Redistribution is the name of the game

We all knew that when Joe the Plumber labeled Obama as a "redistributionist" that he wasn't saying anything that wasn't true of all U.S. politicians. The issue is not whether to redistribute income or not but rather how income should be distributed. Robert Reich in his new book, After-Shock: The Next Economy and America's Future, opens with the single most important statistic for the current political debate: "In the late 1970's, the richest 1 percent of the country took in less than 9 percent of the nation's total income. After that, income concentrated in fewer and fewer hands. By 2007, the richest 1 percent took in 23.5 percent of total national income. It is no mere coincidence that the last time income was this concentrated was in 1928." (page 6)

This "redistribution" of income into the hands of the richest Americans was the work of both political parties but it began with Reaganomics and was accelerated by the Bush tax cuts after a period of some moderation under Clinton. The Tea Party profoundly misunderstands the dynamics of this redistribution in its calls for reduction of government spending and what it calls "confiscatory" taxes. There is an essential problem with rich people getting richer, even a lot richer. The problem is that they got richer by impoverishing the middle class. The middle 60 to 80 percent of Americans whose incomes in real terms have steadily declined since 1980.

This redistribution had two negative effects. First, it concentrated more and more money in the hands of people whose consumption was already at the maximum and thus rather than spend their increased wealth in consumption--the mother's milk of the American economy--they sought to get even richer. If they had actually invested that money in strong fundamental economic activity, we would have all benefited. What they did, however, is what they always do: they speculated. Too much money chasing too few investment opportunities simply drives up prices in a speculative frenzy: think dotcom bubble; think housing bubble. Eventually these bubbles burst and in the last case that almost brought down the entire economy.

The second impact fed into the first. Even though the American middle class had less and less real income, it continued to respond to the essential need to keep consumer demand high. This, for better or for worse, is the fundamental dynamic of the American economy. But if incomes did not keep pace with demand, what would predictably happen? The middle class would use consumer credit to make up for that income loss and when that reached exhaustion, it would use home equity which was ratcheted up by the speculation. Eventually that reached a predictable limit and the middle class was unable to continue to expand demand; the economy slowed and then descended into the Great Recession which was immeasurably worsened by the speculation and the associated abuse.

Government needed to step in and bolster demand lest the Great Recession become another Great Depression. If federal deficits had not become bloated with unneeded war expenditures and unwarranted tax cuts for the rich and if the excesses of the speculation had not required massive bailouts, the central government could have increased demand within acceptable deficit limits since recovery would mean increased federal revenues and the opportunity to pay down the debt. This happened during the Clinton administration but the resulting financial strength was expended on the above tax cuts and the military adventures of the following administration.

The problem now is that a recovery which does not address this maldistribution of income simply will not work. Private demand from the middle class will not develop to take the place of government demand--always meant to be a short response. The 17 percentage point gain in national income held by the rich must be reduced back to its 1980 levels. This redistribution will mean that the middle class will once gain be able to play its role in the American economy. While the richest one percent will have a smaller share of national income, the fundamental economic system will be sound and stable.

In other words, the previous tax cuts for the middle class should be made permanent but the tax cuts for the rich should be allowed to expire. To do otherwise could be disastrous beyond our wildest nightmares.