Paul Krugman makes much of the "Great Compression" , which is his term of choice for the dramatic reduction of income inequality that occurred in the United States between 1935 and 1945. He attributes this equalization of income to FDR and the New Deal. "So what happened to the rich? Basically the New Deal taxed away much, perhaps most, of their income" (Krugman COAL, page 48)
One of the scholars whose research Krugman cites produced a similar series on income inequality for France. The graph for French income inequality (click for larger image) between 1920 and 1945 looks strikingly similar to the graph for American income in the same period.
Surprisingly, Piketty does not attribute France's Great Compression to the New Deal. Instead, he concludes: "the decline in income inequality that took place during the first half of the 20th century was mostly accidental. In France and probably in a number of other developed countries as well ... the secular decline in income inequality is for the most part a capital income phenomenon: holders of very large fortunes were severely hit by major shocks during the 1914-1945 period, and they were never able to fully recover from these shocks, probably because of the dynamic effects of progressive taxation on capital accumulation and pre-tax income inequality" (page 29).
In short, financial crisis, depression, and global war reduced inequality by greatly reducing wealth and the return on wealth; postwar tax rates kept it from re-emerging (for a while). If this pattern is common across the industrialized world, just how important was FDR?
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Monday, November 19, 2007
Posted by Thomas Oatley at 10:14 PM . Monday, November 19, 2007