Washington's Tax Plan 2.0 - Helping Wealthy Americans Get Wealthier

While the world is distracted with Donald Trump's possible ties to Russia, Washington continues to grind forward with his agenda.  In a recent move, the Trump Administration has taken a major step that will help the nation's wealthiest at the expense of households with low or moderate incomes.

In September 2018, the House is expected to vote on the "2.0" tax plan, a plan that would permanently extend the 2017 tax law's individual provisions that were set to expire after the year 2025.  According to an analysis by the Center on Budget and Policy Priorities, the proposed changes will exacerbate America's growing problem of income inequality and hurt the nation's overall fiscal picture. 

Let's start by looking at income shifting.  The after tax income growth for a typical working-class American family has grown far more slowly over the decades since 1979 when compared to the family incomes of households with a college degree; if the income of the working-class family had grown at the same rate as a college-educated family, working-class household incomes would have been $9,600 higher in 2015 than they are now.  As well, when we compare the share of income flowing to the bottom 60 percent to the top 1 percent, we find the following:

The 2017 tax law exacerbated this trend and, if the House passes the "2.0" tax plan, the situation will get even worse.  By making the 2017 tax law's provisions permanent, the average tax cut for a family in the bottom 60 percent of earners (those with incomes less than $86,100) will be only $340, resulting in after-tax income growth of 1.0 percent.  For households in the top 1 percent (those with incomes greater than $732,800), the permanent tax law changes will result in an average tax cut of $32,650, resulting in after-tax income growth of 2.2 percent as shown on this graphic:

The top 1 percent of households will garner 61 percent of the total   :

Here are some of the benefits that will accrue to the well-off:

1.) Cutting the top individual income tax rate - the 2017 law cut the top tax rate from 39.6 percent to 30 percent benefiting couples that make over $600,000 in taxable income.  For a married couple with $2 million in taxable income, their tax bill will be cut by $36,400 annually.  Other cuts in tax rates for the wealthy will result in the same household saving $56,765 annually.

2.) Estate tax exemption - the amount that wealthy households can pass on to their heirs has doubled from $11 million per couple to $22 million per couple.  Those poor, sad couples with more estates worth more than $22 million will see their estate taxes cut by $4.4 million each.  As well, thanks to new tax provisions that shield "unrealized capital gains" that have never been taxed will ensure that those who inherit the estates will never have to pay tax on their "estate lottery winnings".

3.) Deduction for pass-through income - this is income that the owners of businesses like partnerships, sole proprietorships and S corporations report on their individual income tax returns.  Before the 2017 law was enacted, this income was taxed at the same individual rate as a business owner's salaries and wages.  The 2017 tax law change means that the deduction for pass-through income cuts the marginal individual tax rate by 20 percent.  This provision provides the most benefit for households in the top one percent since they will be able to avail themselves from 61 percent of its total benefit compared to only 39 percent for the 99 percent of us.

As you can imagine, all of these lovely tax savings for higher income households has a cost that will be borne by all Americans.  According to the Congressional Budget Office, the 2017 tax law will cost the federal government $1.9 trillion over the decade between 2018 to 2027 and, if the House tax plan 2.0 passes, these cuts in revenue will be permanent.  Here is a bar graph showing the tax losses per year in dark blue and the effect of extending the expiring 2017 tax law indefinitely under the House tax plan 2.0 in light blue:

What is particularly concerning is that the cost of making these tax cuts permanent rises in the future; in the decade between 2029 and 2038, the cost will hit $3.3 trillion.  In 2027, tax revenues will be 17.7 percent of GDP, however given that the debt-to-GDP level will continue to rise over the coming decades, by 2035, tax revenues will have to rise to 20.5 percent of GDP to stabilize the overall debt-to-GDP ratio which already looks like this:

While everyone loves to see taxes cut, as you can see from this analysis by the Center on Budget and Policy Priorities, the cuts in taxes are mainly accruing to wealthy Americans, the people that are far more likely to rub shoulders with and make substantial campaign contributions to policymakers in Washington than Main Street Americans.  As well, given that Washington's current illusion of fiscal health is seen through the rose-coloured glasses of an extended period of ultra-low interest rates, the idea that these tax cuts could be permanent is highly, highly unlikely.

