The newest economic inequality numbers, which ran counter to the expectations of almost all experts, are frightening.

The Associated Press released an article titled, US income gap widens as poor take hit in recession. The opening paragraph of the article, based on recent census data, reads:

The recession has hit middle-income and poor families hardest, widening the economic gap between the richest and poorest Americans as rippling job layoffs ravaged household budgets.

The article, which then discussed the Census statistics that led to this conclusion, failed to mention that the Census Bureau considered the differences between 2007 and 2008, with regard to economic inequality, statistically insignificant.

But, whether the Census Data shows a meaningful increase, or not. is irrelevant. The Census Data reports that, contrary to the almost universal expectations of economists, economic inequality most likely did not decrease in 2008. Experts had anticipated that the declines in income of the rich would lead to a reversal in this groups ever–widening share of our national income. Instead, the Census reported that the 2008 income losses by the top 10% of Americans were offset by larger losses among middle class and poorer Americans.

MIT economist Simon Johnston appears to have been one notable exception to this expectation of a shrinking income gap.

Let’s review what we know about the measurement of income inequality before discussing the disturbing implications of this newest government report.

About two weeks ago, I critiqued a Sept 10, 2009 front page story in the Wall Street Journal titled, Income Gap Shrinks in Slump at the Expense of the Wealthy. My critique had three central points:

First, economists have, with few exceptions, agreed that Census Data is inappropriate for measuring income inequality because it consistently understates the income of the wealthiest families. To protect the privacy of reporting individuals, the Census “top-codes” income, which means that no one is ever recorded as making more than about $1.1 million in a single year. So, oil traders, hedge fund executives and anyone else at the super-high end of the income strata who might earn $100, $50 or $5 million in a single year, always earn $1.1 million or less in this Census Data. In addition, the Census Data does not include capital gains income, which is typically a large source of income for the wealthiest Americans.

Two economists, Professors Emmanuel Saez and Thomas Piketty, developed a method for measuring income inequality using IRS data, which avoided the problems inherent in using Census Data. This data was recently updated in response to the IRS release of 2007 information, and found that: Economic inequality in 2006 was, by some measures at the highest levels, ever found in the data available for the past 95 years. In 2007, these same measure showed a further jump further bringing America to it it’s highest levels of economic inequality in recorded history.

As a consequence of Census top-coding and the lack of capital gains data, the Saez-Piketty methodology has consistently shown that the Census substantially understates the extent of economic inequality in the nation. This means that, there is a real possibility that the the new Census Data understated the extent to which income inequality grew in 2008, and that the relative losses of the wealthiest families, versus less fortunate Americans, will be more than statistically insignificant.

It is possible that losses in reported capital income by the wealthiest Americans, if captured by the Saez-Piketty methodology, will be larger than the the incomes above $1.1 million that were not reported and offset the Census findings, leading as economists anticipated to a decline in the share of income going to the rich. However, I view this as unlikely. In considering this possibility, its important to remember that the IRS works on reported income gains, not gains which were never captured as taxable income. For income reporting purposes, the question is not whether the market value of capital assets declined but whether they were sold at an actual loss from their purchase price.

We will not know the answer to this question until July or August 2010, but in weighing the available evidence my working hypothesis is that as demonstrated by this new Census Report, income inequality did not decrease from 2008 to 2007.

Second, the original Journal article expressed a strong expectation that, as a result of the Great Recession, the ongoing growth of income inequality would decline substantially through 201o. My critique indicated that this was “far from clear.” The conventional economic wisdom, based on historical data, is that income inequality decreases, at least temporarily, as the richest Americans lose income faster than less-well-off Americans during a downturn. In contrast, this new data suggests that the dangerous cycle toward increasing income at the top of America has become even more self-reinforcing than previously recognized. We are now at the point where the pure market forces, which many economists told us would eliminate this issue, are no longer effective.



Third, the Journal article implied that the decrease in economic inequality it incorrectly predicted might be the start of a long-term trend. Instead, I demonstrated that, even if income inequality did decline in 2008 and 2009, it would almost certainly be “temporary.” The historical evidence shows that economic inequality frequently declines in a downturn, in the absence of strong government action, but that it will almost inevitably rebound and continue its march forward.

Now, let’s return to our main point:

Early next week, my new book It Could Happen Here will be released by HarperCollins. The book is an in-depth look , based on a historical analysis, of the implications of our historically high levels of economic inequality for the nation’s ultimate, long-term political stability. As economic inequality grows, nations invariably become increasingly politically unstable: Should we complacently believe that America will be different?

