THE STASH SEPTEMBER 11, 2009
Yesterday’s Wall Street Journal had a front-page story about the declining fortunes of the wealthy, marking a recent burst of journalistic interest one of my three favorite economic classes. The day before, The Washington Post ran a piece about how spending by the affluent may be the key to the recovery. A few weeks earlier, The New York Times was first out of the gate a with a story that, like the Journal’s, linked the struggles of our high-earning friends to declining income inequality.
Of the three, the Journal’s was the most elegiac--mournfully noting that we're not closing the income gap “by lifting up the bottom” but by “pulling down the top.” The Times story wasn’t without pathos either (it’s built around John McAfee, the antivirus software magnate whose $100 million fortune has dwindled to $4 million, forcing him to hawk far-flung estates like they’re heirloom jewelry). But it was more bullish on the social and political consequences of the turn-around, as epitomized by a quote from Harvard economist Larry Katz on the way “incredibly high incomes can have a pernicious effect on the polity.” (Hear, hear.)
Still, both the Journal and the Times mostly treat the consumption habits of the wealthy as curiosities with tenuous implications for the broader economy. (“U.S. sales of Bentleys, Maseratis, Maybachs and Lamborghinis have fallen over 50% this year,” says the Journal. “In one ZIP code in Vail, Colo., only five homes sold for more than $2 million in the first half of this year, down from 34 in the first half of 2007,” says the Times.) Only the Post argues that the retrenchment is bad for all of us, not just the wealthy.
The story crunches some numbers to make the point:
The top 20 percent of the nation's households -- with income of at least $150,000 -- account for 40 percent of all spending, according to government data. …
[A]ccording to research released this year by two professors at Northwestern University, more of their wealth is concentrated in the stock markets and privately held businesses than that of other income groups. The pair, who examined the top 10 percent of households, also found that their work income is more cyclical than those of the less affluent. …
The Northwestern study found that a 1 percent decline in GDP resulted in a roughly equivalent decline in spending by most demographic groups. But for the top 10 percent of households by income, spending dropped 5 percent.
So, to summarize: The affluent are a key driver of consumption (which is itself the key driver of economic growth); but both their income and their spending is more sensitive to recessions than any other group, which makes them a real drag on the recovery.
While the Post piece never quite gets there, it’s easy to interpret it as a brief for tax cuts for the wealthy--as some conservatives have. In fact, that turns out to have been the basic conclusion of a recent Merrill Lynch report called “The Myth of the Overlevered Consumer,” which worked from similar data. (Sadly, it’s not available online) According to Merrill’s economists, it falls to “the wealthy – with modest leverage, full employment, and witnessing a quicker rebound in their wealth - to lead consumption higher.” The only reason they won't is if they're overburdened by taxes:
Rising taxes – both across the board increases and a more steeply progressive tax policy – may offset potential consumption growth as the most important determinant of consumption is after tax income. The latter policy – “soak the rich” – in particular has the potential to mitigate the above conclusion that the wealthy may have the credit capacity and wealth effect (through rebounding stock wealth) to help bolster consumption and economic growth.
It makes a lot of sense, except for one big problem: The wealthy consume a significantly smaller portion of their wealth and after-tax income than the rest of us. Which is to say, at any given moment, the wealthy have the money to consume more but choose not to. So giving them additional money through tax cuts (or refraining from tax increases) wouldn’t increase consumption very much. The poor and many in the middle class, on the other hand, don’t have enough money to consume as much as they’d like. So cutting their taxes would almost certainly increase consumption. In fact, if you raised taxes on the wealthy, even in their beleaguered state, and refunded the same amount to the poor and middle class, you’d probably raise consumption overall.
It’s not that the rich aren’t important to the economy; they clearly are. It’s that, unlike the poor and middle class, our capacity to affect their behavior through public policy is relatively limited--they really are different from you and me. The Journal and the Times, by focusing on the status of rich people as, well, rich, avoid creating that misconception. The Post, by focusing on their status as engines of economic growth, seems to encourage it. It's an easy mistake to make, but no less dangerous as a result.