How American Wars Lead to Increased Income Inequality

With the United States having been in a state of war(s) since 2001, a study by Rosella Cappella Zielinski at the Watson Institute of International and Public Affairs at Brown University is particularly pertinent, especially in this time of growing federal deficit spending.  In this report, she also examines the connection between social inequality and how wars are paid for by Washington.

Dr. Zielinski begins by looking at how governments pay for wars:

1.) through an increase in general public debt (i.e. deficit financing).

2.) through war bonds.

3.) Central bank money printing.

4.) through an increase in direct taxation (i.e. income, property and corporate taxes).

This is particularly critical given the concern about the growing level of sovereign debt in the United States.

Dr. Zielinski then estimates the costs of wars fought by the United States starting with the War of 1812 in both current year dollars (prices in effect at the time of each war) and in inflation adjusted dollars (using fiscal 2011 prices).  Here is a graphic showing how each of the last ten wars fought by the United States were financed by Washington:

It is quite apparent that America's wars between the War of 1812 and the First World War were financed using domestic borrowing (in red) with war debt being dominated by loans purchased from wealthy elites and banking syndicates.  One of the main reasons that taxation did not play a significant role in America's early wars was the fact that Washington only had the ability to raise funds with customs and excise taxes (with a temporary period of income taxation between 1861 and 1871); the imposition of a permanent income tax took place in 1913 when the 16th Amendment to the Constitution was ratified.    Taxation became increasing important for funding wars starting with the Second World War and continuing through to the Korean War which was 100 percent funded by increased taxes.  Like its earlier wars, Washington funded the Vietnam War mainly through domestic borrowing.  In sharp contrast, the Gulf War and the post-9/11 wars began with tax cuts; in these wars, external financing including allied grants and foreign borrowing were increasingly important.

Let's look again at how Washington can/has funded its war efforts:

1.) Debt -

a.) Domestic Debt - money which is lent to the government by its citizens and institutions with the guarantee that it will be paid back over time.  Purchasing war-related debt is voluntary and can take place in two forms; as a war bond campaign and through the issuance of general debt which may or may not be marketed to the public.

b.) External Debt - war funds are raised through the issuance of securities which are marketed on foreign markets or through the use of interstate loans or grants.

2.) Printing additional money.

3.) Taxation -

a.) Direct Taxation - includes income, property, corporate and excess-profits taxes with no option to opt out.

b.) Indirect Taxation - includes sales, value-added, excise and customs taxes with the option to opt out (i.e. these taxes can be avoided by consumers when they decline to consume taxable items).

Now that we have a background on how Washington has funded its wars over the past two centuries, let's look at how war financing relates to wealth distribution.  Wealth redistribution is classified in two ways:

Progressive - wealth is transferred from individuals in higher income brackets to those in lower income brackets which leads to greater social equality.

Regressive - wealth is transferred from individuals in lower tax brackets to those in higher income brackets which leads to greater social inequality.

Now, let's look at the relationship between wealth transferral and the methods of paying for wars as outlined above.  Let's start by looking at two means of financing a war that will lead to progressive redistribution of wealth and lowered income inequality:

1.) When governments issue war bonds and targets them towards lower income brackets by issuing the bonds in relatively low denominations, the interest which is accrued on the bonds over their life promotes the accumulation of wealth in low income households, resulting in progressive wealth redistribution.  

2.) When governments levy direct war taxes, particularly on those in higher income brackets, progressive redistribution of wealth takes place from higher income to lower income households.  In this case, the cost of the war is not a burden to those in lower income brackets. 

Now, let's look at two means of financing a war that will lead to regressive redistribution of wealth and raised income inequality:

1.) When governments issue war bonds that are not intentionally marketed to lower income households (i.e. issue them in only large denominations or market them through larger specialized investment firms that only wealthy households can access).  Those households that can afford to buy bonds will recoup their investment along with accrued interest, however, the cost of servicing the debt through increased taxes falls on all households, including those that cannot afford to purchase bonds which ultimately transfers wealth from lower income households to higher income households.

2.) When governments levy indirect war taxes, those households that are unable to opt out of purchases are forced to pay higher prices for goods and services whose costs have been inflated by war-related tax increases since manufacturers and sellers pass along indirect taxes to consumers.  In this case, indirect taxes result in a transfer in wealth from lower to higher income households.  Additionally, wartime scarcity can result in higher prices which is more problematic for lower income households.  

