Will we see more income equality?

Economic data should show, if it isn't already, that the ridiculously rich have gotten considerably poorer in the Great Recession. The super wealthy have not been immune to the collapse in asset prices.

Perhaps the broadest question is what a hit to the wealthy would mean for the middle class and the poor. The best-known data on the rich comes from an analysis of Internal Revenue Service returns by Thomas Piketty and Emmanuel Saez, two economists. Their work shows that in the late 1970s, the cutoff to qualify for the highest-earning one ten-thousandth of households was roughly $2 million, in inflation-adjusted, pretax terms. By 2007, it had jumped to $11.5 million.

The gains for the merely affluent were also big, if not quite huge. The cutoff to be in the top 1 percent doubled since the late 1970s, to roughly $400,000.

By contrast, pay at the median — which was about $50,000 in 2007 — rose less than 20 percent, Census data shows. Near the bottom of the income distribution, the increase was about 12 percent.

Some economists say they believe that the contrasting trends are unrelated. If anything, these economists say, any problems the wealthy have will trickle down, in the form of less charitable giving and less consumer spending. Over the last century, the worst years for the rich were the early 1930s, the heart of the Great Depression.

Other economists say the recent explosion of incomes at the top did hurt everyone else, by concentrating economic and political power among a relatively small group.

The whole article is an interesting read. It brings forward (data) points such as:

• The Mei-Moses index, which tracks art prices, has fallen 32% in the last 6 months
• Income distribution was relatively flat in the U.S. in the 1950s and 1960s
• For the super-rich to return to their old levels of wealth quickly would likely require another asset bubble
• Incomes of the wealthiest Americans rose the most during the stock market bull markets
• "Since 1980, tax rates on the affluent have fallen more than rates on any other group"
  

The article also weaves the tale of John McAffee, of McAffee anti-virus software fame, into the overall article. So if you're interested in what's happened to him, now you can find out.

What about the recession's effect on the mass affluent? Well, the original article authors did a follow-up blog post responding to a comment one of the orignla article's readers asked. Their argument is that the upper middle class will fare relatively better than other income groups, and bring up a better unemployment rate for the managerial and professional class and favorable tax policy as supporting points.

Let's not forget about Social Security

Allan Sloan has done another first-rate job trying to focus Americans' attentions on the cluster that is Social Security. He's cut through all the tripe that we keep hearing from our leaders and pundits that says Social Security is fine for another 20 or 30 years and even then it will still be able to to pay 80% of benefits. Do yourself a favor and take 10 or 15 minutes to read the whole story. I'll give you the money 'grafs.

Just last year Social Security was projecting a cash surplus of $87 billion this year and $88 billion next year. These were to be the peak cash-generating years, followed by a cash-flow decline, followed by cash outlays exceeding inflows starting in 2017.

But in this year's Social Security trustees report, the cash flow projections for 2009 and 2010 have shrunk by almost 80%, to $19 billion and $18 billion, respectively. How did $138 billion of projected cash go missing in just one year? Stephen Goss, Social Security's chief actuary, says the major reason is that the recession has cost millions of jobs, reducing Social Security's tax income below projections.

But $18 billion is still a surplus. Why do I say Social Security could go cash-negative this year? Because unemployment is far worse than Social Security projected. It assumed that unemployment would rise gradually this year and peak at 9% in 2010. Now, of course, the rate is 9.5% and rising -- and we're still in 2009.

Sloan does more than call attention to the issues. He offers honest to goodness thoughtful (and dare I say non-partisan) solutions. If we don't start paying attention to these generational accounting problems, we will be on our own and have to suffer tax increases.

The end of strong U.S. GDP growth?

Americans, especially those Boomers, are spending less. That's bad news for an economy that is over two thirds driven by consumer spending.

When 79 million people—nearly a third of Americans—start spending less and saving more, you know it won't be pretty. According to consulting firm McKinsey, boomers' conversion to thrift could stifle the economy's hoped-for rebound and knock U.S. growth down from the 3.2% it has averaged since 1965 to 2.4% over the next 30 years. "We would have gotten here in 5 or 10 years as boomers retire, but we pushed it up," says Michael Sinoway, managing director of consulting firm AlixPartners.

