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Income inequality and diminishing marginal utility

Calvin is referring to economic law of diminishing marginal utility.  In general, it states that consumption of preceding goods or services won’t deliver the same level of satisfaction relative to the first (or in Calvin’s case, the second).  As Calvin illustrates, his third or fourth bowl of chocolate frosted sugar bombs will make him sick.  The same is true with almost anything that we can purchase.  You may be satisfied with a lamp you bought to light up your room, but you wouldn’t you buy another to light up that same room.  You might buy a second to light up a different room but you eventually stop buying the lamp because its utility drops.  A second and third car, bedroom set, or dinner won’t make you as happy when you bought them the first time.

What does this have to do with income inequality?

Think about the amount of money you need to purchase the things you want.  Obviously, the wealthy have enough to purchase everything that they want four, five, or ten times over.  Much of the time, however, they don’t and this has to do with diminishing marginal utility.  Sure, there are many top income earners who buy several cars and houses, but spending habits of a small consumer elite can’t sustain a healthy economy.  The automobile and housing industry would prosper with a large consumers base, not a small one.

In truth, the wealthy spend their money differently than the rest of Americans.  A middle class family will likely spend a tax cut on groceries, clothes, or medical bills, etc.  A tax cut for top income earners, however, will most likely be invested.  Below is the distribution of financial investment ownership.

The top 1% of Americans own half the distribution of stocks, bonds, and mutual funds while the bottom 50% own less than 1% of that distribution.  In other words, you can’t expect the top 1% to maintain necessary levels of consumption; the law of diminishing marginal utitilty makes the wealthy consume less and invest more.

Investment is obviously important.  However, our economy suffers from a lack of demand because ordinary Americans don’t have the purchasing power to consume the things they need.

Income equality is not just a moral concern, it’s good economics.


Obama believes in redistribution…and so do I

As Romney recovers from his remarks about the “47% of Americans”, republicans deflect attention back to the democrats after the release of a video of Obama saying that he “actually believe[s] in redistribution.”  As if they found a secret weapon, Romney and the GOP are using that phrase to paint the President as a socialist.  The video below shows how conservatives are framing the President’s statement.

Mitt Romney has even gone as far to say that “redistribution has never been a characteristic of America.”  This is a remarkable comment because it completely ignores the fundamental structure of America’s progressive tax code.  It ignores the basic function that government plays in providing necessary services like veteran’s benefits, food stamps, medical services, and so on.  Things that we may take for granted like education, police, infrastructure, and health all require basic levels of redistribution…and that’s the heart of what the President was saying.  Below is the quotation in its entirety.

I think the trick is figuring out how do we structure government systems that pool resources and hence facilitate some redistribution because I actually believe in redistribution, at least at a certain level to make sure that everybody’s got a shot. How do we pool resources at the same time as we decentralize delivery systems in ways that both foster competition, can work in the marketplace, and can foster innovation at the local level and can be tailored to particular communities.

Read in full, his belief in redistribution sounds a lot less like socialism and more like basic governance, especially when he mentions working with the marketplace and fostering competition and innovation.

On another note, conservatives may have picked a losing battle as their views of redistribution are out of sync with the average American.  Below are the results of Gallup poll asking respondents if the current distribution of wealth is fair or if they feel that wealth in this country should be more evenly distributed.

1984-2011 Trend: Views on Distribution of Wealth in the U.S.

On average, less than 35% of Americans feel that the current distribution of wealth is fair while 60% of the population generally believes that there should be a more even distribution.  These 60% of Americans don’t feel this way because they are looking for a handout.  As I’ve written before, America’s labor force is working harder than ever despite stagnating wages.

Meanwhile, the majority of America’s wealth has been concentrating at the top income brackets.

It’s clear that our economy doesn’t distribute wealth evenly and that the invisible hand is neither fair nor efficient.  Americans works hard, yet many can’t make ends meet.  Given the inequality in economic reward, it makes economic and political sense that some should pay extra for their success.  However, ignoring the imbalance in economic distribution, conservatives are attacking government’s re-distributive policies that create balance.

People forget that capitalism is a source of distribution itself, but one of asymmetry.  Look at nurse’s pay compared to the average pay of corporate executives.  They both perform essential jobs in our society, yet one is rewarded ten, or even a hundred, time more than the other in terms of income.  The purpose of government re-distribution is to ensure that those income inequalities don’t prevent hard working Americans from receiving public goods they otherwise wouldn’t be able to afford.  This is basic governance, not socialism.

Mitt Romney’s 47% who pay no taxes

Illustration: John Darkow

The democrats wasted no time attacking Romney’s remarks he made at a fundraiser dinner where he claimed that 47% of American’s don’t pay income taxes.  He then stated that his job “is not to worry about those people.”

Watch his remarks in the video below.

The Tax Policy Center breaks down that “47%”.

