Bill Gates Walks Into a Bar... (The Hidden Krugman)

Paul Krugman uses his Friday column (Letter to the Secretary, fully available to Times Select subscribers) to address Treasury Secretary John Snow about income inequality, which stems from this pronouncement by Snow (via the WaPo):

"There has been a decline in the inequality" from a high point in 2000 through 2003, the most recent year for which figures are available, Snow said during a meeting with reporters yesterday, referring to Treasury data based on tax returns.

The top 5 percent of Americans, ranked by income, earned 15.4 percent of the nation's after-tax income in 2003, down from 19 percent in 2000, Treasury figures show. The bottom 20 percent took home 2.5 percent of all U.S. after-tax income, up from 2.3 percent in 2000.

But much of the decline in inequality during that period reflected the popping of the stock market bubble, which peaked in 2000, when executives pocketed fat bonuses and stockholders reaped huge profits from selling shares, according to economists inside and outside the Bush administration. The fall in stock prices during those years disproportionately affected high-income households and helped compress the distribution of income.

[...]

And census data, which do not include capital gains, show that income inequality grew from 2000 to 2003 and increased again in 2004, continuing a quarter-century trend.

Administration critics said the income figures in 2000 were an anomaly, reflecting the overheated stock market. "If you look at it over a longer period, the trend toward rising income inequality has continued unabated," said Leonard E. Burman, a former Clinton administration Treasury official who is a senior fellow at the Urban Institute.

Here's professor Krugman:

I find it helpful to illustrate what's going on with a hypothetical example: say 10 middle-class guys are sitting in a bar. Then the richest guy leaves, and Bill Gates walks in.

Because the richest guy in the bar is now much richer than before, the average income in the bar soars. But the income of the nine men who aren't Bill Gates hasn't increased, and no amount of repeating "But average income is up!" will convince them that they're better off.

Now think about what happened in 2004 (the figures for 2005 aren't in yet, but it was almost certainly more of the same). The economy grew reasonably fast in 2004, but most families saw little if any improvement in their financial situation.

Instead, a small fraction of the population got much, much richer. For example, Forbes tells us that the compensation of chief executives at the 500 largest corporations rose 54 percent in 2004. In effect, Bill Gates walked into the bar. Average income rose, but only because of rising incomes at the top.

Speaking of executive compensation, Mr. Snow, it hurts your credibility when you say, as you did in a recent interview, that soaring pay for top executives reflects their productivity and that we should "trust the marketplace." Executive pay isn't set in the marketplace; it's set by boards that the executives themselves appoint. And executives' pay often bears little relationship to their performance.

[...]

Finally, you should stop denying that the Bush tax cuts favor the wealthy. I know that administration number-crunchers have produced calculations purporting to show that the tax cuts were tilted toward the middle class. But using the right measure — the effect of the tax cuts on after-tax income — the bias toward the haves and have-mores is unmistakable.

According to the nonpartisan Tax Policy Center, once the Bush tax cuts are fully phased in, they will raise the after-tax income of middle-income families by 2.3 percent. But they will raise the after-tax income of people like yourself, with incomes of more than $1 million, by 7.3 percent.

And those calculations don't take into account the indirect effects of tax cuts. If the tax cuts are made permanent, they'll eventually have to be offset by large spending cuts. In practical terms, that means cuts where the money is: in Social Security and Medicare benefits. Since middle-income Americans will feel the brunt of these cuts, yet received a relatively small tax break, they'll end up worse off. But the wealthy will be left considerably wealthier.

[posted with ecto]