3.2% growth down to 2.4% growth is a decline of .8 percentage points. Multiply that by the U.S.'s 2008 GDP of $14.3 trillion. That's over $114 billion less in GDP per year, which will compound over the 30 year projection. We'll need to find other ways to grow our economy.

Prepare for a major tax increase

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Your taxes are going to go up. Not just taxes on the rich, or the mass affluent, or the solidly middle class. Taxes for everyone will increase, since we're going down the road of needing a value added tax (VAT) in the form of a national sales tax to get us out of this massive national debt hole that we've dug ourselves into.

The bill is far too big for only the rich to pick up. There aren't enough of them. America will have to lean on citizens far below the $250,000 income threshold: nurses, electricians, secretaries, and factory workers. Within a decade the average household that pays income tax will owe the equivalent of $155,000 in federal debt, about $90,000 more than last year. What the Obama administration isn't telling Americans is that the only practical solution is a giant tax increase aimed squarely at the middle class. The alternative, big cuts in spending, aren't part of the President's agenda. To keep the debt from wrecking the economy, the U.S. would need to raise annual federal income taxes an average of $11,000 in 2019 for all families that pay them, an increase of about 55%. "The revenues needed are far too big to raise from high earners," says Alan Auerbach, an economist at the University of California at Berkeley. "The government will have to go where the money is, to the middle class." The most likely levy: a European-style value-added tax (VAT) that would substantially raise the price of everything from autos to restaurant meals.

(Added emphasis is mine.)

Anyone who tells you that our national debt won't be a huge problem is bs'ing you. Sure, politicians love to talk about how they'll bring down the national debt by eliminating earmarks, cutting discretionary spending, blah, blah, blah. Budget cuts ain't happening, unless China stops buying all those Treasuries which would negate our ability to do deficit spending. And then there is the required spending on entitlements: Social Security, Medicare and Medicaid. Do a search on 'generational accounting' to see what kind of financial damage entitlements are going to do to our children and grandchildren. Except we're the children and grandchildren and the problems are upon us already. Don't get me wrong, I think entitlements are a great thing and keep people out of poverty. However, we as a nation never figured out how to pay for them.

It can't go on forever, and it won't. What will shock America into action is the prospect of fiscal collapse, which will grow more vivid each year. In 2008 federal borrowing accounted for 41% of GDP, about the postwar average. By 2019 the burden will double to 82% by the CBO's reckoning, reaching $17.3 trillion, nearly triple last year's level. By that point $1 of every six the U.S. spends will go to interest, compared with one in 12 last year. The U.S. trajectory points to the area that medieval maps labeled "Here Lie Dragons." After 2019 the debt rises with no ceiling in sight, according to all major forecasts, driven by the growth of interest and entitlements. The Government Accountability Office estimates that if current policies continue, interest will absorb 30% of all revenues by 2040 and entitlements will consume the rest, leaving nothing for defense, education, or veterans' benefits.

National bankruptcies

The other option is national bankruptcy. It's not an option, obviously, and a national U.S. bankruptcy will never happen. But for kicks, I did some research on what happens when nations go bankrupt.

A couple of examples I found (thanks Wikipedia!) are defaults on debt incurred by previous national governments, such as post-Revolutionary France defaulting on the debts of Bourbon France and Soviet Russia defaulting on debts of Czarist Russia. There's also an example of a default of Danish bonds in 1850, and another Danish bankruptcy in 1813. Germany has gone bankrupt twice after the World Wars. More recent examples are Russia in 1998, Argentina in 2001-2002, and Iceland in 2008. A national bankruptcy may lead to massive inflation, as the country prints money to pay its debts. Gold could be a hedge against this situation.

Looking at the last Argentina bankruptcy:

Once the Argentine businessmen had transferred their dollars abroad, the second phase of the collapse began. The Argentine government froze all bank accounts, capping the maximum amount an accountholder could withdraw at only $250 (€198) a week. Small investors, those who had left their money in the banks, were the hardest hit. Tens of thousands of desperate citizens stormed the banks, and many spent nights sleeping in front of the automated teller machines.

