The Costs of Overturning the President’s Health Care Reforms

Partisan politics and constitutional principles received equal billing in last week’s showdown over health care at the Supreme Court.  Much of the commentary has tried to interpret the questions, gestures and tone of the Justices, in hopes of divining which party and vision of government will likely prevail.  Such divinations are notoriously unreliable in controversial cases.  But whatever the Justices decide, the decision will have enormous long-term economic effects on how much medical care average Americans receive and how much they pay for it.  

It has been clear for some time that without major reforms, the U.S. health care system will soon impose unmanageable burdens on millions of middle-class Americans.  By 2016, the average family is expected to earn about $54,000.  In that year, moderately-priced, family health-care insurance coverage will cost about $14,700.  Employers will pick up much of that tab for most middle-class families.  But all of those employer payments come out of people’s wages and salaries.  So, adding the value of that coverage to the average family’s income in 2012 -- $54,000 + $14,700 = $68,700 – we see that the cost of the health care insurance alone will soon claim more than 21 percent of an average family’s annual resources.

On top of that, by 2016, the average family’s co-payments and other uninsured expenses are expected to come to another $5,100.  Our average family also will pay taxes to help cover other people’s health care – 2.9 percent of their wages for Medicare ($1,566), plus perhaps $1,000 more in federal and state taxes for Medicaid and Medicare costs not covered by the payroll tax.  Add all of that to the cost of their insurance, and health care will claim $22,366 from an average family in 2016, or 32.5 percent of their adjusted income of $68,700.

Why should the average American family have to pay nearly 33 percent of its income for a health care system which by 2016 should claim about 18 percent of GDP?  Part of the answer is that the average worker earning $68,700, a manager making $150,000, and the CEO earning $5 million all pay roughly the same $14,700 for their family coverage.  The result is that middle class families spend a much larger share of their income on health care than wealthier families.  

One of the reasons why health insurance costs middle-class families so much, however, is that their bill includes a good share of the costs of treating those without insurance.  The tab for treating the injuries and illnesses of more than 50 million Americans with no public or private coverage will come to about $68 billion this year.  Government picks up some of those “uncompensated costs,” and doctors and hospitals eat some of their costs.  But most of the rest is passed along in lower payments to insurers, who in turn pass along those losses to their customers in higher premiums or reduced coverage which drives up out-of-pocket costs.  A reasonable estimate of the costs of treating the uninsured which are passed along to average policyholders is about $300 per-person, or some $1,200 for an average family.

The President’s plan to end those pass-along costs by mandating universal coverage was, of course, the central issue in this week’s arguments at the Supreme Court.  And behind the high-minded debates over principle lies the harsh politics of who is to pay for it.  The President’s reforms shift most of the costs of the uninsured to the government by expanding Medicaid and providing subsidies to uninsured people and families mandated to get coverage.  These costs ultimately will be financed through non-payroll taxes – the personal and corporate income tax – which in turn fall disproportionately on higher-income Americans.  That is the choice, and it helps explain the vehemence of the partisan battle over the mandate:  The President’s reforms will shifts tens of billions of dollars in annual costs from middle-class families with private insurance to more affluent taxpayers. 

The good news for the well-to-do if the President prevails is that the new reforms also include measures to contain the future costs of covering those without easy access to insurance.  To begin, covering the uninsured should reduce the cost of their care, at least over the long-term.  Uninsured people are much more likely to suffer strokes, for example, because they are much more likely to have undiagnosed hypertension, diabetes and high cholesterol.  Or, among people with cancer, the uninsured today are much more likely to be diagnosed later, and so require the most expensive interventions.  Uninsured people also are less likely to fully recover from many injuries, making them more likely to suffer subsequent medical problems that require more treatment.   Ensuring that everyone has insurance, therefore, should reduce those costs. 

The reforms also include a package of measures that may begin to slow the health-care inflation which for years has been eating away at everyone’s insurance coverage.  These measures range from the push to establish uniform electronic medical records, to a more results-based reimbursement process for doctors and hospitals, and steps to encourage them to adopt more cost-efficient medical protocols and practices.  To be sure, the reforms do not include the most controversial and partisan cost-saving measures, including tough medical malpractice reforms and an option for public insurance in places where competition among private insurers is weak.  Still, they are a beginning.  

After Bill and Hillary Clinton’s push to reform health care failed in 1994, it was 15 years before another President and Congress took up the issue again.  If the Supreme Court unravels what they did, it almost certainly will be many more years before anyone tries again.  The economic consequences of that scenario would be inescapable.  The number of uninsured people and families will continue to grow.  The costs of their treatment will continue to squeeze coverage and increase the costs of private insurance for most middle-class families.  And without measures to “bend the curve” of medical cost increases, average families will find themselves forced to spend one-third or more of their real incomes on their health care.  

