State of the Union: What the President Should Say about Inequality and Fiscal Policy

State of the Union address

The Oxford English Dictionary defines a "bully pulpit" as "a public office or position of authority that provides its occupant with an outstanding opportunity to speak out on any issue." President Theodore Roosevelt was the first to call the White House a bully pulpit, and he and other heads of the executive branch have used it as a platform to raise the profile of various issues and push forward an agenda for change. The most regular, high-profile instance of highlighting priority issues is the annual "State of the Union" address (President Franklin Delano Roosevelt first called it that in 1934), where the president addresses a joint session of Congress huddled together in the House chamber.

It is likely that President Barack Obama will touch on many issues related to fiscal policy in his State of the Union speech Tuesday. Some of them have been previewed in recent months; others are simply unavoidable. Then there are topics that he should talk about but may not make it into his speech.

What We Expect to Hear: Inequality is Important, Raise the Floor

The president will bring up the extraordinarily important issue of extreme income inequality and economic mobility on Tuesday night. In his Dec. 4, 2013 speech before The Arc in Washington, D.C., Obama spoke of how "the basic bargain at the heart of our economy has frayed" and how these issues are "the defining challenge of our time." During his eloquent speech, he expounded on how "the combined trends of increased inequality and decreasing mobility pose a fundamental threat to the American Dream, our way of life, and what we stand for around the globe." He added, "It is not simply a moral claim that I'm making here. There are practical consequences to rising inequality and reduced mobility," such as a weaker economy, negative impacts to families, and a hollowing out of our democracy.

The evidence is clear: inequality has worsened since the 1970s. The top one percent's share of all income in the U.S. has grown from 7.7 percent in 1979 to 17.1 percent in 2007, or 275 percent, according to a 2011 Congressional Budget Office (CBO) report. Meanwhile, the bottom 80 percent of the U.S. population has seen its share of national income decline slightly.

CBO chart
Source: Congressional Budget Office

CBO explains that federal tax and fiscal policies can reduce inequality in two ways: by lifting the floor for low-income households through policies like the Earned Income Tax Credit, and by taxing high-income households. All economically advanced countries use tax and transfer policies to reduce market-based inequality. But CBO finds the "equalizing effect" of U.S. fiscal policy was larger in 1979 than it is now because the "share of transfer payments to the lowest-income households declined," and "[t]he overall average federal tax rate fell," especially for the richest Americans.

But the middle class has been losing wage income before taxes. An analysis of Social Security Administration data by David Cay Johnston found that the annual median pre-tax wage of American workers was just $27,519 in 2012; controlling for inflation, this represents a decline in pre-tax wage income of $980 from 2007 and is the lowest level since 1998.

There is some disagreement among researchers about whether economic mobility has also been falling over this time period, but all agree that economic mobility is "consistently lower in the U.S. than in most developed countries." Despite our Heratio Algers myths, most people who are born poor in the U.S. stay poor. A new study by economists Raj Chetty and Nathaniel Hendren of Harvard, Patrick Kline and Emmanuel Saez of the University of California at Berkeley, and Nicholas Turner of the Treasury Department's Office of Tax Analysis found that economic mobility has been relatively unchanged over the last half century. But as economist Lawrence F. Katz of Harvard noted, "Because there's so much inequality, people born near the bottom tend to stay near the bottom, and that's much more consequential than it was 50 years ago."

We expect the president to review this evidence in the State of the Union address and then turn to policies that would mitigate inequality by helping those at the bottom of the income and wealth ladders.

The President's Policy Agenda

The White House proposed a federal minimum wage of $9, up from the current $7.25, in the last State of the Union address. It has thrown its support behind the $10.10 minimum proposed in the Fair Minimum Wage Act, sponsored Sen. Tom Harkin (D-IA) and Rep. George Miller (D-CA). That bill would raise the minimum wage over two years and then peg future increases to inflation. A broad bipartisan majority of the public supports increasing the minimum wage.

