According to University of Chicago economist Raghuram Rajan and his Money Magazine interview with David Futrelle on November 24th, 2010, he believes income inequality is the main problem with the U.S. today. This is a trend that started in the 1980s as tax code changes and technology dramatically transformed the economic landscape. Also, the rapid decline in delivering goods across the globe led to the rise in globalization and the diminishing influence of unions. As for fighting income inequality, the question focuses on whether to create a larger safety net or emphasize strategies on improving the productivity gap.
Before addressing this issue, you might be asking why minimizing income inequality is even important. My response is that it can be necessary to encourage more social mobility and prevent bad economic policy. In these times, images of wealth and prosperity often dominate our airwaves and lead to envy and conflict. As we have seen with this past recession, many middle class Americans have seen their wages shrink, while also noticing the multi-million dollar bonuses given to executives of failing firms. While this particular scenario is not ideal, it does provide a distorted picture of today’s economy where global forces play a significant role.
It is common to question the merits of globalization, while not realizing its impact in growing prosperity in the U.S. and beyond. Rising living standards and wages from the 1990s happened because former President Bill Clinton openly embraced free trade, which led to lower costs and greater productivity. Instead, we see headlines of jobs leaving and going overseas, but do not recognize the new jobs that are created due to lower prices paid by consumers. When we only recognize the negatives, it can lead our policymakers to bad economic decisions, such as reverting to past protectionist policies that led us to the Great Depression of the 1930s. In order to prevent this from happening, we need to ensure that our workforce is adequately trained to adjust to the strains of globalization.
Rajan believes that the promotion of home ownership by both political parties caused our current economic troubles. Democrats wanted to address the wealth gap and thought that the key was affordable housing. They expanded the role of Fannie Mae and Freddie Mac, who bought up various mortgages from servicers and packaged them into investment products called mortgage backed securities. These investment products were initially attractive to investors, who saw above average returns and low risk, given the implicit guarantee from the U.S. government. However, a souring economy caused delinquencies and foreclosures to rise and many of these mortgage backed securities lost their values, in particular subprime mortgages. Subprime refers to borrowers that do not have good credit and must pay higher interest rates and are considered greater credit risks. Since Fannie Mae and Freddie Mac had no control over underwriting any of these mortgages, they were ill-equipped to handle the rapid decline in credit quality.
It should be noted that the George W. Bush administration also did not take steps to limit the influence of Fannie Mae and Freddie Mac because they wanted to refute charges that they were the party for the affluent and were very interested in boosting home ownership rates to generate wealth and more social mobility. Their thinking was that communities would improve if home ownership took precedence over renting. With owning more private property, it was thought that people would take greater care of it and this would limit decay, which brings more violence and crime. If this initiative was successful and the poor and lower middle class found more access to wealth, then they would be more amenable to changing their allegiance to the Republican Party. Given that Fannie Mae and Freddie Mac allowed individuals to buy homes with a lower down payment than one would receive from a traditional bank, there were limited efforts from the Bush administration to deemphasize their influence.
Since home ownership failed in closing the wealth gap, then the question focuses on whether we should revert back to the income redistribution strategies that occurred before the 1980s. This can take the form of either tax code changes and/or the rise in-kind transfers that can diminish income inequality. Starting in the 1980s, we started seeing a shift in the tax code that showed the marginal income tax rates dropped from 70% for the highest income bracket to 35% today, as referenced by the Tax Foundation's history of U.S. federal individual income tax rates. While this change certainly contributed to high economic growth, it also created a tax system that was less progressive. In the mid-1990s, the Clinton administration and a Republican-controlled Congress pushed through the Welfare Reform Act of 1996, which yielded benefits during an economic prosperity in the late 1990s. However, we have since seen increases in poverty as two recessions during the last decade have taken a toll on the less fortunate. Therefore, should we make the tax system more progressive with the wealthy taking on a greater burden of tax liability or should we expand the safety net for vulnerable segments of society?
One way to accomplish this is by focusing on income redistribution strategies to help vulnerable Americans subsist when their jobs go away. However, expanding welfare programs and raising taxes on even the wealthy is carrying less currency with many Americans. They are increasingly concerned about expanding government's role further. As inferred by Rajan, raising the marginal tax rates on the wealthy can be disruptive to our current fragile recovery. We have seen the difficulty in letting the Bush tax cuts expire for even the wealthy with Senate Republicans blocking two measures aimed at letting them expire at either the $250,000 or $1,000,000 income levels.
Both methods are examples of income redistribution that can lead to less income inequality, but it can come at the expense of lower living standards overall. High deficits matter because it can ultimately lead to higher borrowing costs for both businesses and consumers. If businesses invest less and consumers buy less, then that is a double whammy on the economy. The end result can be an upward trend to the unemployment rate that is much too high as it is.
Then, the question becomes what can we do if above strategies do not work. To answer that question, we need to answer whether the U.S. workforce that is suffering from structural and not cyclical unemployment. In other words, are jobs not available because the economy is in a downward business cycle or is it because employers are having difficulty matching the required skills with their new jobs?
Since I believe the latter is the problem particularly in the South, then attaining more education and skills will be necessary. In this case, our priority should be on lowering the high expense of attaining a college education. Therefore, Obama's efforts in boosting funding for Pell Grants and financial aid are essential, along with expanding partnerships between community colleges and the private sector. If these efforts can be successful, then opportunity to wealth can be more equitable to all Americans.
Also, a 2007 speech from Ben Bernanke hints at other efforts at addressing inequalities that go beyond traditional K-12 and college education. Certainly, we understand the importance of K-12 and college education, but Bernanke points out that any type of training, whether it is from on-the-job training, community colleges, vocational colleges, and financial literacy training are also important in closing the income gap. Until the gap in human capital is minimized, then income inequality will be difficult to overcome.
In summary, we must address income inequality in order to improve social mobility and develop a more stable society. It is a challenge that involves complications brought on by the vestiges of discrimination; disparate funding between school districts; and self-defeating cultural behavior traits. It is very difficult to implement public policy that can distinguish individuals, who truly need and appreciate a helping hand, with those that use public resources to maintain an irresponsible and unproductive lifestyle.
Our fiscal situation and declining overall wealth will also limit the level of income redistribution that can be done, so more strategic programming will be needed to increase productivity across all social classes. While also acknowledging that families who made sacrifices and accomplished great success should be rewarded and not penalized, they must be made aware that it is in their self-interest to have an America that is more equitable. When that occurs and people feel that they are being given a fair chance at success, we will have an America that is less fractured and more self-sustaining in the long run.
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