A Modest Proposal to Help the U.S. Avoid an Economic Train Wreck

The United States is headed for an economic version of a Wall Street “triple witching hour.”  In finance, a triple witching house comes along four times a year, when options contracts on stocks, options contracts on stock indexes, and futures contracts of those indexes all expire at the same time on the same day.  Washington’s own version will unfold at midnight, December 31, 2012.  That is the moment when, at once, all of George W. Bush’s tax cuts expire, President Obama’s payroll tax relief ends, and the grace period before $1.2 trillion in across-the-board cuts runs out.  If the President, Congress and the two parties cannot finally agree on what to do about spending and revenues, their doing nothing will actually solve most of the U.S. deficit problem.  But all of that austerity coming at once would also shut down the U.S. economy.   

We actually face something close to a quadruple witching hour, because sometime in late-December or early-January, within days or weeks of everything else, the U.S. debt limit will run out again.  The irony is that if the lame duck Congress and possibly a lame duck President cannot resolve these matters, the United States could face a technical sovereign debt default even as its political gridlock carves out a sustainable path for its government debt.  Given how tortuously difficult it has been to resolve any one of these issues thus far, on even a temporary basis, the health of the American economy demands some new political thinking.

The range of scenarios for the post-election period is mind-boggling.  For example, conservatives might be tempted to trade a multi-year extension of payroll tax relief for permanent status for all of the Bush tax cuts.  A newly-reelected President Obama might consider agreeing if, say, the Republicans also would agree to find some new revenues from other sources and fold in a multi-year extension for the debt limit.  (Good luck with that.)  And if Romney wins the White House, congressional Democrats could call his bluff, let him enter office with a sinking economy, and then force him to negotiate with a Senate Democratic caucus able to block whatever a GOP House passes.  Or, in what would pass for a rosy scenario here, everyone may be so exhausted from the years of political trench warfare that all sides agree to extend everything for several more months, so the new Congress and whoever is President can try to work it all out. 

Whatever the election results, the debate over taxes and the budget will dominate our politics and government through at least the first half of 2013.   In fact, that happens nearly every four years.  Since Ronald Reagan’s first term, most Presidents have figured out that they can use their initial budget and tax initiatives to carry most of their agenda – and that their sway with Congress will likely only erode with time.  To be sure, this initial focus on budget and taxes made more sense when Washington still knew how to forge bipartisan compromises.  The question today is, can any president get the current crop of Republicans to sign on to any plan that includes new taxes?  And without that concession, could any president persuade congressional Democrats to reform Medicare and Social Security?

If taxes and entitlement remain off-the-table, there can be no grand bargain and no resolution.  For the short-term, the United States instead will face auto-pilot austerity.  More important, the patience of global investors with our stumbling political process could run out, which would mean rising long-term interest rates.  If that happens, the U.S. expansion will end before it can generate any benefits at all for most Americans.

The next president needs a game changer, one that might entice each side to make painful concessions, say, in exchange for control over the impact of those concessions.  As president, Bill Clinton could intuit the terms of such mutual concessions.   We will have to settle for a new process – or for putting an old one to new use.  

For many years, certain aspects of taxation have been seen as too complex and esoteric for even the professional tax mavens at the Senate Finance and House Ways and Means committees.   The taxation of mutual and stock life insurance companies is an example.  So when Ronald Reagan raised corporate taxes, the tax writing committees parceled out several billions of dollars in new revenues to the life insurers and told them to figure out how to raise it in ways that would be least disruptive economically.   Those were simpler times politically, to be sure, but the same model could be adapted to our current problem.

Let’s assume that the lame duck gives the President and Congress a few more months to work out everything.  Next January, the President and the leaders of both parties in both houses agree – tacitly, of course -- on how to broadly allocate another $4 trillion in budget savings over 10 years, under new rules.  Say, for example, that $1 trillion would come from new revenues, $2 trillion from entitlement reforms, $200 billion from discretionary defense spending, $300 billion from additional discretionary non-defense programs, and the rest from interest savings.  By agreeing to $1 trillion in new revenues, Republicans get the right to design whatever reforms they deem best to achieve the target.  Similarly, by agreeing to $2 trillion in entitlement savings, Democrats gain the right to fashion whatever Medicare and Social Security changes they deem best.  Similarly, Republicans could allocate the additional defense cuts, and Democrats would parcel out the additional, discretionary non-defense cuts.  And the looming threats from the expiration of everything, combined with the knowledge that each party would control the terms of the changes it fears most, might just be enough to get both sides to agree to the underlying allocation of pain. 

