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updated 10/13/2006 5:12:47 PM ET 2006-10-13T21:12:47

As he revs up his campaigning for the fall election, President Bush has been thinking about the economy, and about family history.

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In late September, when the major electoral challenge for the Republicans was Iraq, Bush flew to Ohio for oneof a series of appearances on the economy that will continue until Election Day. The destination was Meyer Tool, a midsize maker of testing products for the aerospace industry. Unlike most manufacturers -- a sector that has lost 3 million jobs since 2000 and hasn't gained any ground in the turnaround in employment that began in 2003 -- Meyer Tool has hired 125 workers in the past 12 months. Flanked by Meyer President Artyn Easton and Vice President Beau Easton, Bush noted, "We've got a father and a son who are running this company," and he complimented them for "doing what you are doing" to make the company a success.

Ten days before, in a Rose Garden press conference, the subject had again been the economy, and the president's mind drifted to another father-son team. Bush trotted out what has become his standard line on the economy: The economy is strong; it is strong because of tax cuts; and given the chance, Democrats will raise taxes to the detriment of working Americans. Despite polls indicating that Iraq and the war on terror will dominate the election, Bush suggested another possibility: "I've always felt the economy is a determinate issue, if not the determinate issue, in campaigns. We've had a little history of that in our family."

A little. Bush remembers the disastrous 1992 re-election campaign of his father, who didn't appear to recognize that Americans cared much more about stagnant wages and a sluggish economy than about his victory in liberating Kuwait from Saddam Hussein. President George H.W. Bush, in trying to project confidence (so he said later), came off as unconcerned about the effects of a mild recession (one that economists later concluded had ended just as his re-election campaign began) and about the drop in employment and wages that continued in 1992 during the slow recovery. His seeming detachment reinforced the idea that the elder, more patrician Bush was out of touch with average Americans.

Whether George W. Bush's decision to invade Iraq had Oedipal roots has been the topic of much speculation; less attention, however, has been paid to the more crucial lesson taken from the father's presidency -- the primacy of the economy in elections. The younger Bush has always explicitly acknowledged that his unwavering support of tax cuts in the face of surging budget deficits was inspired by the conservative revolt in 1992 after his father broke his pledge not to raise taxes. Likewise, faced with a tough midterm election for Republicans, Bush is hoping that many voters will look at all of the ways that 2006 is different from 1992 -- the 4.6 percent unemployment rate versus the 7.6 percent rate in September 1992, the 6.6 million jobs created since mid-2003, and the 3.7 percent annual economic growth since then. (He's also hoping that voters won't focus on the less spectacular: only 4 million new jobs and an average 2.6 percent yearly growth counting from 2001, when Republicans took over government.)

Democrats say they would welcome an election that turns on the economy, and they make their own case that most Americans have seen their living standards erode during Republican rule, largely because of tax cuts that the Democrats claim were skewed toward the rich. On the day of the Ohio visit, Democratic National Committee Chairman Howard Dean put out a statementtitled "Americans Not Buying Bush's PR Campaign on the Economy," and used Census Bureau data to argue that household income dropped for most workers last year.

If past midterm elections are a guide, voters may hold Republican lawmakers responsible for Bush's conduct of the war in Iraq, but Congress was a much more equal partner in passing tax cuts and managing the economy. To the extent that voters are influenced by the economy, they are probably more likely to view their vote for a senator or representative as a referendum on recent economic policy, based heavily on tax cuts that almost all Republicans in Congress voted for repeatedly and almost all Democrats opposed. Bush believes that most voters will be alarmed at his image of Democrats intent on raising taxes -- he mentions it every time he mentions the economy. Democrats are betting that most voters are unhappy that tax cuts and income gains have gone mostly to upper-income people and want a Democratic Congress to change course.

