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  Chapter 7 discusses international business. Multinational corporations are becoming larger and more important. Among publicly-traded companies, those with more than a billion dollars of annual sales are responsible for the vast majority of revenues and stock market value. International business comes with important benefits, but it also raises essential concerns. Workers have far less bargaining power than companies do, and this imbalance is heightened by the mobility of multinational companies. National governments fear that tax or regulatory policies might discourage economic activity at home. When governments attempt to tax the profits of mobile multinational companies, teams of corporate lawyers and accountants swiftly move the profits to tax havens. Indeed, tax avoidance now costs non-haven countries over $300 billion in tax revenues each year!

  This does not mean that governments are powerless. Chapter 7 explains how economic policy should be modernized to suit the global economy. Countries may benefit from strengthening international cooperation. Even without international agreements, however, there are many policy options for the United States. We can protect our corporate tax base through simple, commonsense measures, while focusing on building the fundamental strengths of the US economy.

  Chapter 8 describes how immigrants are a source of tremendous strength for the US economy. Immigrants are often innovators and entrepreneurs; they are more likely to found businesses and to win Nobel prizes. Both high-skilled and low-skilled immigrants provide the economy with abilities that complement those of native workers. Immigrants boost economic growth and reduce the demographic pressures of an aging population. In turn, immigrants receive tremendous economic benefits from moving to the United States.

  With so many advantages, what accounts for the backlash against immigrants? Backlash stems from cultural concerns and economic fears among middle-class workers. Yet, evidence shows that immigrants do not generate large negative wage effects for workers; on the contrary, most workers benefit from immigrants. Even when small groups of workers are hurt, the large gains from immigration are sufficient to offset those harms. With these lessons in mind, Chapter 8 suggests immigration policy reforms.

  Chapters 9 to 11 provide a roadmap to keep the gains from the global economy that are described in Chapters 3 to 8, while responding in a serious, bold way to the problems described in Chapter 2. Foremost, we should not shoot ourselves in the foot with counterproductive policies. Beyond that, there are smart, substantial ways to combat middle-class stagnation and income inequality. Policy ideas fit into three big areas.

  Chapter 9 describes better policies to equip workers for a global economy: modern trade agreements, better tools to help workers, improved support for communities, and strong investments in fundamentals.

  Chapter 10 describes the benefits of a grand bargain on tax reform: greater after-tax incomes for those left behind in prior decades; a simpler tax system to reduce distortions, avoidance, and complexity; and lower tax rates and a cleaner planet due to reliance on a carbon tax. These reforms satisfy goals of both those on the left (who want a more progressive tax system and a cleaner environment) and those on the right (who want lower tax rates and fewer distortions).

  Chapter 11 describes a better partnership between society and the business community. The goals of the business community can be met, but a good partnership also requires more tax payments from some businesses, more business transparency on both tax and labor issues, and robust antitrust laws to counter undue market power.

  Finally, we must counter political polarization to respond to these big challenges. In Chapter 12, I conclude with some guiding principles and constructive solutions.

  We are at an important moment in our national history; crucial decisions lie ahead. Do we rise to meet the challenges of the world economy, modernizing our policies so that all Americans benefit from a more equitable globalization? Or do we turn inward, attempting to shelter workers from one aspect of a storm that comes from many directions? Do we work with friends and allies to make more stable international institutions and a more prosperous world? Or do we alienate our friends by shortsightedly (and erroneously) putting America first, and thereby making future conflicts and problems more difficult to solve? These questions are essential to our future. Let’s get the answers right.

  Two

  Middle-Class Stagnation and Economic Inequality

  In recent decades, middle-class incomes have stagnated, fueling economic insecurity. Economic growth did not benefit American households as long expected; although growth continued, inequality surged, and prosperity failed to reach the middle class. These trends began around 1980 and they continue today. This chapter takes a close look at this serious problem. What is happening to the American middle class? And what has caused these discouraging trends?

  Does a Rising Tide Lift All Boats?

  Economic growth is supposed to benefit everyone. If national income (GDP, for gross domestic product) grows year after year, beyond the growth in population, we expect that economic growth should raise living standards of typical workers. Yet, when we compare growth in GDP per person to growth in median household income, we see that something is clearly amiss.

  In the past thirty years, GDP per capita has increased by about $20,000, an increase of over 60 percent. But the typical household has seen its income grow by only 16 percent in the same time period (fig. 2.1).

  These figures explain why typical American households are not content with the pace of economic progress. The standard expectation that every generation would be better off than the one before it has been disappointed. Nearly 90 percent of children born in the 1940s outearned their parents, but that share has fallen steadily. For children born in 1970, only 60 percent outearn their parents. For those born in the 1980s, only half do.1

  Figure 2.1: Growth in US Median Household Incomes Lags Behind GDP Per Capita

  Notes: Both series are indexed so that 1984 = 100. The median shows the typical household in the middle of the economy’s distribution of income. Unlike averages, medians are not affected by large incomes at the top of the distribution. Data source: Federal Reserve Economic Data.