Foreign Policy Chat – Managing China’s Cyber Threat

A new Congressionally-commissioned report on China's offensive cyber capabilities was released today, arriving just in time to contribute to the debate over a new cyber security bill winding its way through the legislature. The report provides some interesting technical details, but it was based off of open-source intelligence, making its big conclusions familiar to those who have been paying attention to these issues over the last several months. We know that China is pursuing a robust program of offensive capability that it hopes would allow it to disrupt foreign information and hardware networks, in addition to demobilizing an opponent's command and control, in advance of a traditional military operation.  The report also highlights the prevalence of Chinese non-government, though perhaps sanctioned, hackers' continued efforts to steal business information and R&D details from American corporations. Intelligence officials and corporate officers have known about his for years, but officials -- both in and outside the Government -- have only recently begun calling out China publically for its role in supporting cyber espionage.

While information theft is certainly a problem, policymakers should not be surprised by China developing cyber capabilities and contemplating its role in their contingency planning. The United States is certainly doing the same thing. US Cyber Command is tasked with a similar mission and one would hope that they're also toiling to stay on the cutting edge of offensive and defense cyber capabilities, as well as developing ways to integrate these tools into strategic and tactical planning. It would be a mistake to view china's foray into this space as an unusually aggressive move, rather than something to be expected. As we manage this new reality, however, we should view the evolving cyber space through two critical prisms.

Building and maintaining our security defenses needs to be a top priority and far more can and should be done to protect ourselves from cyber threats. A large part of Cyber Command's mission -- along with DHS and others -- is to secure government and defense networks from potential attack. This effort should be commended, but there needs to be a commitment of resources that is actually scaled to the task. In addition to more robust funding, though, existing agency constituencies need to sacrifice tightly-held turf in order to promote an effective whole-of-government approach. 

While these reforms can appear daunting, they're actually much further ahead than the private sector. Much of the essential US infrastructure -- power plants, telecom, utilities -- are privately owned. Up to now we have largely relyied on these private corporations to protect their networks and services on their own. Unfortunately, very few have actually stepped up to the plate. James Lewis, a cyber expert at the Center for Strategic and International Studies, highlighted this problem when he recently testified before Congress: "As a nation, we are still too reliant on cybersecurity policies from the 1990s that depend on voluntary action, market forces and feckless public private partnerships.  This approach has failed.  It is inadequate for what has become a global infrastructure that our economy relies upon and, because of its speed and scale, makes criminals, spies and hostile militaries our next door neighbors. Continued endorsement of these old ideas as the basis for cybersecurity puts the nation at risk"

This is the critical issue that the Cybersecurity Act of 2012 is intended to address. The status quo has clearly failed and Congress should make sure to write and pass a strong bill that will not allow our national security to be put at risk simply because corporations would rather spare themselves the expense and hassle of securing and upgrading their systems. Let's be clear; Like the Wall Street banks, it's the American citizens, tax payers, and government who will be left holding the bag if our physical or digital infrastructure is compromised, so it's past time to enforce reasonable regulations.

Along with playing a strong defense, we also need to keep in mind that our approach to cyber is part of our much larger relationship with China. The President's "pivot to Asia" reflects the reality that the nature of Sino-US relations will be, perhaps, one of the most consequential factors driving 21st century global politics. The speed and size of the Chinese economic expansion will inevitably bring with it a desire for more regional, global, and military influence. This situation calls for effective and proactive engagement by the US. Domestic cyber attacks and espionage is also a huge and growing problem within China and, when searching for common interests, we shouldn't dismiss out of hand the potential for this issue to be a potential source of collaboration.

As China grows into its more influential role, US policy makers need to be wary of slipping into an unnecessarily combative relationship. We no longer have the option of falling into a new Cold War. Our economies and interests in the global commons are simply too interdependent. This doesn't mean that we shouldn't confront the Chinese in order to protect US interests. We should not shy away from raising the stakes -- at the WTO and bilaterally -- on issues of trade and currency manipulation. But every new tank produced in Beijing or Chinese hacker who skims a password should not be viewed as an indication of focused aggression and a sign of some imminent attack. As the recent report on cyber capabilities makes clear, China has many broad and diverse interests and they have little motivation to pick a real fight with the United States. Increased military spending should be expected from China given their economic growth and the massive balance of force advantage that the US maintains. Despite large investments by Beijing, China is not a near-peer for the US in conventional military might. The US will remain, for many decades at least, the only country with the hardware, infrastructure, and logistics necessary to project sustained military power around the globe.

The ongoing cyber threat from China is real, but our response must avoid overreaction and be viewed within the larger context of the US-Sino relationship. We need to raise our game in securing our private and public network infrastructure, work with China and the international community to establish a credible cyber regime, and then hold violators responsible through appropriately-scaled penalties. This is not a time to simply withdraw behind firewalls. In the long run, both Americans and Chinese have a shared interest in a stable and secure global digital commons, and this challenge calls on us to be global leaders in making that happen.

