Growth and inequality

by S.M. | NEW YORK 

THE Wall Street Journal is deeply unhappy with Barack Obama’s recent speech on the economy at Knox College in Galensburg, Illinois. The rising inequality in Americans’ incomes that Mr Obama bemoaned last week, the Journal claims, is a direct result of his administration’s policies:

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For four and a half years, Mr. Obama has focused his policies on reducing inequality rather than increasing growth. The predictable result has been more inequality and less growth. As even Mr. Obama conceded in his speech, the rich have done well in the last few years thanks to a rising stock market, but the middle class and poor have not. The President called his speech "A Better Bargain for the Middle Class," but no President has done worse by the middle class in modern times.”

The Journal is right that the middle class has seen little benefit from the modest recovery, and it reports correctly that median incomes today are “5%...lower than the...median in June 2009 when the recession officially ended”. But is it true that “Obamanomics” is to blame for the plight of the middle class? In the interview Mr Obama gave to the New York Times on July 24th, the president trumpeted the fact that “the economy is far stronger now than it was four and a half years ago” and cited long-term fallout from the financial crisis and obstructionism in Congress as the real culprits keeping the middle class down. “Congress moves at such a glacial pace these days”, he sighed.

In response, the Journal screams hypocrisy, arguing that Mr Obama cannot claim credit for boosting the economy while he at the same time insists that economic troubles inherited from the Bush years have precluded more robust growth. There may indeed be some slippery reasoning here, but Mr Obama’s assessment paints about the right picture of the power of a president to control the economy. A year ago, my colleague at the Free Exchange blog captured the constraints facing Mr Obama:

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The real rub for Mr Obama is...that there is only so much any president can do to combat business cycle fluctuations. Congress is always a bear to work with, and the real authority over the demand side of the macroeconomy rests with the Federal Reserve.”

Twelve months down the road, Mr Obama has won re-election and is narrowing down his list for the next Fed chair to a few candidates, but the constraints he faces as a steward of the American economy are unchanged. A pair of disingenuous arguments fuel the Journal’s claim that Mr Obama’s policies have put a brake on the recovery. Here is the first:

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The food stamp and disability rolls have exploded, which reduces inequality but also reduces the incentive to work and rise on the economic ladder.”

The Onion has exposed the oddity of this proposition as well as anyone, and recent research into the relationship between the Supplemental Nutrition Assistance Programme (SNAP) and work incentives belies the Journal’s claim. It stands to reason that a few hundred dollars in food stamps for you and your family every month would not turn you into a beach bum or deter you from searching for a job. (There are other bills to pay, after all.) I suppose some people might descend into lethargy if their daily bowl of Cheerios were covered by a federal programme, but according to a recent study, this rarely happens:

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The overwhelming majority of SNAP recipients who can work do so. Among SNAP households with at least one working-age, non-disabled adult, more than half work while receiving SNAP — and more than 80 percent work in the year prior to or the year after receiving SNAP. The rates are even higher for families with children — more than 60 percent work while receiving SNAP, and almost 90 percent work in the prior or subsequent year.”

More to the point, in the mid-2000s about 96% of people who worked before receiving food stamps continued to work after entering the programme. So helping people put food on the table does not seem to contribute to unemployment and does not, according to available evidence, hamper economic growth.

The Journal’s second warrant for the claim that Mr Obama's policies are anti-growth is equally weak:

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Mr. Obama's record tax increases have grabbed a bigger chunk of affluent incomes, but they created uncertainty for business throughout 2012 and have dampened growth so far this year.”

This bald assertion makes little sense. Uncertainty may have plagued the business community in the run-up to the fiscal cliff, but since the year-ending deal to very modestly increase tax rates on the highest earners, there have been no real surprises. Demand is historically immune to tax-rate changes like these, as the Economic Policy Institute observed in a recent paper:

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As the economic literature widely finds no discernible effect of top tax rate changes on the primary factors driving economic growth, it is somewhat reassuring that a deep body of research, such as that by Gravelle and Marples (2011) and Hungerford (2012), finds changes in the top U.S. marginal tax rates have had no statistically significant impact on real GDP growth itself.”

There is, however, an upside to the tax increases:

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Time series regression analyses of top marginal tax changes’ impact on economic growth (as well as on related factors of growth), the ETI literature, and analyses by nonpartisan budget scorekeepers overwhelmingly suggest that increases in top marginal tax rates should have a negligible impact on economic growth, and that there is substantial scope for raising more revenue. Economic research also suggests that such increases would decrease after-tax income inequality (by definition making the tax and transfer system more progressive) and could also have powerful effects on pre-tax inequality.”

The bottom line? The higher top marginal tax rates that went into effect this year are not holding down economic growth but do represent a small step toward shrinking income inequality and ameliorating the deficit. Still, as Mr Obama emphasised in his speech last week, the middle class continues to fall behind even as the stockmarket surges and the housing market picks up, and there is no apparent quick fix for what seems to be a worsening trend over at least the past decade. The president promises to provide detailed proposals for a long-term solution in the coming weeks, and his ideas should be scrutinised carefully. But dismissive, fact-blind critiques of Mr Obama as an “inequality president” are no help at all./wsj