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Time To Tackle America's Widening Inequality

Author: Matthew J. Slaughter, Adjunct Senior Fellow for Business and Globalization
October 6, 2009
Financial Times

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The financial crisis spurred many policymakers around the world to meet challenges with bold, creative, non-partisan solutions. As the crisis and recession recede, policymakers must refocus on persistent structural challenges. Top of the list in the US - and elsewhere - is income inequality.

US data remain sobering. Recent figures from the Internal Revenue Service show that in 2007 the top-percentile income share reached 23.5 per cent, continuing a 30-year increase. And, in some ways even more troubling, US inequality is widening largely because of falling real incomes for all but the most-skilled highest earners. Between 2000 and 2008, only workers with a professional postgraduate degree - 2 per cent of the labour force - enjoyed increases in mean real money income. All other educational cohorts, including college graduates and those with PhDs, suffered falls. The recession is putting further pressure on many workers: year-to-date, average weekly earnings for production and non-supervisory workers have fallen 1.5 per cent.

These income trends are worrisome for many reasons. One is the contribution of poor real and relative income performance to the protectionist drift in US economic policy seen, for example, in the 2009 Employ American Workers Act. Public support for globalisation is strongly linked to labour-market performance, which for many has long been poor.

So, what to do? Policymakers have long quibbled over the facts. They have also invoked vague and distant remedies. A better educated US workforce? Upgrading skills is terrific - but it takes generations. It took more than 60 years for the US to boost the college-graduate share of the labour force from 6 per cent in 1945 to 29.8 per cent today - and that entailed government programmes and profound socio-economic changes.

For a more immediate effect, policymakers need to redirect their bold, creative, non-partisan energies from the financial crisis to income inequality. Here are three proposals.

First, encourage the global engagement of multinational companies that have US operations. These companies - both parents of US-based multinationals and "insourcing" affiliates of foreign-based multinationals - create precisely the jobs that more Americans need: high-paying work that involves knowledge creation, capital investment and exporting. In 2006 these multinationals undertook 42.6 per cent of all US capital investment, shipped 66.9 per cent of all US goods exports and conducted a remarkable 89.6 per cent of all US private sector research and development. The bottom line that year for their nearly 27m employees was average compensation of $64,121 - more than 25 per cent above the economy-wide average.

America needs to be better at supporting US job creation by these multinationals - by helping them become more globally engaged. Their expansion abroad tends to complement, not substitute for, their US operations. A big obstacle here is proposals to boost their US taxes. The US is already a high-tax outlier relative to nearly all the world. Raising this burden would reduce the global competitiveness of these multinationals - and their US employment and other activities.

Second, direct any fiscal redistribution at the right target. Focusing on personal income tax is misplaced because this tax is already quite progressive. The right target is the Federal Insurance Contributions Act tax for social insurance. By virtue of being both a flat rate on a largely capped base, FICA is a regressive tax that tends to reinforce rather than offset pre-tax inequality. And it is nearly as big as the progressive income tax: in fiscal 2008, $900bn versus $1,100bn.

Third, overhaul and expand America's antiquated labour-market-adjustment programmes. Unemployment insurance was introduced in the 1930s, designed to replace a worker's income temporarily until rehired by the same company. Today's unemployment risks are much more involved and workers need a broader safety net. The higher costs of this overhaul can be paid for by raising the FICA cap and/or marginal rate.

Long-standing income inequality pressures have been overshadowed by the financial crisis. But they will soon return to centre stage. Who will rise to the challenge of addressing inequality with the same determination mustered for the financial crisis?

This article appears in full on CFR.org by permission of its original publisher. It was originally available here.

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