Why Henry Blodget is Dead Wrong

You might be one of the greatest investment analysts of all time, but your article "How to Fix the Economy...In One Simple Chart" shows a fundamental misunderstanding of the causes of America’s economic problems. Can we talk?

Sure, your thesis is simple and appealing. America’s slow growth is caused by increasing inequality that prevents low-income individuals from consuming. If they can’t consume, firms can’t sell their products. Your solution? Firms should raise employees’ earnings so they can spend more and bring the economy back to prosperity.

But by many measures inequality in America has not increased. And employees’ total compensation has risen steadily over the past 30 years. Finally, top earners are paying an increasingly larger share of taxes at the same time as transfers to the bottom quintiles are increasing.

Take inequality. You write, citing data from University of California (Berkeley) economist Emmanuel Saez: "Most American consumers are strapped or broke because most of the income gains in the past 30 years have gone to the top 10%."

But looking at spending power per person, economic inequality is no greater now than it was in the 1980s. The effective purchasing power of those with the least cash income is augmented by food stamps, rent supplements, Medicaid-funded health care, subsidized school lunches, and other social programs.

On a per-person basis, Labor Department data show that in 2010, households in the top fifth of the income distribution spent 2.4 times the amount spent by the bottom fifth. That was about the same as 25 years ago. There is no increase in per-person spending inequality. In addition, the overall level of inequality is remarkably small. A person moving from the bottom fifth to the top fifth can expect to increase spending by only 140 percent.

Compared with 1985, the big winners are the bottom fifth group, whose per person spending levels increased by 6.5 percent in real terms. In contrast, spending per person in the top fifth of income earners increased by 1.5 percent.

This shows that even though the income spread from top to bottom might be larger, those at the bottom are doing better than they did 25 years ago because they have greater spending power, after adjusting for inflation. This is important for the bottom fifth—economically, socially, psychologically.

Spending is vital because it is the principal determinant of standard of living. It influences confidence in the future. It shows more comprehensively than cash income how much purchasing power individuals and families have. In sum, spending inequality provides a more meaningful measure of well-being than cash inequality.

Some increase in perceived inequality since the 1980s is due to the Tax Reform Act of 1986, which lowered top individual income-tax rates from 50 percent to 28 percent. This led to more income being reported on the individual, rather than corporate, tax schedules.

In addition, the composition of households has changed over the past 30 years. Women have moved into the workforce in record numbers, and there are more two-earner couples at the top of the income scale and more one-person households at the bottom, including students and retirees.

When two individuals get married, if both have worked and continue to work, they comprise a household with higher earnings—and the measured distribution of income in society widens. There are more such households now than in the 1980s. In 2010, 58 percent of married couples were in the top two quintiles, and only 7 percent of married-couple families were in the lowest quintile.

If you want to reduce inequality, Mr. Blodget, the simplest way would be to allow only one member of the household to work. It’s two-earner couples who are pumping up the incomes of the top fifth of the distribution. The CEOs and the star athletes are just a tiny fraction, outliers on a massive bell curve. The real culprits are two-earner couples.

And higher divorce rates and a greater share of babies born to unwed mothers have resulted in more single-head-of-household families at the bottom fifth of the income scale. This is a cultural tragedy which cannot be solved by employers raising wages.

You complain that "average hourly earnings in America (adjusted for inflation) have not increased in ~50 years." But average hourly earnings don’t include benefits such as vacation, sick leave, health insurance, and pension plans, which have substantially increased over the past half century.

The Labor Department’s Employment Cost Index, which measures employees’ total compensation beginning in 1981, shows that average real compensation has grown by more than 20 percent over the past 30 years. Everyone is better off—even though some might prefer more take-home pay than benefits—but some, mostly those pesky two-earner couples, are better off than others.

You cite tax cuts for upper income earners as a cause of increased inequality. But the share of federal taxes paid by the top one percent and top five percent have grown steadily from the early 1980s, even as their tax rates declined, Congressional Budget Office data show.

The truth is that our personal income tax system no longer raises revenues from many, if not most, American households. This is a dramatic change over the past few decades.

In 1979 only the lowest fifth had a zero percent share of income tax. By 2009, the lowest two fifths not only made no contribution to income tax revenue, they actually received individual income tax transfers.

In 1979, the middle three fifths contributed 35 percent of federal individual income tax payments. Now, the same group contributes 13 percent. In contrast, the share of individual tax payments of the top fifth has risen from 65 percent in 1979 to 94 percent in 2009.

Your conclusion is a call for employers to take "a few percentage points of your record profits and use it to hire more employees and pay your existing employees more." That way, you say, employees will spend more money and corporations will have higher revenues and profits.

It’s unfortunate that Congress and the administration have taken multiple steps to ensure that businesses, large and small, hire fewer rather than more workers and give them lower take-home pay. Recall when Boeing opened its new plant in South Carolina, the National Labor Relations Board tried for months to close it down, at a cost of millions of dollars to both the taxpayer and Boeing.

Firms and households don’t know what their tax rates will be in four months. They could remain the same, or they could rise dramatically as the past decade’s tax rates expire. Such uncertainty prevents firms from hiring and households from spending.

Beginning in 2014, firms that do not offer the right kind of health insurance and who have more than 49 employees will have to pay $2,000 per worker per year. That comes out of employees’ cash wages, leaving less to spend to stimulate the economy.

Those who encourage the government to require firms to provide sick leave, paid vacation and maternity leave, and other benefits, are just forcing down the take-home wage—because these benefits have to come from somewhere. Some employees would prefer more cash to these benefits.

And if the employee makes minimum wage, he’ll probably lose his job, because the $2,000 tax will make it unprofitable for employers to hire him. That’s another unemployed worker to add to the 12.8 million America has now.

Mr. Blodget, millions of Americans need meaningful jobs, but how can you expect companies to hire and pay more when the government is giving them every incentive to do the opposite?

This piece originally appeared in WSJ's Marketwatch

This piece originally appeared in WSJ's MarketWatch