Larry Summers and Wealth Inequality

April 3, 2014

From the very nice blog post by Annie Lowrey:

“I asked Mr. Summers what was behind secular stagnation, and he said he was still thinking through all of its causes. But globalization, automation, income inequality and changes in corporate finance might be important factors, he said.

Income is now more concentrated in the hands of the rich. Those well-off households tend to save and invest higher proportions of their earnings than middle-class or low-income families do. That might mean, on aggregate, less spending and less demand across the economy for a given level of income.”

And here is a snippet from our post last week:

“But perhaps even more interesting are the implications for the secular stagnation hypothesis, which holds that we are in a long-run stagnating economy because of inadequate demand. Is it a coincidence that the secular stagnation hypothesis is being revived exactly when income inequality is accelerating? If a higher share of income goes to the wealthiest households who spend very little of it, then perhaps these two trends are closely related.”

Rising income and wealth inequality is not just about distributing the economic pie. It may very well have an effect on the size of the pie itself.

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21 Responses to Larry Summers and Wealth Inequality

  1. Ryan on April 3, 2014 at 9:06 ami

    Is “demand” synonymous with “consumption”? If not, wealthy households saving and *investing* does not necessarily reduce demand over the long run.

    This “secular stagnation” idea, and its links to inequality, is a long way from being a cogent argument.

    • Atif Mian and Amir Sufi on April 3, 2014 at 9:30 ami

      We agree that it is not yet a fully developed argument. But the failure of investment to fill gap has been addressed:

      • Anonymous on April 4, 2014 at 10:32 ami

        It is not the tax rate that is the most important thing to consider when discussing the tax code. Our tax code is static. Our economy is.dramatic. Our economy is continually changing between the inflation cycle and the recession cycle. Unless the tax code changes to reflect these economic cycles, the tax code can become a destructive force rather than a force that guides people to be more productive and less speculative. A economy that is productive increases the standard of living of its participants. A speculative economy creates money and bubbles, which creates poverty and financial inequality.

      • Brent Buckner on April 5, 2014 at 9:25 ami

        Tough for me to see “underconsumption” or “excess saving” in the U.S. national accounts:
        [FWIW - that one processed by Pete Peterson's folks ]

        • Marko on April 5, 2014 at 6:08 pmi

          You’re comparing PCE to a depressed overall gdp level. Look at PCE compared to where gdp should be. You can use FRED’s potential gdp to get an idea :

          You can also see how the federal deficit moves in unison with the shortfall in private activity , as reflected in the pce/potential gdp ratio.

    • Harlan Green on April 4, 2014 at 9:42 ami

      Ah, but capex spending has been trending down for decades, and that does reduce jobs and AD. So why do corporations spend less on capex? Because of a reduction in AD. And drastically reduced government spending on infrastructure, education, and environment a major cause, which is component of AD, don’t forget.

  2. Ajit on April 3, 2014 at 4:34 pmi

    Even if we assume that the long term stagnation is the result purely from this wealth gap/liquidity trap, I’m still a bit curious to hear what the right policy ought to be.

    Raising marginal tax rates through the roof is neither politically palatable, nor is it likely to be very effective anyways.

    On the other hand, there seems to be suggestions that policies ought to be geared to forcing savers to actually spend. I’m not sure how effective these are either.

    • Richard on April 3, 2014 at 11:03 pmi

      “Raising marginal tax rates through the roof is neither politically palatable, nor is it likely to be very effective anyways.”

      Based on what evidence?

      The US did have extremely high marginal tax rates once upon a time. It was a time period when the economy grew rapidly and inequality went down.

      • Ajit on April 4, 2014 at 12:44 ami

        A lot of evidence suggests that most of the so called high income folks ended up getting out of those kinds of taxes.

        Also, see evidence by ed Prescott on the effects of very high marginal tax rates.

        Not too mention, by Romer and Romer, they find that permanent income taxes seem to have the highest impacts on gdp growth.

        Again, I don’t necessarily have a one size fits all view to marginal tax rates. However, I do think they have negative effects and our goal, if we are to raise them, should be for some overall net benefit. I’m not convinced raising marginal tax rates for the sake of income redistribution makes a whole lot of sense. And let’s be clear, this isn’t about finding bridges or building infrastructure, this about selling the idea that taking money from the 1 percent and giving it to us non 1 percent folks will make us all better off.

        • Richard on April 4, 2014 at 9:50 ami

          On what time periods were these studies done?

          Again, once upon a time, the US had extremely high marginal tax rates and it was a time period when the economy grew rapidly and inequality went down.

          The thing is, even if some folks manage to do enough gyrations to avoid the most onerous income tax, it has a positive effect on companies and company executives. Basically, the tax code makes it much more sensible to plow back excess profits in to investment, research, development, and competition for lower-priced workers than as compensation to executives (which also lowers inequality). Basically, it mitigates the principal-agent problem that really plagues corporate America now. If you look around, you’ll find plenty of evidence that execs of public corporations really run companies for their own benefit rather than for shareholders. Which makes sense when you realize that corporate boards are on the whole useless as a police of management.

          Mind you, there’s no reason for capital gains or dividends tax to not be as high as income tax, so that gets rid of the income tax concern.

          • Ajit on April 5, 2014 at 12:29 ami

            A few things:

            First to the fact that Ceo’s abuse their rights. There’s no evidence for this. In fact, Steve Kaplan of U Chicago wrote a paper to show this. Essentially, CEO pay has been consistent with the pay of other top professions. Unless you want to make the argument that everyone at the top is gaming the system, there’s no evidence to support the CEO argument.