Tax Policy Center - 47 Percent with annotation

To suggest that those 47% don’t pay taxes is very misleading.  Two thirds of that group does pay payroll tax. The other third don’t because they are very poor and qualify for certain tax credits or are elderly and receive special kinds of deductions (many of these deductions for the poor and elderly were put into effect by republicans, by the way).  Don’t forget that everybody pays other kinds of taxes, primarily the sales tax which is a much larger percentage of the poor’s income than anyone else.

Where do these people live?  David Graham from the Atlantic provides a map the non-payers by states.  Those state in red have the highest shares and the blue states have the lowest.  Notice how the states in red also tend to have more republicans as well.

This is not to say that the 47% are mostly republicans.  One would have to look at party vote share by annual income to get a better look.  However, what we can say is that Romney’s off-the-cuff remarks are going to make it much harder for him in those states above.

Politics aside, Romney has a problem – his remarks demonstrate a seething contempt for the poor.  He sees them as free-riders.  I’m not sure where this antipathy for the poor comes from, but we have to stop demonizing them as if they are cheating the system.  These 47% are not lazy or scheming, but hardworking folks like everyone else.

I plan on writing future articles about why we demonize the poor, and why those who do have the wrong idea – so stay tuned.

Moody’s warns about credit rating

From CNN: Moody’s warns that “U.S. credit rating hinges on Congress.” Money quote – “Currently the outlook assumes that Congress will increase it ‘in a relatively orderly process.’ But Moody’s said it would put the U.S. rating under review during negotiations over the debt limit.” I’ll write more on this later.

The human brain likes equality

A neuroscience team at Caltech, using fMRI imaging, found that our brains are wired to prefer equality. “The team found that the reward centers in the human brain respond more strongly when a poor person receives a financial reward than when a rich person does.”

The “are you better off than you were four years ago” question.

Artist: John Darkow

Now that the RNC and DNC are over, both parties are rushing to frame their answer to the question: are you better off than you were four years ago?  Who ever makes the more persuasive argument will likely win on election day – that is if history tells us anything about who wins elections.

If you are old enough, you may remember this

Reagan asked the voters “are you better off today than you were four years ago” in 1980…and they answered by voting Jimmy Carter out of office.  The same question is posed today and both parties are rushing to frame the answer in their favor.

So, is America better off today?  Well, it’s complicated question – in fact it may be a misleading question given the wording of it.  This is a political economy blog so we’ll consider the economic side of it.

First, lets look at the numbers.  Republicans are quick to point out that the unemployment rate was 7.8% when President Obama took office and now it sits at a high 8.1%.  For them, the answer is clear – things are worse off.  However, let’s give these numbers some context.  Below is a chart of unemployment from the Bureau of Labor Statistics:

As you can see, January 2009 unemployment was at 7.8%, but it was riding an accelerating increase from the fall out of the 2008 crisis.  That sharp rise in unemployment would have happened, no matter who entered the White House.  A more appropriate question would be – how well did the President handle the crisis?

Soon after taking his oath, Obama bailed out the auto-industry and passed the American Recovery and Reinvestment Act, two very controversial acts.  However, according to the Center for Automotive Research, the government bailouts of the automobile industry saved around 1.14 million jobs in 2009 and as well as prevent “additional personal income” losses of $97 billion.  According to the CBO the ARRA, also known as the stimulus, saved 3.3 million jobs.  I have more on the stimulus here.  Below is a chart from the Bureau of Labor Statistics showing job growth before and after those two acts.  If you are looking for the effects of policy, this is the chart to look at:


Notice how the downward trend turns around at the end of the first quarter, right after government action was taken.  In other words, the controversial actions taken by the President reversed the job less trend.  As the trend in job losses reversed, unemployment peaked around 10% and started a rocky road downward.

The only reason the unemployment rate is higher today than it was when Obama took office is because the 7.8% rate was increasing and accelerating – so you can hardly use that number as a marker to compare today’s unemployment rate.  You can, however, judge the President’s ability to address the economy – and his policies did, in fact, reverse the direction of our recession.  Whether he did enough or not is up for you to judge.  One thing to keep in mind, though, is that policies take time to implement and the jobs numbers lag behind the implementation of those policies.

What also matters here is perception.  Below is a graphic from a Gallup poll measuring people’s financial expectations for their future.

Trend: Looking ahead, do you expect that at this time next year you will be financially better off than now, or worse off than now?

American’s have consistently been optimistic about their personal finances (around 60% of Americans expect next year to be better off in a year).  This kind of optimism is good news for the incumbent.

In closing, it’s important to note that this post looks only at jobs, while a nation’s welfare includes so much more in terms of economic, social, and foreign policy related issues.  Let’s not forget other factors like the Patient Protection and Affordable Care Act, or the killing of Osama bin Laden.  How Americans think about these issues are also important when deciding who to vote for.