Seeing Is Believing
One big question about this election is what voters see when they look at the economy. Will it be the full effect of five and half years of nearly complete Republican control of government? Or will they focus on a snapshot of recent conditions? Polling and other research indicate that most voters who are influenced by economic conditions (rather than national security or other issues) are swayed by events in the six months or so before an election. In 1992, George H.W. Bush found that a turnaround in economic growth in the second half of 1992 came too late to help his campaign. In 2006, job growth has been solid, if not spectacular, since February, averaging about 126,000 jobs a month, a level that has almost exactly matched the growth of the working-age population. Economic growth ran at about a 4 percent annual rate for the first six months of the year, but it is expected to slow down in the second half.

Edward Lazear, the chairman of Bush's Council of Economic Advisers, notes that while average wages had been rising at an accelerating rate since 2004, inflation had more than wiped out those gains, resulting in a drop in average wages after inflation through August of this year. Lazear said that almost all of this decline was due to the surge in energy costs beginning in 2005. Factor out energy, and real wages would be rising now, he said.

This observation bodes well for the fall, because of the sharp drop in energy prices that recently brought gasoline prices down by as much as 25 percent, below $2 a gallon in some areas. "This represents -- no, this is -- a big boost in the spending power of consumers," Lazear said.

Likewise, a moderation in long-term interest rates in the past three months is likely to boost the confidence of consumers. The slowdown in the housing sector, even in those areas where home prices are dropping, may not have a huge effect on the confidence of the average homeowner. While almost everyone will notice the drop in energy prices in their weekly purchases, only a small proportion of the population will perceive a loss in wealth from selling a house for less than they expected, Lazear said.

Democratic leaders, candidates, and their surrogates are likely to maintain their argument that the Bush tax cuts in 2001 and 2003 resulted in a windfall for the wealthy and contributed to the relative stagnation in income for middle- and low-income families. They cite data showing that most American families saw their take-home pay lag behind inflation in the past five and half years, and they say that Republican tax cuts have made the distribution of wealth and income more unequal today than at any other time since the early 20th century.

From a crassly political point of view, one question that has hung over the Bush tax cuts is why Republicans wouldn't have structured them to give a proportionally larger refund to the lower 80 percent of the income-distribution curve, which comprises vastly more voters than the top 20 percent, which got the lion's share of the benefits. Was it smart politics to give most of the tax cuts to a small number of rich folks, even if they do pay most income taxes? Wasn't it dumb to stiff the vastly larger bloc of voters who aren't rich?

Not as dumb as one might think, based on who actually votes. During the 2004 election, about 34 million voting-age people lived in households that earned $30,000 a year or less, according to the Census Bureau[PDF]. Fifteen million, or about 44 percent of them, turned out to vote. On the other hand, 19 million people from households earning $100,000 or more turned out to vote that year. The number of high-income people in the population was much smaller -- only 24 million compared with 34 million lower-income people. But they turned out to vote at nearly twice the rate -- 78 percent.

According to exit pollingby CNN, 58.7 percent of voters from households with more than $100,000 a year in income voted for Bush in 2004, and 41.2 percent of them voted for Kerry.

Exit polling doesn't reveal why high-income people, in particular, voted the way they did, but we do know a related fact -- in 2004, taxpayers earning more than $100,000 a year received 59 percent of the 2001 and 2003 tax cuts. By comparison, people from families earning $30,000 or less got 8 percent of the tax-cut pie. Upper-income voters also turned out in greater numbers in 2004 than they had before. In 2000, the turnout rate for people from households earning $75,000 or more was 71.5 percent, but it rose to 76.5 percent in 2004.

Who's Right?
In the back-and-forth between Republicans and Democrats over the economy, the facts get a thorough massaging from both sides, but it is possible to pick out a few details that will probably be important to voters.

First, the Bush administration is right to emphasize that unemployment is at a relatively low level -- the 4.6 percent rate in September is lower than the average unemployment rate in each of the past four decades. Democrats respond with data showing that a larger proportion of people have left the workforce than ever before because they can't find work, and that the duration of unemployment for those who are looking is longer. For most workers who might vote, however, it is a relatively good time to find a job.