As well, wars that are financed by the printing of money promote income inequality because the increased supply of money in the economy leads to higher levels of inflation.  Wars that are financed by external debt may or may not increase domestic income inequality because American wealth is transferred to individuals and financial institutions that lie outside the American economy.

Let's look at the most recent and ongoing War on Terror and how it has impacted American wealth equality.  The War on Terror is paid for with domestic debt (60 percent) and foreign debt (40 percent).  The war began with a tax cut under the Jobs and Growth Tax Relief Reconciliation Act of 2003 with tax cuts continuing into the Obama Administration.  Unlike most U.S. conflicts, tax rates continued to decline throughout the war.  Here's a quote from the paper on the impact of the War on Terror on income inequality:

"The effect of post-9/11 war finance, including continuous tax cuts and domestic borrowing, on wealth redistribution will likely entail a transfer of wealth from low- and middle-income individuals to wealthy individuals. This regressive redistribution will be mitigated by the fact that due to general economic weakness, the increased military spending and resulting deficits did not result in wartime inflation."

Let's close with this graphic showing the relationship between war finance, inequality and the share of wealth held by the wealthiest one percent of Americans:

As you can see, the era after the Vietnam War resulted in increased income inequality, thanks to tax cuts, deficit war financing (outside of war bond issuance) and war-related inflationary effects.  The period since 2001 has also seen an increase in income inequality thanks to tax cuts and deficit war financing with the only saving grace being a period of relatively low inflation.  Dr. Zielinski predicts that, unless Washington shifts from a program of funding wars by deficit financing to funding wars through direct taxation, wars being fought by the United States will continue to contribute to America's growing income inequality.

Who Is Really Benefitting from Freer Trade?

Updated September 2018

With the NAFTA talks dragging on endlessly, a look at why freer trade seems to be so important to the corporate world is key to understanding who gains and who loses in a more open environment.  Obviously, a regular part of Donald Trump's "raging against the machine" is his views on international trade, particularly how the United States comes out as the losing party in many of the trade deals that form part of the move toward globalization.  In actuality, as recent research has shown, there is one clear winner and it might not be particularly surprising when you find out who is the clear winner.

A 2017 paper by Wolfgang Keller and Willian Olney looks at a comprehensive data set that explains this trend:

As most of us are aware, compensation for the top one percent of earners in the United States has risen at far greater rates than compensation for all other earners, a trend that has led to increasing income inequality.  In fact, the vast majority of the growth in income inequality has been driven by income gains among the top 1 percent of earners.  The authors look at the role of one key factor that may have caused this earnings growth; the growth in exports, particularly the growth in exports that is unrelated to decisions made by company executives and management, that is, globalization.

There is no doubt that globalization increases access to foreign markets; this results in an increase in  sales as well as a reallocation of market share from less productive companies to more productive companies.  That said, over the past two and a half decades, there have been other factors at work that have increased exports, particularly improvements in computing power,  investments in capital goods including automation, improvements in communication and improvements in transportation, all factors that have relatively little to do with who resides in the upper floor corner offices in Corporate America. 

Since there are actually many other factors that could influence both executive compensation and exports, it is important to understand whether one trend creates the other (i.e. are more highly compensated executives more successful at promoting exports?).   As such, the authors looked at data for the years between 1992 and 2015, looking for a causal relationship between export growth and executive compensation.  For the purposes of the study, the authors used a dataset which included total compensation information (i.e. salary, bonuses, non-equity incentives, value from exercised stock options, deferred compensation etcetera) for 44,000 top executives at 3,500 publicly traded U.S. companies.  The data for the top five executives in each company is included in the study and all companies must have data for all of the years in the sample (1992 to 2015).  The trade data, both export and import, is taken from the United States Census Bureau with nominal trade flows converted to real U.S. dollars using the Consumer Price Index.  The two data sets are then merged to create a complete analysis of each firm.  As well, the authors were able to use the data to ascertain insider board relationships, a variable that may indicate whether an executive at a given firm serves on a committee that makes executive compensation decisions at their own firm or at another firm which has an executive serving on the board of their company.  When these data are combined, the dataset included 3,821 executives from 191 firms over 21 years for a total of 19,788 observations.