Unemployment in the Obama economy vs. the Reagan economy

Barack Obama isn’t the first president to struggle with high unemployment.  Ronald Reagan took office at the beginning of the 80s recession where the unemployment rate almost reached 11%.  However, unemployment under Reagan fell to 7% after four years, while joblessness refuses to drop below 8% for the Obama administration.  Check out the graphic below

Why is Obama having a harder time than Reagan?  Conservatives like to attribute the Reagan recovery to lowered taxes, but few economists really believe this.  Even David Stockman, Reagan’s budget director, disputes the canard that lower taxes led to the recovery.  In truth, Reagan’s unemployment problem was different that Obama’s – American consumers in the 80s weren’t recovering from a credit crunch like we are today.

Personal savings today, compared to what it was in the 1980s, is virtually non-existent while household debt as percentage of GDP is climbing well above 130%.  The U.S. economy is 70% consumerism, and consumers today have to deal with the less savings and more debt than they did in the 1980s.  So Obama’s economy suffers from a demand-problem absent in the Reagan economy.

What can we do about.  As I’ve argued before, a lack of consumer spending can be balanced by a rise in public spending.  If there is anything we have learned from the Reagan economy is that his massive increase in defense spending helped move the economy out of recession (dare I say that Reagan was a Keynesian).  I’m not suggesting that we invest more money in our military, but there are plenty of other public works projects that need attention – roads, bridges, schools, etc.

The bottom line is that we have to be careful when we compare administrations.  Reagan and Obama faced different economic problems which can’t always be neatly compared to each other.

Renewed criticism over the stimulus, despite the fact that it worked!


President Obama received renewed criticism for the American Recovery and Reinvestment Act, also known as the “stimulus,” from conservative speakers at the RNC.  Paul Ryan led the criticism during his speech.  He said, “The stimulus was a case of political patronage, corporate welfare, and cronyism at their worst. You, the working men and women of this country, were cut out of the deal.”  He continued, “What did the taxpayers get out of the Obama stimulus? More debt. That money wasn’t just spent and wasted — it was borrowed, spent and wasted.”

This isn’t the first time that conservatives have attacked the President’s stimulus.  The consensus among Republicans considers it a failed policy.  However, the consensus among economists tells a very different story.

According to a study done by the University of Chicago Booth School of Business 80% of economic experts agree that the unemployment rate was lower at the end of 2010 than it would have been otherwise without the stimulus.  Only 4% disagreed or strongly disagreed.

Below is a chart from the study illustrating the results.

The results are even sharper when weighted by expert’s confidence.  Still not convinced?  Then, lets look at the data.

Below is a chart of real GDP growth.

Growth was historically negative in 2008.  Notice, however, that growth quickly returned to positive numbers after the stimulus took affect.  Some may say this is just coincidence, but what makes it not coincidental is the economic contraction in late 2010 – this is when the money for the stimulus faded out.  In other words, the economy expanded with stimulus and contracted without it.  In fact, the CBO’s analysis says that it added 3.3 million jobs as well as prevent the nation from slipping back into recession

It works like this: A recession is simply a contraction in the economy; sales drop, production slows, unemployment rises, and consumerism falls.  Essentially the flow of money slows down because people stop spending it.  If no one buys anything, the economy tanks.  However, government spending can compensate for a lack of consumer spending and keep money flowing.  In actuality, spending of any kind, including government spending, boosts GDP.

Below is a chart from the Center on Budget and Policy Priorities illustrating what GDP would have been without a government stimulus.

Charts and graphs aside, I want to direct you to an article in the Huffington Post that shares personal stories of people who benefited from the stimulus.  The authors, Sam Stein and Arthur Delaney, took an interesting angle and revealed that a number of stimulus recipients had no idea that they received money from the controversial law.

From the article:

The Huffington Post reached out to a dozen stimulus recipients in the Tampa area near the Republican convention to see how the bill affected them. Of those who agreed to talk about it, only one initially knew that they’d received any stimulus money.

The article continued to talk about specific cases, such as Jay Catalani:

Jay Catalani didn’t know the $22,550 contract he received to electrify water meters inside veteran cemeteries throughout Florida came from the government.

(…) “Nobody explained the stimulus and nobody explained the health care bill,” Catalani said. “It should have been just literally peeled through like an onion and it wasn’t.”

And yet, the stimulus has had a lasting impact on Catalani’s company, which now has 12 workers. “I ended up adding two employees,” he said. “I didn’t know it was a stimulus, but it stimulated my company. And I still have them today. Even though it was only $20,000, but … we were right on the cusp of, ‘Hey, should we bring more people on or shouldn’t we?’ We brought two guys on and ended up keeping those two people.”

The article covers other stories of Tampanians who learned that they benefited from the stimulus.  It makes you wonder how many critics of the stimulus attending the RNC unknowingly felt the positive impacts of it.

New Pew poll measures opinions of the rich

New Pew poll claims “many Americans believe the rich are different than other people.” Some interesting findings: 1) “Nearly six-in-ten survey respondents (58%) say the rich pay too little in taxes, while 26% say they pay their fair share”, and 2) “A much higher share of Republicans (55%) than Democrats (33%) say, compared with the average person, rich people are more likely to be hardworking.”