Let's Talk About Real Middle Class Economics

10 Feb 2015 9:47 AM | Deleted user
We hear a lot of talk these days about how the new “middle class” economics of taxing the wealthy to pay for more programs, and perhaps reduce taxes for middle class Americans, will also reduce income inequality. This argument appears to assume that those at the top of the income distribution are able to keep more of their after-tax income than those at the bottom, or even those in the middle. Obviously, this is not fair. In other words, the problem of income inequality boils down to a problem of after tax income. This focus, however, obscures the real problem, which is that income inequality over the last three decades has increased because wages have been stagnant; not because the wealthy have not been taxed enough.

The issue is not income inequality, but wage inequality, and the two are not the same. When using income as a measure, that would include wages and other sources of income, whereas wages are solely what are earned in exchange for work. If the low-wage worker is receiving subsidies that effectively boosts that person’s income, the gap between the top and the bottom might not be nearly as wide if we were looking at the gap in wages between the top and the bottom.

If income inequality is narrowly defined as after-tax income, then taxing those at the top of the distribution will have a limited effect. Because their after tax income will be less, the ratio of the top to bottom will also be less, in which case inequality will be reduced. A few months ago it was reported that with the end of the Bush tax cuts, income inequality declined because the wealthy had less after tax income. But this is not the same as saying that those at the bottom at more.

Taxing the wealthy in the name of reducing income inequality does no such thing. It merely redistributes. Rather we should be looking at the issue of wage stagnation and look for ways to boost income. A more effective way to reduce inequality is to strengthen institutions like unions and the minimum wage. Our concern from a policy standpoint should be wage inequality.

Consider that in Europe that inequality is less because of more centralized wage setting institutions. Inequality in states in the U.S. where the minimum wage is more than the federal minimum wage is also less. Why might that be? Because wage inequality decreases when the rate of increase among the bottom is higher relative to the rate of increase among the top. Would it come as a great surprise to learn that wage inequality is also less in those states where union density is higher? Now the impact of unionism on wage inequality today may nor be that strong because unionism has declined considerably over the last three decades. But three decades ago when union membership was higher, the impact of unionism on wage inequality was clear: less wage inequality.

Perhaps the debate needs to be brought into clearer focus. There is no question that inequality is a social, economic and political problem that needs to be addressed. It needs to be addressed because it speaks to the shrinking middle class, and it also results in the wealthy being able to wield disproportionate power which in turn only leads to more policy favorable to their interests, and not those of the middle class.

If middle class economics is what our politicians want to talk about, then stop the phony middle class economics, and give us something real. First, focus on wage inequality. The remedy for that is to boost wages, beginning from the bottom through the wage distribution. At a minimum, the minimum wage needs to be raised, and then subsequently indexed. But other labor institutions, like unions, need to be revitalized, and labor laws which have fallen victim to conservative courts, need to resurrected and properly enforced.

When Republican governors seeking the Republican nomination for President campaign on a platform of having brought the unions to heel, that is perhaps all you really need to know about where they stand with regards to the interests of the middle class. The decimation of unions by denying them the rights to collectively bargain or passing more right-to-work laws only harms the middle class and in the end exacerbates wage inequality.

While we are strengthening labor market institutions that traditionally maintained the middle class, we need to wholly revamp the tax code, which also not only hinders economic growth but also decreases the after tax income of the middle class, which in turn reduces their demand for aggregate goods and services.

A simpler code with three or four progressive flat tax rates and no deductions will do more to encourage economic growth than the current code which seems to be more about social engineering than what the code is really supposed to be about: raising revenue. Such reform would broaden the tax base, put more money in many’s pockets, and grow the economy because individuals would have more to spend.

Eliminating deductions would also address one of the greatest consequences of rising inequality in recent years: greater responsiveness of members of Congress, regardless of their party, to those interests with the greatest amount of money who often seek their wares through favorable tax treatment. It would, in short remove many of the interests from the political process that have successfully skewed policy towards moneyed interests and away from middle class interests.

Middle class economics involves more than simply levying more taxes on the wealthy to pay for more programs for the poor in the hopes that maybe some in the middle class will benefit. Of course, it also involves more than simply lowering corporate tax rates so that businesses can pocket more profit without raising workers wages and creating more jobs. But then a simpler tax code would address that issue as well.

What the middle class needs is real commitment to economic development which will create growth and raise wages. Investment in human capital writ large — investing in workers — is certainly needed; not platitudes about free community college. Let’s start by paying workers more, and strengthening institutions to make that happen. Employers will then be rewarding workers for their effort, and be induced to invest in their workers. As more people earn higher wage, we might be able to reduce some of our tax expenditures on social spending, because as people earn more they will no longer need the programs that have effectively been subsidizing lower wages. Now that might be real middle class economics.

I am available for comment: (914) 629-6351
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