The last phase of the downturn began in the Buenos Aires suburbs. After consumption had dropped by 60 percent, young men began looting supermarkets. In December 2001, 40,000 people gathered on Plaza de Mayo in front of the Casa Rosada, the presidential palace. There, they banged pots and pans together day and night, until an unnerved President Fernando de la Rúa fled by helicopter.

[...]

Nevertheless, the country recovered from the crash with astonishing speed. In recent years, the Argentine economy has grown at impressive rates of 7 to 9 percent.

Again, it's inconceivable that the U.S. will go bankrupt. That's just not going to happen. But, I do see a large tax increase and increased inflation. The hardest thing to swallow about the tax increase is that since it may be a national sales tax, there's no way to avoid the taxes later by using vehicles like a Roth IRA or Roth 401(k).

Financial crisis numbers

I was reading a story about how innovation will lead us out of the current financial crisis (the online version has some differences from the print version). What really interested me was not the praise given to innovation, which is the central point of the article, but some of the facts and figures the author gave about the cause of the crisis.

He lays the blame for the crisis not on any one group, but on just about everyone involved; American consumers, the U.S. government, politicians, banks, rating agencies and regulators. And he says that allowing Lehman Brothers to collapse is what really made things awful. But on to the numbers.

From 1930 to 1997, U.S. house prices grew by .7% annually. From 1998 to 2006, they rose at an 8% clip.

[...]

driving mortgage equity withdrawals to over 10% of disposable income versus 3% a decade earlier and the equity content of the U.S. housing stock down from nearly 70% in 1965 to 43% - the lowest level since records have been kept.

[...]

These lower-quality mortgages grew from less than 10% to 40% of originations; interest only or negative amortization loans that didn't require near-term principal repayment were introduced and grew to around 25% of originations; and over 75% of these mortgages were not held by the lenders but rather were packaged into securities and sold to others.

[...]

Consumer balance sheets swelled with indebtedness as debt service payments reached nearly 15% of disposable income - as in the 1930s.

[...]

we experienced after 2002 the first economic recovery since the war in which real median incomes went down.

[...]

The decline in the prices of stocks and values of homes robbed American households of nearly $11 trillion in net worth - which equals the combined output of Germany, Japan and the U.K. - and perhaps $30 trillion globally. Since consumers usually spend about 5% of their net worth a year, the negative "wealth effect" likely caused them to reduce spending by about $550 billion domestically and perhaps $1.5 trillion globally.

Market graphs

Some telling graphs accompany the story.

Wicked plunge in Americans' net worths

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Recently released Fed data on consumer finances paints a picture of how bad things are. In the Fed's report, their assumption of the average drop in net worth from beginning of 2008 to October 2008 is 22.7% (see them on page 12 of the PDF), and their assumption of the median drop in net worth is 17.8%. Since the median is less than the average, it is the wealthier families that saw greater drops in net worth. (The BusinessWeek slide show that I linked to seems to be using the adjusted net worth on page 12, since it quotes about a 13% drop in median net worth.)

If you look at the BW slide show, you can see that only the top decile of households had less than 40% of their entire net worths tied to their primary homes. Housing price declines would tend to disproportionately affect the less well off.

Some other nuggets I've pulled out (keep in mind these, unlike the net worth numbers above, only cover up to the end of 2007, before the financial crisis really hit):

• Capital gains went from 3.2% of income (across all families) in 2004 to 6.7% in 2007. Wages decreased from 69.7% of income in 2004 to 64.5% in 2007.
• 'Education' given as an answer to the 'reason for saving' question decreased from 11.6% in 2004 to 8.4% in 2007. 'Purchases' increased as an answer from 7.7% in 2004 to 10.0% in 2007.
• 59.7% of families use the Internet for financial information or financial services
• Vehicles are the most commonly held nonfinancial asset. From 2004 to 2007, the share of families that owned some type of vehicle rose 0.7 percentage point, to 87.0 percent.

One thing that our government does well is provide economic data after the fact. Economics isn't everyone's cup of tea, but if you're an arm chair economist, read this one.