Now, let's look at the results.  The authors found that four factors had a positive impact on executive compensation:

1.) insider board relationships

2.) firm size

3.) technology

4.) trade 

The authors found that exports are just as important in driving executive compensation as technology, firm size and insider relationships.  Even after controlling for firm characteristics like assets and sales, exports still have a significant positive impact on executive compensation.  In fact, the authors found that a ten percent increase in exports leads to a two to three percent pay increase for executives that work in that industry.

In closing, let's look at a graphic which shows how average executive compensation for the top five executives and exports levels have risen in lockstep over the past 25 years:

Here is a quote from the author's conclusion:

"The results of this paper suggest that globalization is playing a more central role in rising top incomes than previously thought. The importance of globalization in explaining the growth of top incomes is often dismissed using basic comparisons across countries and occupations. Instead we use a comprehensive data set and rigorous empirical analysis to show that globalization has played an important role in the growth of executive compensation.

Identifying why top incomes are increasing so quickly is an important step forward. However, we remain cautious about interpreting these findings as a rational to restrict international trade. Globalization has generated enormous benefits that likely dwarf the distributional consequences highlighted here. In addition, the rapid increase in executive compensation, while startling, seems to be at least partly driven by the increasing difficulty of the job in a global economy. Instead policy makers concerned about these distributional implications, should think more carefully about how to ensure that the gains from trade are more equitably distributed."

At least now you know who is really benefitting from all of those freer trade deals that governments around the world, particularly the United States, are so anxious to make.

How Workers' Share of Gross Domestic Income Has Shaped America's Angst

In this posting, I want to look at an economic measure that many of my readers will not be familiar with since it is much less commonly covered by the mainstream media that gross domestic product (GDP).  In this posting, I will look at gross domestic income (GDI) and show how the components that make up this measure of economic health have changed over the past five decades.

Gross domestic income (GDI) is defined by Investopedia as:

"GDI is calculated as the total income payable in GDP income accounts. It can be calculated in two ways:

1. GDI = compensation of employees + gross operating surplus + gross mixed income + taxes – subsidies on production and imports

Compensation of employees encompasses the total compensation to employees for services rendered. Gross operating surplus, also known as profits, refers to the surpluses of incorporated businesses. Gross mixed income is the same as gross operating surplus, but for unincorporated businesses.

2. GDI = rental income + interest income + profits + wages + statistical adjustments

Statistical adjustments may include corporate income tax, dividends and undistributed profits."

Basically, gross domestic income is what we are paid to produce gross domestic product.  It includes wages, profits, interest and taxes on production and imports.  In contrast, gross domestic product measures what the economy produces in goods, services, technology etcetera.

Here is a graph from FRED showing the year-over-year changes in both real GDI (in red) and real GDP (in black) going back to 1948:

You will notice that GDI and GDP tend to track each other and that both are showing a relatively modest level of growth since the end of the Great Recession when compared to other economic expansions.  According to the Bureau of Economic Analysis, GDI and GDP are conceptually equal, however, they differ because different sources of information are used in their computation.   There is even a name for this difference; it's called the "statistical discrepancy".  That said, over the longer term, both GDI and GDP provide a similar picture of economic health (or lack thereof).

Now, let's focus on one key component of GDI, compensation paid to employees in the form of wages and salaries.  Here is a graph that shows the how the wages and salaries component of GDI has varied over time going back to 1948:

Between 1948 and 1975, wages and salaries comprised between 49 and 51.5 percent of gross domestic income.  This began to drop in the early 1970s and continued to fall right through the 1980s and 1990s.

Let's focus on the period since 1970 with the red line showing the trend:

In 1980, wages and salaries made up 51.5 percent of GDI, hitting a two and a half decade, pre-Great Recession low of 43 percent in 2006.  While the level did rise to 44.6 percent in 2008, it has since fallen, hitting a new, all-time low of 42.2 percent in 2013.  Looking back to its peak of 51.5 percent in 1970 (and 1953), that's a drop of 9.3 percentage points or 18.1 percent.  That's four and one-half decades that workers have experienced a declining share of gross domestic income.

In contrast and to close off this posting, let's look at the corporate profit component of gross domestic income and how it has changed since 1948:

Let's focus on the period from 2000 to the present:

You will quickly notice that the corporate profit share of GDP rose rather sharply in the early years of the new millennium, more than doubling from 4.54 percent in 2001 to a high of 10.3 percent in 2012, a five decade high.