Memo to American Conservatives: America Is NOT Greece

European leaders next week will sign off on another $172 billion bailout for Greece, one small step back from a disastrous debt default. When the deal is signed, brace yourself for a chorus of charges from President Obama’s critics that his policies will make America the next Greece. These Chicken Littles are talking nonsense. They misunderstand Greece’s real weaknesses and our genuine strengths, along with government’s role in each. Moreover, they miss the issue in the Eurozone crisis that matters most to America — the new bailout will not prevent a broader European financial crisis that could tip the United States back into recession.

By the critics’ primitive reasoning, Greece has large deficits and public debt, and so does America, so the two countries must be headed for the same fate. If that were true, most of the world would be headed for default, since most nations today have large deficits and public debts. The economic fact is, the grave problems facing not only Greece, but also Italy, Portugal, Spain and Ireland lie much more in their economies than in their national budgets.

Yes, Greece’s deficits skyrocketed when the 2008–2009 financial crisis stalled out its economy — as in most of the world’s countries. And yes, the public debt of Greece, and Italy too, was large already as a share of GDP, so the burden of financing the new debt came on top of the burden of regularly refinancing their existing debts. But even that doesn’t explain much, since Spain and Ireland’s existing national debts were modest by world standards. At the same time, Japan’s public debt is larger than almost anyone’s as a share of GDP, and no one worries about a Japanese default.

The economic issue in sovereign debt defaults is not the size of a nation’s public debt, but its economy’s capacity to finance it. The problem that Greece faces — followed closely by Italy, Portugal, and Spain — is that its economy is relatively unproductive and uncompetitive. When its financing burden soared in the deep recession following the 2008 meltdown, its businesses and people found themselves financially strapped, and so unable to generate the additional savings to finance the new debt. And Greece cannot become more competitive and boost exports by depreciating its currency, because it no longer has a national currency to devalue. Along with Italy, Spain and the other countries facing debt peril, Greece uses the Euro — and the Euro exchange rate is set by the larger, more productive economies of Germany and France. Nor can Greece spur new investment in its economy with easy monetary policies, since the European Central Bank controls that for Eurozone members.

So, it is not simply Greece’s large deficits and government debt that raise the possibility of default. Rather, that prospect rests on what can be called a perfect storm in public and private finance. Yes, Greece has fast-rising public debt. But one of the key reasons is that the Greek economy hasn’t been strong and productive enough to come out of a deep recession now four years old and running. That’s the main reason why Greece’s national debt soared from 113 percent of GDP to 163 percent in the last three years, despite its recent austerity. It’s also why Greek businesses and households cannot generate the additional savings to finance that new debt.

Greece’s low productivity, on top of its continuing recession, also has discouraged foreign investors from buying its bonds. Once the risk of default took hold in the minds of those investors, they have demanded much higher interest payments on new Greek government bonds to offset that risk. Those higher interest rates only compound Greece’s problems, since they greatly increase the burden of both financing the new deficits and refinancing the government’s prior debts. To top off all of this, Germany has turned these grim conditions into an imminent crisis by insisting that Greece embrace harsh austerity, right now, to reduce its deficits. But as the International Monetary Fund has warned, additional austerity in an economy already in recession or just recovering from one will only expand deficits.

Whatever President Obama’s economically-untutored critics may claim, America’s circumstances are different from Greece’s in every respect. The U.S. recession ended in mid–2009 thanks to stimulus from the President’s program and the Fed. Savings by both American businesses (retained earnings) and households shot up, providing additional resources to help finance our rising deficits. Moreover, the U.S. economy is the most productive in the world, attracting hundreds of billions of dollars in foreign funds to help finance both our business investments as well as our deficits. And the lowest long-term interest rates in generations signal clearly that global investors are confident America will stabilize its national debt as a share of its GDP. The only time that the United States has ever flirted with default came not from the economy or deficits, but from the reckless behavior of conservative extremists last year who threatened to block the debt ceiling legislation. And for the record, the U.S. public national debt as a share of GDP is considerably less than half that of Greece.

Credible signs are now appearing that the U.S. expansion is finally accelerating. The greatest threat to that upturn is a Greek debt default which then spreads to Italy or Spain. Unfortunately, that threat is very real. The conundrum here is that the new Eurozone bailout of Greece is predicated on the Athens government implementing yet more austerity — and that’s a losing strategy. Additional austerity almost certainly will only increase Greece’s deficit and debt, not tame them, requiring more bailouts in the future.

At the same time, much of the Greek public unequivocally opposes more austerity. It’s hard to blame them. Greece’s GDP has contracted 25 percent through the last four years of savage recession, and unemployment there is now over 20 percent. Moreover, wages have fallen at least 20 percent — the Eurozone’s only answer to Greece’s low productivity and non-competitiveness. Now, Germany’s Angela Merkel is insisting they accept another large dose of austerity. They just might say no, at which point a genuine default probably cannot be avoided.

