Tuesday, November 29, 2011

How does Fiscal Austerity affect the 99% vs. the 1%?

During times of fiscal austerity, income inequality goes up. Inequality goes up more when the austerity comes about through spending cuts than through tax hikes. The income share of the richest 1% of the population increases after fiscal austerity. Those are the main findings of a new paper by Luca Agnello and Ricardo Sousa.

The paper adds to a growing, but still scant, literature on how fiscal austerity affects different segments of the population. My paper with Larry Ball of Johns Hopkins University and my IMF colleague Daniel Leigh [available here] shows that fiscal austerity lowers incomes—hitting wage-earners more than others—and raises unemployment, particularly long-term unemployment. These costs must be balanced against the potential longer-term benefits that consolidation can confer.

See the discussion of this work by Paul Krugman, Washington Post and Huffington Post here.

Agnello and Sousa note that their results are “close in spirit” to the evidence of Ball, Leigh and Loungani that “fiscal consolidation reduces the wage share in total income. The authors suggest that, while the fall in wage income is persistent, the fall in capital and property income is short-lived. This can be explained by the fact that fiscal austerity plans typically call for a fall in public sector wages or lead to an increase in unemployment (in particular, long-term unemployment)” (p. 10, Agnello and Sousa).