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What Does It Really Mean to be Middle-Class?

Paul Krugman is on again today about the disappearing middle class, and how the Bush tax cuts are and always have been a huge, unfair giveaway to “the rich,” whoever they are. Because I happen to remember that the Bush tax cuts actually were an across-the-board cut in marginal rates, together with strong reductions in taxes on capital, I wondered how Krugman gets from there to considering them unfair.

Well, of course it’s because high-income people pay more taxes than lower-income people. A LOT more taxes. So any change in marginal rates necessarily affects them more, whether you raise rates or cut them. Clearly enough, Krugman doesn’t have a problem with low tax rates. He has a problem with the fact that some people earn a lot of money.

That got me wondering why we have so much income inequality in the first place. I don’t think there’s one simple answer to that question, but a lot of it comes down to the amount of risk you take.

First, let’s quickly acknowledge a few important things. It’s true that a lack of good education means that millions of unfortunate people have little of worth to trade in return for a good living. That accounts for a lot of inequality at the low end of the scale.

It’s also true that much if not most of the financial industry has shifted from making capital available for investment, to a range of rent-seeking behaviors which are made possible by wrong-headed government regulation. Wall Street and the banking industry are ripping the rest of us off. This accounts for a lot of inequality at the high end.

But what’s happening in the middle? Think about what it means to be middle-class, a category that in much literature represents the ideal of a good, gentle life, conducive to moderation, societal health, and the raising of good children.

In practice, to be middle class means you have a job that gives you little risk and pressure, while also paying you enough money to escape material need. Unlike a small businessman, you don’t ever have to worry if today is the day you lose your biggest customer. Unlike an unemployed unskilled laborer, you don’t have to worry where your next meal is coming from. At worst, you adjust to economic vicissitudes by modifying your consumption of small luxuries, like clothing from Neiman-Marcus or your annual vacation.

Being middle-class, as Roosevelt astutely realized, is all about SECURITY, which is the absence of risk.

I was led to this thought, as I mentioned, by noticing that in today’s uncertain environment, many people are adjusting by becoming contractors. They offer their services (from web-site design to domestic help to high-end legal work) on an ad-hoc basis, rather than as part of a permanent full-time job with benefits. A steadily increasing number of people get much of their income on Form 1099 rather than Form W-2.

Something similar happened during the Depression, but I saw it start to happen at mid-decade, even before the crisis hit. America has upwards of 20 million small businesses, and many of them are people who are simply marketing their skills as best they can, possibly employing a small number of assistants and tradespeople along the way.

Every entrepreneur understands the linkage between risk and reward, in an immediate and visceral way. There’s no safety net. Your success is determined by your hard work, intelligence, and no small amount of good luck. The reverse is true in equal measure. Plus, luck is out of your control, and it changes on a daily basis.

It makes a lot of sense that people who take a lot of risk should be rewarded for it. On the other hand, Paul Krugman, Robert Reich, and many others who see salvation in a rejuvenated labor movement, fantasize that we can somehow engineer a prosperous but genteel society in which nearly everyone can make a comfortable living without exposure to the gut-wrenching swings faced by entrepreneurs.

And can you blame them? This is a wonderful fantasy! How, indeed, can you focus on the most important task in your life, which is raising your children, if you’re constantly worrying about money? The natural human desire to avoid risk is indeed the source of most of the inherent instabilities in the financial system, and current reform efforts do less than nothing to change this.

(Have you ever seen a TV commercial while watching golf or the evening news, from some insurance company that promises you investments that gain value in good times, but provide good yields in weak times? If this notion attracts you, then you’re part of the problem.)

Market and finance people like me tend to believe that there is a fundamental linkage between risk and reward, cast in stone when the Hebrew God wrote the Ten Commandments. (“Thou shalt not leave thy gamma-exposure unhedged.”) Other people insist that the linkage is not fundamental. They say it’s not only possible, but actually a moral imperative to construct a society in which most people have a job that is both well-paying and secure, so they can rest easy at night.

Which of these views is true is a deep question that I can’t answer. But I will say that we achieved (or appear to have achieved) a near facsimile of the prosperous, stable promised land in the decades after World War II. These of course were the good old days of high labor-union participation.

But they were also days of extremely high rates of capital investment, and a generally closed economy with relatively little dependence on trade. They were the days when Detroit automakers could sign lavishly expensive labor contracts, incorrectly believing that they would never face real competition, and therefore needed no cost-structure flexibility.

We can’t go back to that world. But the fact that it existed suggests that we might be able to construct something like it.

Right now there is a notable lack of new ideas for macro policy that can foster a return to high real growth in the long term. This is what all the headscratching, chinpulling, and posturing from pundits, economists, and elected officials is all about. They got nuthin’.

But I think we can find our way back to the answer. As always, real answers and real change will come from people not heavily invested in the status quo. (Having a Nobel Prize in either economics or peace is a contrary indicator for new ideas and the ability to change.) In the absence of actual good answers, the intelligent policy is for government to step back and leave the private sector to either find the answers or not. This is the essence of the opportunity, and the challenge, facing the Republicans who will be returned to power this November.

The middle class is disappearing because the lack of long-term growth means that we don’t have enough prosperity to give most people a comfortable, risk-free life. This is a secular trend, having nothing to do with the recession that ended twelve months ago. We know that we can have a middle class because we did it once. But we also know that it was very much a historical anomaly.

There’s a right way to do this and a wrong way. Nostalgia for the Fifties is the wrong way. I don’t know what the right way is, but 20 million entrepreneurs will probably be able to find it.

As long as we stop taxing and regulating them to death.

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