Our new economy spreads the pain

  • By James McCusker / Herald Columnist
  • Saturday, August 7, 2004 9:00pm
  • Business

Our feelings about the rich are usually a bit mixed. Jealousy, admiration, envy and pure fascination all swirl around in our conscious minds like ingredients in a botched crock-pot dinner.

Because of this emotional content, it is difficult under any circumstances to conduct a purely analytical discussion about wealth.

In an election year, it is probably impossible.

A new Internal Revenue Service report on personal income, though, certainly gives us something to think about even if this isn’t the time to discuss it.

For two years in a row, 2001 and 2002, personal income reported to the IRS declined. This is the first time since World War II, when the present withholding tax system went into effect, that we have experienced back-to-back declines in taxable income. There was a one-year decline in 1953, but by comparison it was a minor, short-lived blip in our upward progress.

The Byzantine complexity of our tax laws makes it dangerously easy to overinterpret IRS data when we try to give it economic meaning. What constitutes adjusted gross income, for example, can be affected by many things, especially the timing of individual decisions about investments. A stock that goes up or down, for example, does not usually count toward gross income until it is sold, because individuals generally pay their taxes on a cash accounting system, as opposed to the accrual system required of most corporations.

Despite the uncertainties embedded in the IRS data, there is no doubt that the source of this income decline is the collapse of the stock market bubble in 2000. Accumulated fortunes were transformed almost instantly into worthless pieces of paper. Businesses collapsed, jobs disappeared, and our country found itself in the grip of an economic recession.

That much we already knew, and it was confirmed by the precipitous decline in capital gains income over the 2001-02 period. But what we didn’t know was exactly how the evaporation of financial assets would show up in household income. And even when we took the shock of the Sept. 11, 2001, terrorist attacks into account, we couldn’t explain why some employment effects of the recession seemed so persistent when the overall economic data did not seem to warrant them.

The economic recession of 2000-01 barely met the minimum definition required to be considered a recession at all. The deep, and prolonged, decline in income now documented by the IRS, though, would seem to explain why this past recession, which was brief and almost insignificant by the usual standards of economic measurement, was more painful than it should have been.

The data suggests that the who may, in this case, be as important as the how much. During 2001 and 2002, total income for those who earned under $200,000 a year didn’t decline at all. The big losers were those with higher incomes – over $500,000 a year. And the top earners in the country, those lucky ones with annual incomes of over $10 million, saw a jaw-dropping decline of 63 percent. As surfers used to say when viewing a particularly spectacular wipeout, “That’s gotta hurt.”

What the IRS report makes clear is that the economic structure of our country hasn’t so much changed as it has become more market-driven and, in that sense, more efficient. The savings and investment of the rich have always been an important factor, but now things happen a lot faster. Market-based, financial assets play a bigger part than ever before in our everyday economic lives, and while the rich still take the biggest hit when the stock market tanks, the decline in their investment spending spreads quickly, via business contraction and restructuring, to produce painful, and persistent, employment effects.

While the stock market itself has recovered quite nicely, thank you, the surprisingly deep and long-lasting income effect of the bubble’s collapse has serious implications for economic policy-makers, and for us.

The first implication is that market bubbles present a high risk to our economy because the costs of a collapse are clearly higher than we had thought. This implies pre-emptive action if we are to avoid paying the price for a speculation-driven market. The second is that we need to learn a lot more about how income distribution affects our economy.

The third implication and economics lesson we can draw from the IRS report is that even though there may be a wide gulf between us and the rich, in this market-driven economy we are all in the same boat. And if they get hurt, we get hurt. Perhaps in a perfect world we wouldn’t have to share the price of their foolishness. But this is our imperfect, beautiful world, and in it we have the economics of our time.

James McCusker is a Bothell economist, educator and consultant. He also writes Business 101, which appears monthly in The Snohomish County Business Journal.

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