And we wonder why there is anger seething just below the surface among America's working class who have seen the benefits of a growing economy head straight into the pockets of those who dwell in upper floor corner offices.

The Growing Ethnic/Racial Wealth Gap

A study by Dedrick Asante-Muhammad, Chuck Collins, Joshn Hoxie and Emmanuel Nieves at the Institute for Policy Studies looks at the racial wealth divide in the United States and the futility of trying to get ahead when you're not a white American.  The study looks at the accumulation of wealth in the United States over the past three decades, a problem that has become particularly prominent since the Great Recession, and projects what it will look like over the next three decades.  This study is particularly pertinent given the obvious social disparity in the U.S. and the connection between civil unrest, poverty and race.  Let's look at some of the key observations that the authors of the study have made.

Let's start by looking at a table that shows how household wealth has changed for Black, Latino and White households over the period between 1983 and 2013:

As you can see, in 2013,  average White households were by far the wealthiest, having 7.7 times the household wealth of an average Black household and 6.7 times the household wealth of an average Hispanic household.  As well, over the three decade period prior to 2013, Black households saw their wealth rise by 26.9 percent compared to 69 percent for Hispanic households and 84.8 percent for White households.

Other key measures of prosperity also show Black and Hispanic households falling behind their White counterparts:

1.) Homeownership:  71 percent of White households own their homes compared to 41 percent of Black households and 45 percent of Hispanic households.

2.) Unemployment:  White workers have an unemployment rate of 4.4 percent compared to 8.6 percent for Blacks and 5.8 percent for Hispanics.

3.) Earned Income:  A median White household earns $50,400 compared to $30,400 for Black households and $37,400 for Hispanic households.

4.) Use of Alternative Financial Services including cheque cashers and non-bank entities:  18 percent of White households use these high fee service providers compared to 46 percent of Black households and 40 percent of Latino households.

5.) Retirement Savings:  White households have an average of $130,472 in retirement savings compared to $19,049 for Black households and $12,329 for Latino households.

With this data in mind, let's look at what the future holds for all three people groups.  Here is a graph showing what household wealth will look like for Black, Hispanic and White households over the next three decades (to 2043) if the trends are the same as they were from 1983 to 2013:

By 2043, the authors' projections show that White households would experience an average annual wealth increase of $18,368, bringing their total household wealth to $1.2 million.  Black households would see their annual average wealth increase by $765, bringing their total household wealth to $107,000.  Hispanic households would see their annual average wealth increase by $2,254, bringing their total household wealth to $165,000.  In 2043, average White household wealth will be 11.2 times the household wealth of an average Black household (up from 7.7 times between 1983 and 2013) and 7.3 times the household wealth of an average Hispanic household (up from 6.7 times between 1983 and 2013).

While this growing racial/ethnic wealth divide is interesting, what is even more interesting is, that by 2044, the U.S. Census Bureau projects that non-White households will account for less than half of all U.S. households in what they term as the "majority-minority" scenario.  By 2020, more that one-half of the nation's children will be part of a minority race or ethnic group.  This means that this very significant and racially-linked wealth disparity will impact more than half of American households.

The authors then projected how long it would take for Blacks and Hispanics to overcome this significant wealth disparity.  Assuming that White household wealth doesn't increase in the future (a highly unlikely scenario), it would take Latino households 84 years to accumulate the same wealth as White families have today (i.e. the year 2097).  In the case of Black families, the situation is even worse as shown on this graphic:

Let's close with one more interesting fact; the list of billionaires on the Forbes 400 list contains only two African-Americans and five Latinos.  These seven families own more wealth than the entire Black population and one-third of the Latino population in the United States combined.  Now that's inequality at its best/worst!

The massive and growing ethnic/racial wealth disparity in the United States is increasingly expressing itself as social and political unrest.  The sense of economic helplessness has grown, particularly since the Great Recession, and millions of non-Whites (and poorer Whites for that matter) are feeling as though they are being left further and further behind with no hope of providing for their futures or for the futures of their offspring.  The notable presence of public policies that exacerbate racial and economic inequality and the lack of will by Washington to change the system mean that the ethnic/racial wealth gap is becoming more firmly entrenched in society.