That leaves Merkel with a clear choice. She can finally accept that the European Central Bank must stand behind the sovereign credit of every Eurozone member, or pray that a Greek default won’t spread to Italy or Spain and threaten the solvency of most large European banks. Our own banks would probably survive a new European banking crisis, but there’s little doubt that this scenario would cost the U.S. economy. So, while America has little in common with Greece fiscally or economically, our own short-term fate may still rest in its hands.

The Economics and Politics of Inequality, Part 2 – The Role of Tax Policy

Economic inequality is an important issue this year, because a growing number of Americans now see it as a threat to their living standards and aspirations.  Mitt Romney and others say that envy, not facts, drives this debate.  But the facts are too large and well-known to dismiss, starting with the astounding one that from 1976 to 2007, the share of the country’s annual national income which the top 1 percent takes home rose from 8.7 percent to 23.5 percent.  Stated differently, over the last three decades, almost 15 percent of annual national income shifted from the bottom 99 percent to the top 1 percent.  To be sure, most Americans found this upward redistribution acceptable so long as their own incomes were rising.  But that changed in the 2002-2007 expansion when for the first time on record, the incomes of most Americans stagnated or fell through ostensibly good times.  And since the average income of the top 1 percent increased 65 percent over those same years, inequality accelerated. 

Does this new inequality reflect simply the way that an advanced market economy operates these days, or has public policy contributed to it?  The truth is, we are not helpless in the face of economic forces, and tax policy in particular is a real factor.  

To understand how and why, we have to start with the distribution of wealth as well as incomes.   The reason is that most of the income of those at the top comes from their wealth, in the form of capital gains, interest and dividends.  And wealth in America is now distributed even more unequally than incomes.  In 2007, the top 1 percent owned nearly 35 percent of all wealth in the United States, and the top 20 percent held 85 percent.  Moreover, this inequality of wealth is even more pronounced for the financial assets that produce the capital gains, interest and dividends.  In 2007, the top 1 percent held almost 43 percent of the value of all stocks, bonds and other financial instruments, including pension plans and retirement accounts; and the top 20 percent held an astonishing 93 percent of all those financial assets. 

Tax policy is a link between the inequalities of wealth and income, because we tax the income from wealth at lower rates than the income that most Americans earn from their own labor.  That is why, of course, Warren Buffett pays a lower tax rate than his secretary – and how Mitt Romney managed to pay only 13 percent in taxes on an income of more than $20 million last year.  Moreover, this tax favoritism for the income earned by those at the top has a compounding effect on the growing inequalities of both income and wealth.  The smaller tax bite leaves more of the income of those at the top to be reinvested in more financial assets, which then generate more income than is taxed at lower rates, and on and on.  

The defenders of these arrangements say that everybody benefits, because low taxes on capital income encourage more investment that raises productivity, which in turn lifts everyone’s wages.  It’s a nice story, but most economists cannot find hard evidence that lower taxes on financial income lead to significantly higher overall investment.  And even if there were such evidence, the link between productivity gains and broad wage increases broke down in the last decade, which is another reason why income and wealth inequalities have reached record levels.

We can see the role of tax policies by comparing what has happened to the incomes of different groups, before and after taxes.  To begin, from 1979 to 2007, after-tax income grew faster than pre-tax income up and down the income distribution.  Tax policy, then, reduced tax burdens across the board.   At the bottom, however, the effect has been distinctly progressive.  The average, inflation-adjusted pretax income of the lowest 20 percent of Americans declined by 7 percent from 1979 to 2007.   But the same group’s average, real post-tax income increased by 14 percent.  Similarly, the average real income of those in the second income quintile fell by 4 percent before taxes, and rose by 23 percent after-tax over the same years.  In short, tax cuts more than offset falling wages at and near the bottom, through especially the expansions of the Earned Income Tax Credit, the deduction for children and the standard deduction.  

The heart of the middle class, the third income quintile, saw their average income grow 11 percent before taxes and 23 percent after taxes over the same years.  That means that about half of their modest economic gains came from the economy and half from tax policy.  Similarly, for Americans in the fourth income quintile – the top 60 percent to 80 percent by income – average income grew 23 percent before taxes and 36 percent after taxes.  The economy delivered faster income gains to this group than to those in the middle, and then Uncle Sam added half again as much through tax policy.  

From this point until the very top, the gains from tax policy increase with income.  Across the top 20 percent, average income from 1979 to 2007 rose 49 percent before taxes and 96 percent after taxes, or roughly half from economic effort and half from tax policy changes.  The result: pretax gains grew twice as fast as those in the next lower income quintile; and thanks to tax policy, post-tax gains grew three times faster.  Similarly, for the top 5 percent of Americans, average incomes increased 73 percent before taxes and 160 percent after taxes – a split of 45 percent from the economy and 55 percent from the tax writers.  Put another way, the average pretax income of the top 5 percent grew 6.5 times faster than the average income of those in the middle.  Nonetheless, tax policy boosted the post-tax income of the top 5 percent over this period by an additional 87 percentage-points or 55 percent.