As Roosevelt Institute fellow Mike Konczal points out, an increase to $10.10 an hour "would reduce the number of people living in poverty by 4.6 million. It would also boost the incomes of those at the 10th percentile by $1,700." He added, "That's a significant increase in the quality of life for our worst off that doesn't require the government to tax and spend a single additional dollar." Furthermore, the weight of the economics evidence shows "little or no employment response to modest increases in the minimum wage," according a comprehensive literature review by John Schmitt, senior economist with the Center for Economic and Policy Research. Instead, many argue that a higher minimum wage could spark some additional hiring if workers spend more of their increased income and stimulate more economic activity.

We expect the president to renew his calls for extended unemployment benefits for people in regions with high levels of joblessness. At the end of December, Congress failed to extend emergency unemployment benefits for them, immediately cutting off 1.3 million Americans. This figure has already increased to 1.6 million and could grow to more than 4 million over the course of the year, as their spell of unemployment goes beyond 26 weeks.

CBO chart
Source: Center on Budget and Policy Priorities

As many have noted, in the past, federal extended unemployment benefits were not stopped until the long-term unemployment rate had fallen to a much lower level. Given the continued weak state of the labor market, it makes economic and moral sense to keep these benefits in place until the number of long-term jobless falls substantially.

The president will no doubt talk about the way the Patient Protection and Affordable Care Act, otherwise known as Obamacare, has started helping millions of low- and middle-income Americans gain access to health insurance through subsidized health care exchanges and through an expansion of Medicaid that many states have not accepted. He may urge more states to adopt the Medicaid expansion.

The expansion of early childhood education will probably make a repeat appearance in this year's State of the Union address. The president is committed to "a new federal-state partnership to provide all low- and moderate-income four-year old children with high-quality preschool, while also expanding these programs to reach additional children from middle class families and incentivizing full-day kindergarten policies." And now that the House is producing its own immigration bill, the president will undoubtedly renew his call for comprehensive immigration reform, including a pathway to citizenship for the 11.7 million undocumented immigrants living in the U.S. today. According to the Congressional Budget Office's analysis of the Senate's immigration bill, legalizing undocumented immigrants would increase tax revenue and produce "net savings of about $135 billion over the 2014-2023 period."

What the President Should Talk About, But Probably Won't

The president is likely to suggest policies that reduce inequality by helping those at the bottom of the income distribution. He should also talk about tax policies that return some of the vast wealth that has accumulated at the top of the income ladder to public purposes. After all, the wealth created by society would not have been possible without the public structures that enable societies, economies, industries, businesses, workers, and consumers to thrive.

The Center for Effective Government supports a set of policies that would do just this:

  • End offshore tax abuse (would raise $220 billion over 10 years) – Multinational corporations have intensified their use of aggressive accounting practices to shift their U.S. profits to offshore tax havens. By some accounts, corporate tax haven abuse alone costs the U.S. Treasury $90 billion a year. Nearly $2 trillion of U.S. corporate assets are currently held offshore – all of it untaxed in the United States.

  • Adopt the Buffett Rule ($171 billion over 10 years) – The Buffett Rule would require taxpayers earning $1 million or more to pay an effective tax rate of 30 percent, around what middle-class taxpayers pay. Seven thousand millionaires paid no federal income taxes in 2011. In 2009, the 400 wealthiest Americans each had, on average, more than $200 million in taxable income and paid less than 20 percent in federal income taxes, a rate lower than many middle-income families pay.

  • End subsidies for CEO pay ($75 billion over 10 years) – Current tax law allows corporations to deduct limitless amounts of executive pay so long as the pay is based on achieving measurable performance targets. Pending legislation would eliminate the performance pay loophole and cap this deduction at $1 million per executive per year (companies can still pay their CEOs more; they just can't write off the costs on their taxes).