A central conclusion of the book is that once economic inequality reaches a self-reinforcing cycle it is halted only by inevitably controversial, hard-fought, bitterly opposed government action. Senator Jim Webb encapsulated this idea, when he wrote in his book, A Time to Fight: Reclaiming A Fair and Just America:

“No aristocracy in history has decided to give up any portion of its power willingly.”

In 1928, economic inequality was near today’s levels. Franklin Roosevelt succeeded in reversing the trend toward the continuing concentration of wealth, but it was a turbulent battle. In 1936, while campaigning for his second term and speaking at Madison Square Garden, FDR told the crowd:

“Never before in all our history have these forces [Organized Money] been so united against one candidate as they stand today. They are unanimous in their hate for me and I welcome their hatred. I should like to have it said of my first Administration that in it the forces of selfishness and of lust for power met their match. I should like to have it said, wait a minute, I should like to have it said of my second Administration that in it these forces met their master.”

In FDR’s era and in our own, money brings power: both explicitly and implicitly, in hundreds of different ways, both large and small. Today, the wealthiest Americans, together with a number of financial and corporate interests that act on their behalf, protect their ever-increasing influence through activities that include, among others, lobbying, supplying expertise to the councils of government, casual conversation at dinner parties, the potential for jobs after government service, the power to run media advertisements that influence public opinion. Indeed, MIT economist Simon Johnston, writing in The Atlantic asserted that the U.S. is now run by an oligarchy:

The great wealth that the financial sector created and concentrated [ from 1983 to 2007] gave bankers enormous political weight–a weight not seen in the U.S. since the era of J.P. Morgan (the man) … Of course, the U.S. is unique. And just as we have the world’s most advanced economy, military, and technology, we also have its most advanced oligarchy.

The new inequality data suggests that the potential problems for the nation associated with the concentration of wealth and power are even more severe than previously recognized. Two weeks ago, I wrote that “Once income concentration becomes a reinforcing cycle of the kind we are witnessing, it is never stopped by pure market forces.” This mechanism is now in full swing. The market forces associated with the Great Recession, which many economist had expected to stem the growing, corrosive gap between the rich and the poor, appear to have become ineffective.

The great strength of American democracy has always been its capacity for self-correction. However, Robert Dahl, the eminent political scientist, recognized that political power fueled by wealth may ultimately neutralize this central aspect of our democracy. In his 2006 book, On Political Equality, Dahl wrote:

As numerous studies have shown, inequalities in income and wealth are likely to produce other inequalities..

The unequal accumulation of political resources points to an ominous possibility: political inequalities may be ratcheted up, so to speak, to a level from which they cannot be ratcheted down. The cumulative advantages in power, influence, and authority of the more privileged strata may become so great that even if less privileged Americans compose a majority of citizens they are simply unable, and perhaps even unwilling, to make the effort it would require to overcome the forces of inequality arrayed against them.

In the chapter following this quote, Dahl notes “that we should not assume this future is inevitable.” He’s right. But, was clearly concerned. Three years late, we should be even more concerned.

Many current Executive Branch initiatives deserve our support and praise: However, nothing proposed to date will effectively halt growing economic inequality, and its corrosive impact on our economy and the long-term future of the nation. (In a future post, I will explicitly discuss the proposed regulatory reform of the financial sector.)

My analysis in It Could Happen Here concludes that without a vibrant middle class, the the American democracy as we know it, is not sustainable. Before the Great Recession, the middle class was in far worse shape than was generally acknowledged. In an economy with a record number of job seekers for every available job, the potential for nearly one-half of all home mortgages to be underwater, and increasing foreclosures, the collapse of the middle class will accelerate. With each job loss and each foreclosure, another family becomes a member of the former middle class.

America has never been a society sharply divided between have’s and have not’s. Unfortunately, this new data says to me we continue to head in that direction. Economists assumed that the Great Recession would be a circuit breaker that would halt this advance, at least temporarily. It did not.

With no new legislation, it appears we are potentially on course for 13 million foreclosures, almost one in every four mortgages in the nation, from the end of 2008 through 2014. Do we really believe that we can turn such huge numbers of Americans out of their homes with no consequences for the health of our system of governance? Could our democracy survive a transformation into a nation composed principally of a privileged upper class and an underclass which struggles from paycheck to paycheck and lacks basic economic security?

We will only stop the growth of economic inequality if the President and the Congress are ready to fight in the style of Franklin Roosevelt. FDR was a divider not a conciliator. Before World War II, he fought an all-out war at home. Today, “There’s class warfare, all right,” as Warren Buffett said, “but it’s my class, the rich class, that’s making war, and we’re winning.”

I fervently hoped that we have not passed the point of no return, described by Professor Dahl. The recent news shows we are one step further on this road. If we continue down it, our nation may be on the path to becoming a House divided against itself, which ultimately cannot stand.