Democrats have one compelling response to this, and it fits in with a theme that they will be polishing for the 2008 election -- the risk of declining living standards. While the number of jobless Americans may be lower than normal, according to Yale University economist Jacob Hacker, the risk of their experiencing a sharp drop in income has increased significantly since the 1970s. Back then, the chance that a family would suffer a 50 percent drop in income over a two-year period was 7 percent; today it is 16 percent and has been rising at an accelerated rate since 2000, Hacker said recently at the Brookings Institution. Another study showed that on average, workers who lost their jobs when the technology bubble burst in 2000 earned 13 percent less in their next job. While a relatively small number of potential voters have lost a job or know someone who has, the fear of losing a job (plus health insurance and a worker's place in society) is worse today, he said.

This is probably one answer to what Treasury Secretary Henry Paulson Jr. recently called "the $64,000 question" -- why the public seems to feel more anxious about the economy than the unemployment rate and other indicators would seem to warrant. For example, in an ABC News/Washington Postpollin September, 4 percent of respondents rated the economy "excellent" and 33 percent rated it "good," versus 63 percent who rated it "not good" or "poor."

When discussing how living standards have fared over the past few years, the Bush White House tends to emphasize two things -- measurements of averages (rather than medians) and compensation (rather than wages). There are reasons for its preferences.

Lazear has a stump speechhe's given in different forms over the past few months, in which he argues that average compensation for workers has grown during the Bush presidency and grown strongly in the past year, even when accounting for inflation. Jared Bernstein of the Economic Policy Institute says that Lazear's argument is misleading because much of that increase comes from nonwage boosts for the rising cost of health care insurance that rarely extends or improves coverage. Average wages for nonsupervisory workers -- representing the bulk of the workforce -- have actually fallen, when accounting for inflation, by about 2 percent from November 2003 to August 2006. Bernstein says that take-home pay, rather than compensation, is how average workers judge their earnings. "For most of them, wages have been flat or stagnant for 26 of the last 28 months," he says.

But the larger flaw, Bernstein says, is that the White House prefers to look at average figures, rather than medians. The median is the theoretical middle -- 50 percent of wage earners made more, and 50 percent made less. Even when average wages rise, the median can drop if the number of people who earned less has increased -- in other words, if income has grown unequally.

Higher average wages reflect the sharp increases that have occurred for highly educated, highly skilled workers, such as computer programmers and emergency-room nurses. When thinking about the average voter, this is a distinction that seems worth making -- even with the greater turnout among higher-income people, most voters aren't computer programmers or ER nurses. For example, in the two years from 2004 through 2005, the lowest-earning one-fifth of American households saw their average income increase by only 0.6 percent after inflation. The middle fifth saw a 0.9 percent increase. But the upper 5 percent of workers saw a 3.1 percent increase. Bernstein notes that in 2005, households in the upper fifth of the income scale earned 50.4 percent of all income, the highest proportion since records started in 1967. Especially now, Bernstein says, using "average numbers hides the fact that a very small number are doing very, very well, and most are not."

In fact, median household income, after adjusting for inflation, has dropped 2.7 percent since 2000. This information was included in a census survey[PDF] in August that at first blush seemed like a big boost for the administration. That report found that for the first year since 1999 median household income after inflation had risen in 2005, by 1.1 percent.

But Bernstein says the numbers were not so good for working-age Americans. It turns out that all of the gains went to households headed by someone age 65 or older. Income for this group surged by 2.8 percent. Bernstein speculates that most of these gains came from nonlabor income, such as Social Security, which is indexed to inflation, as well as from stocks and home sales. Meanwhile, the median income for households headed by someone under 65 fell 0.5 percent. Since 2000, he says, working-age households saw their median income drop 5.4 percent after inflation, twice as much as the 2.7 percent decline for all households. (As Bush political adviser Karl Rove may have noticed when pushing for a new prescription drug benefit, rewarding those over age 65 pays a political dividend -- they turn out to vote at a rate of 69 percent, versus 56 percent for others.)