  • Abolish the Carried Interest Exception ($21 billion over 10 years) – The carried interest exception allows hedge fund managers to pay taxes on their earnings at the 20 percent capital gains rate, rather than individual income tax rates. Taxing the 10 top hedge fund managers' reported incomes at the 39 percent rate instead of the 20 percent rate would produce $1.9 billion in tax revenue – and leave them among the 400 highest-income Americans.

  • Eliminate "corporate tax extenders" that reward offshore tax dodging (one-year cost in 2013: $10 billion) – The corporate tax extenders bill is a package of 30 corporate tax subsidies renewed as a package every year or two by Congress. The cost of the total package when last renewed in January 2013 was nearly $41 billion. Of these, two subsidies have little economic value and exist simply to reward companies that have successfully shifted U.S. profits offshore. These two provisions are referred to as the "active financing exception" and "the controlled-foreign corporation look-through."

More revenue could mean an expansion of job training programs, expansion of early childhood education, and improvements in and modernization of America's aging infrastructure ‒ all things that grow the economy in the long-run and address real needs. This more expansive role of government would go beyond helping just the most vulnerable, but would broadly benefit the middle class, as well.

In budget after budget, the White House has called for expanded infrastructure investments to address critical transportation and other needs that underlie our economy and society's success, as well as spur more job creation since it still lags behind that of past recoveries. It is likely the White House budget proposal for fiscal year 2015 (it will not be released until March) will continue to do so. However, the size of the proposal is already substantially smaller than civil engineers and other experts say is needed.

The Center for Effective Government released a report in December that identified $124.4 billion in annual physical infrastructure spending needs. Were funds released for these essential investments, up to 2.5 million jobs would be created.

It's not clear if the president will mention the need for expanded infrastructure investments in his State of the Union speech, but in a mid-January speech in Raleigh, NC, he announced the creation of a high-tech manufacturing hub and encouraged Congress "to pass the bills that would create 45 of these manufacturing hubs." This suggests he may reiterate his previous calls for these manufacturing and innovation hubs, as well as expanded infrastructure investment.

There is a bipartisan effort in Congress to pass legislation that would give multinational corporations a significant tax break for bringing back the profits they've shifted offshore, if they invest these funds in an infrastructure bank. This is an expensive way to pay for infrastructure – taxpayers would first have to pay for the corporate tax breaks, and then pay again for the infrastructure. The bonds issued to fund infrastructure under these proposals would not count toward the national debt, but they would nonetheless need to be paid back to the multinational corporations that capitalized the infrastructure bank. The president should announce his opposition to such schemes, which reward corporations that have for many years gamed the tax system, and instead call for offshore tax rules to be tightened immediately, with the revenue generated directed toward creating jobs through rebuilding America's infrastructure.

One policy that the president is expected to enact just before or shortly after the State of the Union address: raise the wages of private-sector employees working for contractors. With an executive order, the White House will require that any private contractor working for the federal government pay its workers at least $10.10 an hour. A Demos study found that nearly two million employees working for government contractors earn less than $12 an hour, "more than the number of low-wage workers at Walmart and McDonalds combined."

The president will use the White House bully pulpit to push many worthwhile policies designed to improve the economy and the lives of everyday Americans. Some are particularly focused on those at the bottom, with good reason. And the government can and should do more to grow the economy from the middle out. But for the government to do more to build a broadly shared prosperity, it needs resources. The very few at the top who have swallowed most of America's gains in the last several decades need to pay their fair share.

In the wake of the rollout debacle, and continuing gridlock in Congress, the president may scale back his agenda and go for smaller compromise wins. Or he could make maximum use of his bully pulpit and swing for the fences. He could outline a true progressive populist agenda for Congress and the American people that sets the stage for fights over policy on both the federal and state levels. We're hoping he swings away.

Editor's Note: This article was updated since its original publication date to reflect President Obama's intention to raise the minimum wage of federal contract workers.

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