What the debate about income inequality and stagnation usually misses

Much of the debate about income inequality and stagnant incomes is reflected by the left side of the above chart from the McKinsey Global Institute. Focusing specifically on America, it shows most of us worse off today than a decade or so ago. Which perhaps would not be terribly surprising, given meager 1.5% average annual GDP growth in the 2005-2015 decade (including the Great Recession).

But while there is certainly a use for looking at market incomes, so too disposable income. The latter gives information on spending power. And as the MGI chart points out, “In the United States, lower tax rates and higher transfers turned a decline in market incomes for four-fifths of income segments into an increase in disposable income for nearly all households. … And in fact, as a result of tax and transfer policies—particularly since 2000—median US disposable income has risen sharply, even as market income has dropped.”

Well, that seems like an important finding! Public policy matters! Ignoring it, as typically happens in discussions about the American middle class, presents an overly gloomy picture.

Still, things could be a lot better. What can we do to boost income growth? Faster economic growth for one thing. Let’s say US GDP grew about point faster over the next decade than the previous one. McKinsey finds that income growth would be “significantly better.” And faster productivity growth means faster GDP growth. MGI:

In the United States, growth-oriented policies in energy, trade, and infrastructure could potentially raise GDP by at least $200 billion by 2020 and create more than 1.5 million jobs. … Historically low interest rates could present governments with an opportunity to increase infrastructure investment, easing pressure on flat or falling incomes and increasing employment. … Making it easier to launch new firms has been linked to faster job creation. Furthermore, increased innovation has been linked with higher social mobility. Policy makers can streamline processes for registering firms, increase access to funding, provide business training for small enterprises, adjust tax structures to incentivize innovation and R&D, and limit industry-based barriers to entry for innovative entrepreneurs. While such measures may lead to an even greater share of income gains going to high-skill workers, they nonetheless could boost overall output and wage growth for middle- and low-skill workers.

Then there are more worker-oriented policies. Among them:

Policy makers and employers could also look to develop more non-college options, such as vocational training and community college certificate programs. … Increasing geographic mobility through affordable housing and transportation can also improve mobility. … Policy measures to encourage women to remain employed include sufficient maternity leave, affordable child care, and tax reforms that reduce disincentives to work. … Governments can encourage older workers to remain employed through tax incentives and pension reforms, as well as by enforcing employment protections, such as antidiscrimination laws.

It’s a lengthy report but worth reading, especially since it gives examples of what other nations are doing to improve growth and boost incomes. That’s the basic thrust of the report; we need to improve growth: ”

MOst people growing up in advanced economies since World War II have been able to assume they will be better off than their parents. For much of the time, that assumption has proved correct: except for a brief hiatus in the 1970s, buoyant global economic and employment growth over the past 70 years saw all households experience rising incomes, both before and after taxes and transfers. As recently as between 1993 and 2005, all but 2 percent of households in 25 advanced economies saw real incomes rise. Yet this overwhelmingly positive income trend has ended …  between 2005 and 2014, real incomes in those same advanced economies were flat or fell for 65 to 70 percent of households, or more than 540 million people (exhibit). And while government transfers and lower tax rates mitigated some of the impact, up to a quarter of all households still saw disposable income stall or fall in that decade.

Along the same lines, I would recommend two new Conservative Reform Network reports, one on work from my AEI colleague Michael Strain, and one on housing from Reihan Salam.