For the lucky few in the top 1 percent, most of the gains did come before taxes:  From 1979 to 2007, the average income in this rarefied group increased 241 percent before taxes and 281 percent after taxes.  So, the pretax incomes of the richest Americans grew 22 times faster than the incomes of middle-class Americans, and their post-tax incomes grew 12 times faster.  Stated differently, the very rich saw their incomes soar 241 percent over this period, and tax policy nevertheless further boosted their post-tax income an additional 15 percent or 40 percentage points. 

Over the last 30 years, then, U.S. tax policy has sustained at least two large themes.  As the income gains of many Americans slowed down, Washington has consistently used tax cuts to blunt some of the inevitable public disappointment and resentment.  And second, those tax changes have ultimately reinforced an historic increase in economic inequality, creating a treacherous new political environment for wealthy office-seekers who pay little taxes. 

For more on inequality, please read The Economics and Politics of Contemporary Inequality, Part 1

The Economics and Politics of Contemporary Inequality, Part 1

Barring some unforeseeable event, Mitt Romney is virtually certain to be the GOP nominee for president. Judging by President Obama’s decision to make inequality a main theme of his State of the Union address, the White House has been counting on facing Romney. More than anyone else in national politics, Mitt Romney’s own deeds and words may be said to embody the dynamics which define the top end of contemporary inequality. He spent his adult life accumulating capital assets, he deployed those assets to earn higher returns than those available to middle-class people, and he took aggressive advantage of the highly favorable tax treatment accorded those assets.

Even so, why have wealth and economic inequality become powerful political issues today, when the fortunes of John Kennedy, both George Bushes, John Kerry, and even the billionaire Ross Perot did not? The big difference, of course, is timing. For one, the rich have become much richer, both absolutely and relatively. In 2007, the top 1 percent took home 23.5 percent of all of the income earned in the United States. That’s the same share the top 1 percent claimed in 1928. But for the next half-century, the income share of the top 1 percent fell slowly but steadily, reaching less than 9 percent of national income in 1976. Throughout those years, the incomes of everyone else grew faster than the incomes of those at the top, creating a vast American middle class. But since 1976, incomes at the top have once again grown faster than everyone else’s incomes, restoring their pre-Depression share.

That still doesn’t explain why the very rich in politics inspire so much more wariness and anger today than just 12 years ago, when George W. Bush’s wealth didn’t faze most Americans — and unlike Romney, he didn’t even earn it. After all, one standard liberal meme cites the data on median incomes in 1976 and 2010 to insist that most Americans have stagnated economically for 35 years. Behind those two data points, however, lies a more complicated reality which shows that most Americans did make real economic progress — until the last decade.

First of all, everybody ages; and as we do, most of us see our incomes move from somewhere below the median to somewhere above it. Moreover, real median incomes did increase at respectable rates throughout the expansions of both the 1980s and 1990s, although the recessions which followed took back some of those gains. From 1983 to 1989, real median income increased more than 2 percent per-year, before giving back nearly half of those gains in the 1990–1991 recession and its aftermath. It happened again from 1993 to 1999, when median income rose by nearly 2.5 percent per-year, and then gave back 30 percent of those gains in the 2001 recession and the following three years.

The reason Americans seem so much more skeptical of the very wealthy today, is that this pattern has broken down. Not only did median income fall for three more years after the 2001 recession, that was followed by annual gains of barely 1 percent from 2004 through 2007. Moreover, the 2008–2009 recession and the year following it took back all of those gains, twice over. The result is that by 2010, median income was back to levels last seen in 1996 and 1989.

Also, while the recessions of the 1980s and 1990s drove down median income, those losses were fairly concentrated near the bottom and at the top. The people most likely to lose their jobs in recessions are those in the second and third income quintile, and their incomes fall fairly sharply. At the top, most income comes from financial assets. And since recessions drive down both stock markets and interest rates, they cut sharply into and the capital gains, dividends and interest that especially enrich the top 1 percent. So, for example, the 1990–1991 recession and the initially slow recovery that followed cost an average household in the second income quintile more than 2 percent of their annual incomes. Moreover, the average household in top 1 percent saw their annual capital income fall by nearly 20 percent. In between, most Americans kept their jobs and held on to most of their incomes gains from the 1980s and 1990s.

So, from 1983 to 2000, the average income of the first three income quintiles — covering the less affluent 60 percent of Americans — grew steadily by an average of 1.3 percent per-year. People in the fourth income quintile — the equivalent of a $90,000 income today — did better. They registered average income gains of nearly 1.7 percent per-year from 1983 to 2000. Households in top-earning quintile did better still, with annual income gains of more than 4 percent from 1983 to 2000. And consistent with the top 1 percent’s outsized share of total income, those households way outpaced everyone else: Their incomes grew by nearly 10 percent per year from 1983 to 2000.