  How does so much GDP growth occur without benefiting the typical worker? In short, the growth has been accompanied by increasing inequality. This was not always the case. Pretax income growth over the period 1946 to 1980 exceeded 100 percent for the bottom 90 percent of the population, and the percentage growth in incomes was actually lower for the richest members of the population.

  Figure 2.2: Before 1980, Growth Lifted All Boats. Since Then, Not So Much.

  Data source: Thomas Piketty, Emmanuel Saez, and Gabriel Zucman, “Distributional National Accounts: Methods and Estimates for the United States.” Working Paper 22945. NBER Working Papers. National Bureau of Economic Research, 2016.

  That pattern has since reversed. Between 1980 and 2014, the income growth of the bottom 50 percent of the population is literally invisible in the chart, at 1 percent. Growth in incomes for the middle 40 percent is 42 percent, and it accelerates from there, with the growth of the top 1 percent exceeding 200 percent.

  Figure 2.3: The Top 1 Percent and Bottom 50 Percent Trade Places

  Data source: World Top Incomes Database. Accessed March 14, 2017.

  Figure 2.4: In 2015, the Bottom 90 Percent Earn What the Top 10 Percent Earn

  Data source: World Top Incomes Database. Accessed March 14, 2017.

  As a result, there has been an increasing concentration of national income at the top of the income distribution. The top 1 percent now command a fifth of national income, 50 percent more income than is earned by the bottom half of the income distribution. The bottom 90 percent share has shrunk from 68 percent of all income in 1980 to only half of all income in 2015. These trends are a dramatic reversal from the experience of the post–World War II years, when income inequality fell between 1946 and 1970, and was relatively unchanged in the 1970s.

  Labor and Capital in the Global Economy

  Middle-class
income stagnation, economic insecurity, and patterns of increasing economic inequality have been accompanied by ongoing changes in the role of labor in the economy.2 Workers are getting a smaller share of the pie than they did in prior decades. For a long time in the United States, workers’ share of national income held steady at roughly two-thirds.3 But in recent decades, both in the United States and elsewhere, the labor share of income has been falling. Since employment in good jobs is the key engine for raising middle-class standards of living, the falling share of labor is of enormous concern.

  If capital income (the income people receive from their investments, such as interest, dividends, and capital gains) were distributed across households in the same way that labor income is, there might be less concern, since declining work opportunities might be offset by increased income in the form of interest or dividends. Capital income, however, is far more concentrated at the upper end of the income distribution than labor income. For example, the top 5 percent of taxpayers report 37 percent of all income (both labor and capital) in 2012, but 68 percent of dividend income and 87 percent of long-term capital gains.4 Thus, the reduced role of labor has made an important contribution to income inequality.

  The declining labor share of income has been confirmed by many studies. Economists focusing on the corporate sector have found that the US labor share declined by 8 percentage points over the period 1980–2012, from 65 percent to 57 percent, and other sources suggest similar declines.5 Labor shares have also declined in other large economies, although the steepness of the decline varies.6 7

  Figure 2.5: For Most Countries, the Role of Labor Has Declined in Recent Decades

  Panel A: Advanced Economies

  Panel B: Emerging Economies

  Notes: Figures show the change in the labor share of income. These data were also depicted in ILO and OECD, “The Labour Share in G20 Economies” Report, International Labour Organization and Organisation for Economic Co-operation and Development, 2015. Figures refer to the change from 1970 to 2014 for advanced economies and from 1995 to 2012 for emerging economies. Exceptions are the Republic of Korea 1991–2014; Saudi Arabia 2002–09; Turkey and Mexico 1995–2014; South Africa 1995–2013; and Brazil 1995–2009. Note that prior to 1991, “Germany” refers to West Germany. Data source: International Labour Organization.

  The labor share of income and income inequality are not the same thing, since income inequality can also arise from an increased dispersion of labor incomes, if workers at the top experience higher wage increases than workers at the bottom.8

  Notably, income inequality has also increased in many (but not all) other countries, despite a wide variety of economic policies and circumstances. Still, income inequality has increased more rapidly in the United States than in most other countries (fig. 2.6).

  Are Things Really So Bad?

  The data reported above come from work that uses the broadest definition of income, including capital income from investments.9 Using other sources of data would somewhat moderate the increase in income inequality, though all sources of data agree that income inequality in the United States has increased substantially in recent decades.

  Inequality need not be associated with wage stagnation, but it is particularly troubling when it is.10 Some argue that the wage stagnation of the US middle class is not measured accurately, since there have been huge gains in standards of living due to new products. The numbers shown here are adjusted for inflation, and since inflation does a poor job of measuring the benefits of new goods and services, it is possible that living standards have increased more than these data indicate.11 As an example, thirty years ago, there was no Internet and we spoke on dumb phones that were tethered to the wall, whereas today a wealth of information and entertainment awaits anyone with Internet access, and most people use smart phones that are more powerful than advanced computers were thirty years ago. Do the inflation numbers accurately account for gains in consumer happiness from these inventions?