The Productivity Miracle
In an interview, Lazear conceded that median wage growth had lagged behind inflation since the 2001 recession but argued that a recovery in income growth is imminent, based on another statistic that he often cites approvingly -- the increase in productivity since Bush took office. When workers are more productive, they boost profits and allow pay increases above the rate of inflation. And the pickup in productivity that workers made in the latter 1990s is one of the few economic trends that has continued in the Bush years. While the average long-term growth rate in productivity is about 2 percent a year, productivity rose 2.5 percent in 2001; 4.1 percent in 2002; 3.7 percent in 2003; 3 percent in 2004; and 2.3 percent in 2005. So far this year, productivity growth is running at an annual rate of 6 percent, Lazear said. He displayed a chart showing a close relationship between productivity and average income after inflation. Since 1950, the two have tracked each other closely. Another chart showed that wages have indeed lagged behind productivity growth since 2000, but he pointed out that similar lags, lasting four or five years, occurred after other recessions. "What's happening, we think, is that following a recession, there is slack that is being taken up in the labor market, and once that happens, the gains in productivity get passed on to workers. I would suspect that most Americans have not seen the benefit of the productivity growth in large part because of the point that we are at in the business cycle," Lazear said. "Bear with us."

But some new research casts doubt on his projection. First, an observation about Lazear's chart purporting that wages lag behind productivity after recessions: Actually, it shows that real wages (those adjusted for inflation) began to lag in 1998, during one of the strongest labor markets of the post-World War II period. For most of that time, wages and productivity were moving in opposite directions. Likewise, real hourly wages were dropping during the best years of the 1980s boom, when the gap between real wages and productivity growth was historically high.

Robert Gordon, an economist at Northwestern University, questions whether productivity growth is really the source of income growth for most workers. While average income growth seems to have paralleled productivity over the past 40 years, Gordon finds that from 1966 to 2001, only earners in the top 10 percent of the income-distribution scale enjoyed income gains (after inflation) that were equal to or above the productivity growth rate. For the remaining 90 percent of workers, wage growth was less than productivity growth. For the highest-income workers with the most skills, higher wages did indeed seem to be connected to productivity growth. But for most workers, what showed up in their paychecks seemed to have nothing to do with productivity. If Lazear is right, then the extended period of wage lag that began in the latter 1990s and is continuing today is about to end, and workers will finally see wages increase faster than inflation. If Gordon is right, then most workers will continue to suffer from wages that lag behind inflation and the growth rate in productivity.

Kevin Hassett of the American Enterprise Institute says that inflation-adjusted income is actually a misleading way to judge popular attitudes about the economy, since consumers can quickly adjust to higher prices for some things that might briefly lower their living standards -- trading in their Hummer for a Prius, for example. Instead, he argues that consumption is the best guide to public sentiment about the economy, since it reflects how consumers feel about their present situation going forward. And the numbers show that since 2000, a time when income has only inched upward, consumption has risen 17.5 percent. For the middle 20 percent of income earners, the group that saw real income drop, consumption increased 7.5 percent after inflation. With falling income, much of this consumption has been financed with debt, a development that alarms some other economists but not Hassett. He sees this borrowing as another sign that consumers are confident about the future, and expects that this will be evident at the ballot box in November.

Jacob Hacker, among other economists allied with Democrats, doesn't think this borrowing is so benign. Americans have taken on record levelsof debt, and the proportion of income that Americans use to service their debt hit a new record in the first quarter of 2006. Hacker said that crushing debt is one of the financial risks that are making many Americans pessimistic about the economy.

Democrats hope that this fall Americans will look beyond the low unemployment rate and the solid growth numbers to vote based on the disappointing lack of growth in their paychecks, as the prices for energy, health care, and most other things take a bigger bite than before. Lazear says he suspects that most voters will be heavily influenced by the recent drop in energy prices, which is effectively putting more money into their pockets every week. He also hailed the solid numbers on consumer spending. "So far, people are acting like they feel good about the economy."

Copyright 2012 by National Journal Group Inc.

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