Is it Still Worth Growing the Economic Pie?

November 9, 2018

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It has become widely accepted in the last several years that there has been a massive increase in income inequality in America, with average workers faring especially poorly as their real income growth has stagnated or even declined. This malaise is said to be behind the rise of populism on both the right and the left. It’s a compelling narrative, but is it borne out by evidence or simply accepted as true because it is such a constant refrain?

This is more than just an interesting academic debate, because it goes to the central feature of U.S. economic policy: Should policy seek to grow the economic pie by accelerating productivity, or should it redistribute ill-gotten gains from the flush “1 percenters” to everyone else? If the prevailing narrative is right that inequality is growing, then there very well may be compelling reasons to abandon policies to grow the economy and instead focus on more equitably redistributing the gains.

But in fact, the narrative is wrong. The truth is that growing the economic pie still benefits most American workers. Much of the idea that workers no longer benefit from growth has come from the research of economists Thomas Piketty and Emmanuel Saez. In 2005, they shocked observers when they reported that 91 percent of income growth between 1979 and 2002 went to the richest 10 percent of tax filers. In follow-up studies through 2014, they continued to show uneven growth, and they neglected to mention middle-class incomes, so it was assumed that the small amount available to the bottom 90 percent of earners would mean that median income growth would be near zero. Indeed, when they finally reported data on median incomes in 2017, their 2014 median income was actually 6 percent lower than the 1980 level, on par with the median income from 1967. What could be a more compelling case for a shift from growth to redistribution—or, as Senate Democrats have suggested, “a better deal” for beleaguered American workers?

However, several researchers immediately criticized Piketty and Saez’s approach, in part because they excluded Social Security income and relied solely on tax returns, which included an extra 25 million people filing separate returns while living with other family members. Most of these 25 million people reported very little income (e.g., a spouse or 20-year-old son or daughter working part-time), so including them misrepresented trends in household income.

In contrast, the Congressional Budget Office used a more comprehensive and accurate method for measuring income changes. After including employer benefits, Social Security, and other government benefits received by individuals (e.g., Medicare, Medicaid, food stamps), then accounting for demographic changes of more single households, and using a more accurate price deflator, CBO found that real median after-tax incomes grew by 51 percent from 1980 to 2014—a far cry from the 6 percent decline Piketty and Saez had asserted. Other economists offered similar criticisms and findings as the CBO.

In 2017, in response to some of this work, Piketty and colleagues developed a new approach that incorporated many more sources of income. In their new work, real after-tax median incomes are up 36 percent from 1980 to 2014. One might think that Piketty and his coauthors would highlight how these findings differ from the ones they reached using their original approach, but they don’t. In fact, in a widely cited graphic that appeared in a New York Times op-ed, they show that real incomes grew 0.9 percent per year from 1980 to 2014. This is equivalent to a 36 percent gain over that period, but one could excuse the casual reader for thinking it was piddling gain of close to zero. Given the lack of attention they have received for their new finding that median incomes are up since 1980, albeit not as much as the CBO estimate, the notion that inflation-adjusted incomes have stagnated for many decades continues to be widely accepted as the truth.

If we are going to implement good economic policies, we need to have a clear understanding what has happened to incomes for the vast majority of the population. The fact that most workers have seen modest gains does not mean that no one has been suffering. There certainly are many Americans who have been displaced and have not fully recovered. And there certainly are many Americans who have been stuck in low-paying jobs throughout their careers. But it is simply not true that the majority of Americans have been stuck in a rut and not benefited from the economic growth of the past 40 years, modest as it has been. As such, accelerating U.S. economic growth rates, particularly the current anemic rates of productivity growth, should remain the single most important goal for economic policy. Candidate Bill Clinton’s 1992 campaign theme still applies—“it’s the economy, stupid.”