  Figure 2.6: In Many Countries, the Share of the Top 10 Percent Rises

  Data source: World Top Incomes Database. Accessed March 14, 2017.

  There are also larger philosophical questions. Do people care only about their absolute living standards, or are there other important economic desires? Is meaningful work itself a source of happiness? Do people determine their well-being by comparisons to broader society, and if so, how large is their circle of comparison? Are they considering the neighborhood, the city or state, the country, or the world?

  Regardless of the answers to these larger questions, a few basic facts stand out. First, the United States has recently experienced several decades of large increases in income inequality. Second, middle-class incomes have not grown as rapidly as GDP. Third, recent generations have not realized the same degree of economic progress that past generations experienced.

  Finally, economic discontent and insecurity are a prevalent and recurrent theme in our political discourse, so it is not unreasonable to think this discontent is rooted in reality. For example, in a recent Pew survey, 57 percent of Americans said they were not financially prepared for unexpected events, and a third of Americans had no savings. A majority of Americans spend as much as, and often more than, they earn each month.12 Economic insecurity is more than just inequality. When growth in household incomes does not keep pace with expectations, the economic status of many households becomes less secure.

  One general marker of financial strain on households is rising household debt (fig. 2.7). While some categories of debt have not increased, the overall trend of increasing household debt is particularly notable given the very low interest rates since 2009.

  Why Are These Trends Important?

  In addition to the clear economic consequences for the middle class, these troubling trends have grave consequences for society. Stagnant incomes are harmful during recessions, since income gains that are concentrated at the top are less likely to fuel consumption and, in turn, greater production of goods and services. Increased inequality amidst wage stagnation also creates social tension and dissatisfaction. When workers’ wages fall short of expectations, people often express their discontent by turning to populist solutions.13

  Figure 2.7: Debt in US Households is Still Rising Steadily

  Notes: This is total household debt per capita in US dollars. Student loan debt was not included until 2003. Data sources: New York Federal Reserve Bank and World Bank.

  The rise of populists like Bernie Sanders and Donald Trump speaks to the depth of public dissatisfaction. Political polarization extends beyond the 2016 election in both time and space. The US Congress is nearly synonymous with dysfunction, in large part due to ever-increasing polarization. In Europe, both far-left and far-right parties are ascendant.14 The shrinking importance of moderate political groups likely generates several costs: more policy variability, more policy uncertainty, more difficulty enacting policy, and more extreme policies.

  Concentration of incomes also creates disproportionate political power for those who are affluent. Those at the top of the income distribution can afford to hire lobbyists to influence the policy process as well as lawyers and accountants to work around existing policies.15 Affluence also brings greater access to policy-makers, since the wealthy are more likely to frequent the same elite institutions and social circles.

  There are also important implications for the tax system. Since recent gains in national income have accrued to those at the top of the income distribution, a progressive tax system becomes more important. Meanwhile, when the share of labor income shrinks, the tax base also falls—since most of the federal tax burden falls on labor income via income and payroll taxes—and this makes capital taxation more important. These policy implications are fully addressed in the final section of the book.

  Why Has This Happened?

  Six major factors have contributed to these troubling trends, each of which is discussed below. While this list is not exhaustive, it captures the crucial me
chanisms at work. There are clear causal forces behind each of these six factors, and there are also important interdependencies among them.

  Technological Change

  The technology of today bears little resemblance to that of 1980. In 1980, there were a few computers, but they were the size of a desk and about as user-friendly as a block of wood. The Sears catalog still arrived in most American homes, and if you wanted to place an order, you dialed a large, landline phone. Your orders arrived slowly. Gasoline was paid for by interacting with people, most people waited in line at banks instead of using the relatively new and scarce ATMs, and secretaries did the vast majority of professional typing and phone answering. Long-distance phone calls were very costly; international phone calls were still more costly, and rare. Manufacturing processes were mechanized, but rarely computerized.

  Since 1980, a computing and Internet revolution has occurred, and this has changed every facet of American life. Computers are everywhere: in our phones, in our gas pumps, on our desktops, at the grocery store, in our cars, and embedded in most aspects of our manufacturing processes. Professionals do their own typing, and voicemail takes what phone messages remain, though most have been replaced by email and texts. The Internet has changed the way we shop, the way we gather information, the amount of information we have access to, and the ease and speed of communicating both within countries and across borders.

  These changes have been pervasive, and they have had profound effects on workers and their incomes. The effects have been mixed, given that technology acts as a competitor for some workers, reducing demand for their labor, while it serves as an assistant to other workers, increasing their productivity. Secretaries, gas station attendants, bank tellers, and manufacturing workers all experience less demand for their work, as much of their work can be done by computers. Meanwhile, investment bankers, software developers, engineers, scientists, and managers all use computers to become more productive.