Far from ignoring middle-earners, America’s government spends freely on them
A PUZZLE exists where America’s economics meet its politics. Income inequality is higher than in other rich countries, and the recent election was interpreted by many as the revenge of the left-behind, who found their champion in Donald Trump. Yet the candidate who made income inequality a campaign theme, wanted higher taxes on the rich and promised more financial regulation lost. Since the election, Mr Trump has nominated a cabinet with a combined net worth of over $6bn, by one estimate. He has invited the bosses of big corporations to advise him on economic policy. And he has filled key White House posts with Goldman Sachs alumni. The riches of top earners do not seem to bother voters nearly as much as many on the left would like them to.
In fact, some argue that a focus on inequality actually harmed Democrats’ chances. Most of the rise in inequality happened over a decade ago (see chart 1). Polls usually suggest that Americans care less about inequality than they do about economic opportunity. And voters have reason to worry about stagnation in the middle-classes. Median weekly earnings, adjusted for inflation, were the same in 2014 as they were in 2000. Health-insurance premiums have soared. A recent paper by Raj Chetty of Stanford University and colleagues documents the “fading American dream”. In 1970 more than nine in ten 30-year-olds earned more, in inflation-adjusted terms, than their parents did at the same age. In 2014 only half did.
Democrats, the logic goes, focus too much on helping the poor and taxing the rich, ignoring justified feelings of abandonment in the middle. But there is another half to the political argument: the potent charge that government redistribution also picks the pockets of the hard-working middle, offering welfare to the feckless poor. This suspicion of redistribution explains how Mr Trump could run simultaneously as populist insurgent and as champion of huge tax-cuts for the highest earners.
The idea that government has exploited the middle may seem to explain a lot politically, but it is not true. Much federal policy benefits middle earners more than the poor. One example is the tax-deduction for mortgage-interest payments. This handout currently costs slightly more than the earned income tax-credit (EITC), the flagship anti-poverty programme that tops up poor workers’ earnings. Yet it benefits only those who can afford to own their home (the bigger the mortgage, the more generous the deduction). Another example is the tax exemption for employer-provided health insurance. Unlike the mortgage-interest deduction, this does help many poor workers. But it benefits the middle more, and this disparity has become sharper in recent decades as insurance has become more expensive (see chart 2).
Handouts to the relatively well-off do not end with tax exemptions. Ignoring public pensions, America’s biggest federal redistribution programme is Medicare, which offers free health insurance to over-65s of any income. Much Medicare spending, which totalled $589bn (around 3% of GDP) in 2016, benefits the middle class, notes Gabriel Zucman of the University of California, Berkeley. With Thomas Piketty and Emmanuel Saez, two other economists, Mr Zucman recently produced new estimates which harness GDP data to improve the familiar figures from surveys and tax returns. They find that the incomes of those in the 50th to 90th income percentiles have grown by 40% since 1980, more than previously thought, thanks to growing tax exemptions. The poorer half of Americans pay roughly as much in taxes as they receive in cash redistribution, in spite of the EITC.
Before the financial crisis, government redistribution kept median incomes rising even as wages stagnated (see chart 3). Since then it has kept incomes flat as wages have fallen. By 2013 median household income before taxes was 1.6% lower than it was in 1999. But after taking off taxes and adding in government transfers, it was fully 13.7% higher. More recent data suggest that even pre-tax incomes are now growing again: they were up by 5.2% in 2015.
The economic safety net for the poorest, however, remains perilously thin by international standards. A typical jobless married couple with two children can expect a welfare income, including the value of food stamps, worth 23% of median pay. The average in the OECD, a club of mostly rich countries, is 40%. Partly as a result, relative poverty is higher than every other member of the club bar Israel. This looks even worse as the lower-paid have borne the brunt of rising inequality. Messrs Piketty, Saez and Zucman find that the trend since 1980 can be summarised as a shift of 8% of national income from the bottom half of earners to the top 1%, with no effect on those in between.
That all still leaves those whose earnings place them between the middle and the poor. Median household income in 2015 was nearly $57,000. Exit polls suggest that Mr Trump lost among voters with incomes beneath $50,000, as a Republican presidential candidate would be expected to. But he did much better with such voters than Mitt Romney did in 2012. The positive swing might be thought of as a revolt of the lower middle. However, it was largest among those with incomes beneath $30,000. Most of these voters are probably in the poorest fifth of households, though some may previously have held more lucrative jobs. The Pew Research Centre estimates that the middle class, defined as those with incomes between two-thirds and twice the median, shrank from 55% of the population in 2000 to 51% by 2014.
Inequality will rise if Mr Trump succeeds in slashing taxes for the highest earners, as it did after Ronald Reagan’s tax cuts in the 1980s. Then, the labour market was about to bifurcate into winners and losers from globalisation and technological change. Today, rising inequality in wealth, rather than in wages, might be a bigger concern. Mr Zucman and his co-authors find that a boom in investment income at the top has driven inequality since 2000. A recent compendium published by the Russell Sage Foundation warns of growing differences in wealth even among those who are not rich. Mr Trump’s plan to reduce taxes on capital returns and abolish them on inheritance could exacerbate these trends, much as the Reagan income-tax cuts coincided with growing disparity in wages.
The effect of Mr Trump’s economic policies on median incomes will depend on whether they encourage firms to invest, boosting workers’ productivity. Historical evidence is not encouraging: median earnings barely grew in the 1980s. But if wages continue their recent recovery, Mr Trump is sure to claim the credit. And, unlike his party, Mr Trump has shown little appetite to curb spending on the middle class. A very rich elite, high poverty and plentiful government spending on the middle could make Mr Trump look like a continuity candidate after all.
This article appeared in the United States section of the print edition under the headline "Fat tails"