            As for how Firms respond to the tax code. It’s very complicated, but the answer isn’t a single lock step behavior. Papers by Poterba, Gaffney, and Siegel have discussed some of them. Some are good, some are terrible, and some are highly distortionary. I think the whole topic is far too complex for an overall picture.

            But forget taxes for a moment. And forget the fact that we have all these projects that are so clearly underfunded that need to be done. Let’s take things on a purely theoretical level. Is the wealth gap the result of mostly rent seeking? If it’s not and it’s earned through innovation, globalization, and scalability, is that still a bad thing? And finally, again forgetting what public goods we could use the money on, is forcefully redistributing the wealth from the rich to say poor or middle income families a better thing to do?

            This blog is suggesting it could cure our demand stagnation, which is a fair argument and I suppose is plausible.

        • Richard on April 4, 2014 at 10:22 ami

          Also, during that time period of high marginal tax rates, high growth, and decreasing inequality, you didn’t have nearly as many financial crises as you do these days. That is not a coincidence. When marginal tax rates are high, financiers just aren’t incented to take gigantic risks that pay them handsomely if they turn up heads but sink the economy if they turn up tails.

          In fact, considering that real average hourly wages have barely risen in the US over the past 40 years (and I believe has remained flat or even fallen for the lower half of wage-earners), it’s far from clear that the increased economic activity (and increased financial instability) from the lower marginal tax rate is actually worth anything for the majority of society.

    • Richard Treitel on April 4, 2014 at 7:37 pmi

      Speaking as a saver, still in or near my peak earning years, what would induce me to spend more would be more confidence that I’ll be able, decades in the future, to buy the services I’ll want with only a fraction of my savings. As things are, I neither know how much medical service I shall want, nor how much it will cost me in nominal money. So I do a lot of defensive saving. To put it another way, lifetime consumption smoothing seems really hard to get right.

      I haven’t really answered your question ….

  3. edward ericson jr. on April 3, 2014 at 5:29 pmi

    not so hard, really, in theory. You tax the very wealthy. You spend that money on what is needed for the common good. Start with rebuilding infrastructure & providing an income floor. You employ people to build things we all need. You pay them a fair wage. You enforce fair labor laws. You enforce the laws against fraud.

    From that you get increased consumption–more demand for needed stuff from people who can’t now afford those things. You get a better multiplier.

    The only people who don’t understand this are those who believe government spending is always a dead-weight loss, and that taxation is theft.

    Assuredly, these people currently control the government . . . .

    • Ajit on April 3, 2014 at 10:15 pmi

      All that sounds good in theory but I am skeptical about how well it works in practice. Take for instance – just taxing the very wealthy. Exactly how? Passing high marginal tax rates has been shown to have potentially poor consequences. Work by Prescott in Europe shows it ends up discouraging new entrants into the labor force and encourages close to retired workers from leaving the labor force. Additionally, high marginal taxes encourage more tax shelters, moving cash to safe havens, or moving all together. And of course, this only makes our tax code even more dysfunctional.

      I am also incredibly skeptical about how well government spends the money that it has. We already have one of the highest per capita spending on education with very poor results. Studies in KC and inner city Chicago have shown almost no increase in performance despite huge cash inflows.

      I don’t want to sound like there aren’t projects that need to be done. I’m more in the camp that government already does a poor job with what it spends on that giving them more money will lead to very little benefits and potentially much larger costs on long run growth.

      • XO on April 4, 2014 at 12:58 ami

        “Work by Prescott”…come on man, please. It’s a cult, Prescott does not do “work” or “studies”. What he does is sutras for the Ayn Rand religion.

    • Tim on April 4, 2014 at 7:04 ami

      1) raise capital gains taxes to 90% on any assets held for less than 1 year (solves the high frequency trading problems as a side benefit). 2) apply a 2% financial asset tax annually on holdings over $X. The latter being similar to current property taxes and based on similar principle the the government needs to recover its cost for providing the infrastructure to hold and trade financial assets.
      This will quickly erase the deficit – look at the numbers – and motivate the wealthy to spend rather than hold the assets.

  4. Chris on April 4, 2014 at 8:55 ami

    The second chart in your March 29 post shows that income to the top 0.1% has increased by roughly 5% (I’m eyeballing it). So your contention is that GDP shortfall of $1T (or more?) below its potential (which appeared only in 2009) is due to the lower marginal propensity to consume from a 5% increase in income to this 0.1%, which began in 1975 or so, but somehow only showed up to affect demand recently? Am I missing something?

  5. Chris on April 4, 2014 at 11:07 ami

    The tax rate is not the most important thing when discussing the tax code. Our tax code is static. and requires a 535 politically divided committee to change it. Which is inefficient and damaging to our economy. Our economy is dramatic. The economy is continually changing between the inflation cycle and the recession cycle. Unless the tax code changes automatically as the economy moves through these economic cycles, the tax code can change our economy from a productive economy to a speculative economy. A productive economy raises the standard of living of its participants. A speculative economy creates money, bubbles, and economic inequality.

  6. Charlton Butler Jr on April 4, 2014 at 12:12 pmi

    It’s very simple best expressed by Henry Ford when asked why he paid his employees so well. “I want them able to afford the product they make…” and then some so when you argue over BS that has nothing to do with anything but either confirming what you know by common sense that no money at the bottom means the top soon runs out of any source of rents. All you do, otherwise than admitting the simple facts, is alert everyone that you are arranging chairs on the Titanic; while, playing with terms, semantics and all other manner of BS in an attempt to escape the facts.

  7. MN on April 4, 2014 at 10:24 pmi

    Larry Summers is framed as an innovator in this post, but this idea is not new. It is very old. Why don’t economists read Marx or Hobson anymore?