the same mistakes repeatedly.  Whether due to ignorance, myopia, self-preservation,  corruption, or cognitive dissonance, leaders often lack both the foresight and integrity to follow a prudent path.  In this particular case, I believe Republicans are more anxious to claim a political win than to construct sound policy.  Extremely low poll numbers for the sitting president, and a failure to pass substantial legislation have left the GOP desperate.  Some members have stated publicly that their biggest motivation is to make wealthy donors happy.  As their tax proposals stand at the moment, the outcome looks more like a blatant “land grab” than a sound economic and fiscal plan.  The willingness to run substantial deficits after several years of demanding fiscal responsibility when they were in the minority smacks of hypocrisy.  It’s particularly imprudent to pursue deficit spending at a time when growth is actually on solid ground, and the labor market looks to be tightening.  Most analysts concur that wealthy tax payers stand to gain substantially more than the middle class with this plan, in contrast with how it’s been promoted. Such cynical political machinations are disconcerting during normal times.  Given the present political state, it should be alarming

 

We have seen an epic loss of confidence in official institutions in the past few decades.     (Americans Have Lost Confidence in…Everything ).  Both elected officials  and experts in most fields are held in low regard by many Americans.  Sociologists point to the late 1960’s as the beginning of this trend.  Americans had historically expected their leaders to speak frankly, and to be trustworthy. The realization that the government was not being truthful concerning the Vietnam War was a watershed moment in people’s view of the government.  No longer did voters take officials at their word.  The Nixon era Watergate scandal solidified this trend.

 

Income Inequality is at Record Levels

Chart 1 shows the Gini Coefficient, which is the most common measure for income inequality.  The higher the number, the more concentrated wealth is in a society.  As the chart shows, the Gini Coefficient for the U.S. has been on a 50 year uptrend, and is now at the highest number since the Census Bureau began measuring in the 1960’s.

 

Chart 1

Gini Coefficient for U.S.

Gini

 Source:  U.S. Census Bureau; Federal Reserve

 

 

The Gini coefficient, while being the most commonly used measure of income dispersion to measure inequality, is a rather opaque metric for most people to interpret.  A zero Gini represents a perfectly equal income distribution, while 1.00 signifies one that is completely unequal (1 person has all the money).  This seems simple enough, but the problem is that each Gini measurement is not unique.  That is, different distributions can have the same number.  It’s also not easy for laypersons to understand if a particular number is “good” or “bad”.  For a more intuitive understanding of the problem, I am also including Chart 2.  It shows the percentage of income held by the wealthiest 1% of U.S. citizens.  At 22%, the share of income of the top 1% is right near the record of 23.9% set in the 1920’s, and more than double the low of 8.9% set in the 1970’s.

 

 

Chart 2

Percentage of Income Received by Top 1% Wealthiest in U.S.

Top1%incomeShare

Source:  Emmanuel Saez, UC Berkeley

 

 

 

The sources of rising income inequality is the subject of much debate, but several potential causes stand out.  Unions have lost significant power in the U.S. over the last few decades, as manufacturing has shrunk as a percentage of the economy, and services have risen.  Exacerbating this situation is the expansion of free trade, which means U.S. workers must compete with cheaper labor worldwide.  Finally, and possibly the most damaging to workers’ ability to command higher wages, is the accelerating trend of replacing labor with technology.  Historically, automation has primarily displaced manufacturing workers. But increasingly, as computers have grown more powerful, and artificial intelligence (AI) has advanced, white collar workers are experiencing the same angst that manufacturing workers have for decades.  These causes of widening income inequality are inescapable economic realities.  Certain policies enacted to impede these forces, such as curtailing free trade, are neither efficient, nor are they beneficial in the long-term.

 

More controversial is the arguement that capitalism automatically leads to income inequality, and progressive taxation is necessary to bring about a better economic balance.  Thomas Piketty, an influential French economist, made this argument in his book, Capital in the Twenty-First Century (2013) ( Thomas Piketty ).  The primary divide between Republicans and Democrats throughout the last century has dealt with this issue.  At times, the debate has been focused on morality, with Democrats emphasizing the importance of equitable distribution of income, and Republicans stressing individual liberty.  Ideological predilections of individuals are based on subjective value judgements, and I have no desire to wade into that territory.  However, in light of widening income inequality,  I see several serious problems with the Republican tax plan.

 

Not Just Bad Economic Policy

 

Republicans, despite the constant missteps of President Trump, who has a record low approval rating for a first year president, have been given some great advantages, which I believe they are about to squander.  Rising global economic momentum, which began last year in the third quarter, has recently accelerated, and is providing a solid backdrop to the U.S. economy.  Of course, the push for deregulation and tax cuts is doing its part as well by boosting sentiment.  I have already covered why I believe the GOP plan will fail to provide a boost to growth ( ’80’s Nostalgia: Glue That Binds the GOP  ).  But what strikes me as extraordinary is how bad this plan looks from a political standpoint. 

 

With income inequality at record levels, it seems like passing a tax bill that favors wealthy individuals and corporations (which further benefits wealthy people) would be political suicide.  Republicans are pushing back against that characterization, but most analysis has found the wealthy benefit considerably more than the middle class ( Fortune Magazine ).  As one extreme example, Donald Trump’s children would be expected to net $1 Billion on the repeal of the estate tax alone. 

 

Last year’s election laid bare the raw anger caused by decades of stagnating real income growth in the U.S. All along the political spectrum, the middle and working classes increasingly see the deck stacked against them.  On the Democratic side, that anger manifest as the success of the Bernie Sanders campaign.  For Republicans, it ended with Donald Trump taking over the party.  Hard-core Trump supporters, based on his average percentage of votes during the primaries, represent about one-third of the Republican party.  Most of these individuals are not wealthy, with many lacking college degrees.  No doubt, motivation among this group has much to do with social issues rather than economic. But it is difficult to believe this demographic will be placated indefinitely if they fail to see their own financial positions improve.  Even if Trump’s supporters remain loyal, middle class moderate Republicans and Independents, who do not favor Trump’s social views, are not likely to be happy with the agenda being set forth.  Polls show that the GOP tax plan is not popular, with only about 25% of voters approving ( GOP Tax Plan Approval ).

 

If the present economic momentum holds, Republicans may not pay a price for this tax plan at the polls in 2018.  But that shouldn’t be a foregone conclusion.  Liquidity is likely to be withdrawn by global central banks next year.  Less liquidity, along with higher federal deficits and tight labor markets, could cause U.S. rates to rise more than markets anticipate.  If that happens, I believe we will once again see the global economy falter.  Regardless, once the business cycle turns down again, anger will resurface.  Psychological studies show that people have a natural tendency to dislike unfairness ( Psychology of Fairness ), and polls show that is how this plan is being viewed by the majority of Americans.  Regardless of cause, there are societal implications for widening income disparity, and they feed back into economics through the political arena.  In their zeal to pass this legislation in record time, with no input from Democrats, Republicans are putting themselves and the country at risk (I’ll cover the economic implications further in a future post).  That won’t be apparent in the near term, as markets may continue to scale new heights in anticipation of a windfall for corporations.  I’m sure that GOP legislators will be euphoric if they are successful in passing tax reform.  But they should be careful what they wish for.  This is one Christmas gift they (and the country) would be better off without.

 

 

 

 

 

 

 

 

 

 

 

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