After 2000, most people’s gains first turned to losses, then grew slowly for a few years, and then fell back sharply in the 2007–2009 recession. But once again, the story is different for those at the top. To be sure, the incomes of the top 1 percent fell by nearly 30 percent from 2000 to 2002, along with stock and bond markets. From 2003 to 2006, however, those markets recovered, and the incomes of the top 1 percent increased 65 percent. More recent income data for the very wealthy are not yet publicly available. But while everyone else struggles to regain their financial footing, the top 1 percent has seen the S&P 500 and other market indexes already recover. And if all of this wasn’t enough to make Americans pause before making one of the country’s richest men the president, federal tax changes pressed by presidents over the same period have exacerbated the inequalities. That will be our topic for next week’s blog.

John Kennedy famously reminded us that life can be unfair. JFK’s focus, unsurprisingly, was on matters of greater import than wealth: To illustrate that “[t]here is always inequality in life,” he notes, “[s]ome men are killed in a war, and some men are wounded, and some men never leave the country. Life is unfair.” Mitt Romney has had a lion’s share of extraordinarily good luck in his life. Now, he will have to make his run for president at a time — perhaps the first such time in generations — when millions of Americans will be very wary of a candidate who grew rich while everyone else struggled just to hold on.

The State of the Union and the Power of Technological Change

President Obama made inequality a major theme of his State of the Union address last night, an unsurprising choice as he prepares to face Mitt Romney. Everyone now knows that just last year Mr. Romney paid a smaller share of his $21 million income in taxes than the average American paid on a $50,000 salary. But if inequality was the President’s theme, his main subject was jobs. For Obama, faster job growth depends on more government. We need Washington, for example, to retrain workers, reduce college costs, and provide special supports for manufacturers. For Romney, the answer for job creation is, what else, less government: Washington needs only to cut regulation and reduce taxes, especially for the wealthy people and corporations who, in the Romney worldview, create the jobs.

But not so fast — there are other options as well. A new report from the NDN think tank suggests that certain kinds of new technologies can spur job creation more effectively than most government programs or tax cuts. The new study, conducted by Kevin Hassett of the American Enterprise Institute and myself, found that the rapid spread of new 3G wireless devices from 2007 to 2011 led directly to the creation of nearly 1.6 million new jobs. And those job gains occurred even as the overall economy was shedding 5.3 million other jobs.

Our analysis tracked shifts by consumers and businesses from 2G wireless phones to 3G smart phones and tablets, quarter by quarter and state by state, from July 2007 to December 2011. We then analyzed the links between the shift to the more powerful 3G devices and changes in employment, quarter to quarter and state by state. We did the math and found that every 10 percentage point increase in the use of those devices generated more than 231,000 new jobs within a year.

It makes clear and compelling economic sense. As a growing share of Internet use shifts to wireless devices, the people and businesses that use them become more efficient and productive. Those gains, in turn, create new value which ultimately leads to more job creation. The spread of 3G wireless devices also created a platform for new services — for example, in mobile e-commerce, mobile social networking, and location-based services. The growth of those new services also led to more job creation.

And the best news for jobs is that another technological shift is occurring right now, from 3G to 4G wireless devices. 4G wireless networks and the Internet infrastructure that supports them have the potential to drive significant new efficiencies and innovations across the economy. Jobs already are being created in 4G-dependent areas such as cloud-based services and mobile health applications. According to industry analysts, 4G wireless networks in the near future could be used to create a Smart Electricity Grid and a national public safety system.

This analysis, then, can provide a new direction for job creation efforts: Adopt spectrum and other policies that will promote the broad and rapid deployment of 4G

Still, there are also kernels of economic truth in the Romney and Obama positions. Romney is not wrong, for example, when he says that lower taxes are usually better for the economy than higher taxes. But there’s no evidence that lower taxes on wealthy people or corporations would produce many jobs. And in a period of trillion-dollar budget deficits, calls for tax cuts seem at best irrelevant, and at worst politically cynical and misleading.

The President is on firmer ground. Greater access to higher education and retraining should increase productivity and growth, at least over the long haul. Since the direct benefits from those efforts would presumably go to people from modest or middle-income households, Obama’s approach also could help address inequality. And since the President seems prepared to raise the revenues to finance his proposals, they could be more than political window dressing.

For all of these good points, these approaches are not the answer to slow job creation. For that, President Obama and Mr. Romney have to directly address the forces that actually create and destroy private-sector jobs. One such force is technology, and our new analysis shows that the 3G and 4G wireless technologies can create many more jobs than they may destroy, and do so quickly. Another approach could focus on reducing the additional costs that businesses bear directly when they create new jobs. That could mean cuts on the employer side of the payroll tax or new measures to slow increases in the health care costs that businesses bear for their employees. At a minimum, any of these approaches would produce more economic benefits for more people than all of the tax cuts promoted by Obama’s opponents.

The Bankruptcy of Austerity Economics

Conservative conventional wisdom collided this week with a dose of economic reality, and the winner is reality. For two years, every Republican congressional leader and presidential hopeful has proudly insisted these days that austerity is the cure for a sluggish economy like ours. It is an approach embraced most memorably, of course, by Herbert Hoover, although Angela Merkel also pushes it today for the faltering Eurozone. In fact, austerity in the face of high unemployment, slow investment and weak demand has been decisively refuted by a half-century of economic analysis and policy. The best medicine for a slow economy is usually measures to jump-start investment and consumption funded by more private or public debt.

Congress has refused to let Washington play that role since the 2010 elections, so finally American households are stepping into the breach. Last week, we learned that employment rose sharply in November, and this week we found out why: Borrowing by American households jumped $20.4 billion in November. That’s the largest increase in ten years. This new willingness by Americans to take on new debt is the main reason why consumer spending is finally picking up, which in turn is the main reason why the jobless rate keeps on falling.

It would be rash to read too much into these new data, but they could be a powerful signal of stronger growth ahead. For three years, Americans have saved in order to reduce the burden of their outstanding debts. New Federal Reserve data show that it is working. In 2007, payments on mortgage, consumer and auto debts claimed a larger share of the incomes of an average household than at any time since 1980. But by the third quarter of last year, this household indebtedness had fallen to the lowest levels since 1994, providing a reasonable basis to begin borrowing again.

Moreover, the renewed willingness of average Americans to take on new consumer debt may also signal that housing values have finally bottomed out. Falling housing values — and Washington’s inability to do anything to help stabilize them — have been the single largest obstacle to a strong recovery. When home prices fall month after month, that not only increases the net debt of most homeowners; it also makes American homeowners poorer, month after month. And people who see their assets shrink, month after month and year after year, cut back on their spending. So, recent signs that consumer borrowing and spending are heating up again suggest that housing values may have finally stabilized. If that’s the case, the recovery may finally accelerate.

America’s new acolytes of austerity could still screw this up. In the last year, they tried to block payroll tax relief and extended unemployment benefits, and the truest believers among them even hoped to block an increase in the legal debt limit. All three of these matters will come back to Congress in coming months. The political landscape has shifted, however. The public now holds Congress in such low esteem — and especially House conservatives — that even fervent advocates of austerity may hesitate to repeat their wildly unpopular 2011 performance in an election year.

A stronger U.S. recovery could still fall victim to the European austerity caucus. Merkel continues to press austerity on the Eurozone governments, even as Europe slides into recession. Moreover, piling yet more austerity on economies in recession can only worsen the sovereign debt crisis which already threatens to pull down the Euro and major banks across Europe. Sometime next week or in the next few months, global investors may conclude that Merkel’s attachment to austerity will finally preclude meaningful steps to stabilize Italian and Spanish government debt. If that comes to pass, the ensuing financial crisis almost certainly would short circuit a strong American recovery.

For now, that recovery is in the hands of America’s households. Thankfully, they display more economic sense than many members of Congress or leaders of the Eurozone.

Statement on the Jobs Report

I released the following statement today:

"Today’s report that the U.S. economy created  200,000 new jobs, net of layoffs, certainly counts as strong gains for this recovery.  Of course, what constitutes strong job growth today would have seemed, at best,  moderate in the 1990s and 1980s, when the United States routinely created more than 300,000 new jobs per month.   Still, for the first time since the 2007-2009 recession, decent levels of job creation seem sustainable.  Business investment is growing nicely, creating jobs directly.  The trade deficit keeps falling, slowing the drain of U.S. jobs overseas.  And while consumer spending is still fragile, household debt continues to fall, setting the stage for a stronger recovery.  

If Washington would take steps to help stabilize housing prices, as Ben Bernanke called for this week, and if the Eurozone manages to avoid a financial meltdown, Obama could find himself presiding over a decent recovery by November."

You can find Rob's statement on Thursday about the promising ADP report showing similar numbers here.

Statement on the Economy

A word of caution to President Obama's critics:   American families and businesses may be finally recovering from the economic beatings they suffered in the 2008 financial crisis and the extended unwinding of the 2002-2007 housing bubble.  The giant payroll company ADP, whose surveys have a good record of anticipating the official jobs reports, said today that private sector employment grew by an estimated 325,000 in December.  This follows several months of encouraging news on jobs from the Bureau of Labor Statistics.   Business investment and corporate profits also have shown renewed strength.   

Yet, GDP growth has been modest, mainly because consumer spending is still fragile.   Americans want proof that job creation is back and the value of their homes has stabilized.  The first factor may now be in place.   If housing prices stop falling - and Europe avoids a financial meltdown -- the American economy in 2012 is likely to be the strongest since 2007.

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