Is Income Inequality a Bad Thing?

A friend of mine asked me this question a couple of weeks ago. While it seems to me obvious that a country in which the rich continue to increase their share of the wealth, is in a bad place, demonstrating that this is true is not so straightforward. First a quick recap of my last post –the United States has the most unequal income distribution of all advanced countries, and that inequality has been increasing for thirty years. At the same time, the income of the poorest 20% (or quintile) has been increasing, and poverty rates have declined. Progressive tax policy has somewhat mitigated this income inequality and provided important income support to people at the bottom.  

However, the central fact is that the percentage of the population in the middle class has contracted from 62% in 1971 to 52% in 2016, while at the same time, the share of the population in both the upper and lowest income classes has increased (see figure below).

The most striking aspect of the unequal distribution of income (and wealth, which is even more unequal than income), has been the relative stagnation of the income of the middle class, while the incomes of the top 1%, and particularly the top one-thousandth of the distribution has grown by leaps and bounds. So the very rich are getting richer while the middle class is stuck and the poor are seeing their incomes rise slightly. These are the main takeaways of an economy with increasing income inequality. Why is this a bad thing?

I want to look at this question from three perspectives: the economic, the political and the social. Let’s start with the economic side.  

Increasing Inequality results in slower economic growth. If a country’s economic inequality is increasing, then the wealthier portions of the population get a greater share of income than they would if inequality stayed the same. If those wealthier segments invest less or less efficiently than the poorer segments, growth is slowed.

There are many studies of this question, and the results are somewhat ambiguous. The most comprehensive study, authored by Frederico Cingano for the Organization for Cooperation and Economic Development (OECD), found that for a set of countries, including the United States, the United Kingdom, Sweden, Finland and Norway, economic growth rates would have been 20% higher (from 1990 to 2010) if income inequality had not worsened.  For the United States the loss in growth means that US GDP in 2010 was 90% of what it would have been had income distribution not worsened.  That comes out to $5,386 per person (in 2010$). This is a big deal.

Increasing Inequality results in distribution of political power toward the wealthy.  The evidence for this is somewhat sketchy.  According to the Sunlight Foundation, in the 2014 elections, “31,976 donors — equal to roughly one percent of one percent of the total population of the United States — accounted for $1.18 billion in disclosed political contributions at the federal level. Those big givers — what we [the Sunlight Foundation] have termed the Political One Percent of the One Percent — have a massively outsized impact on federal campaigns…those 31,976 top donors combined accounted for more than one out of every four dollars raised by PACs, super PACs, parties and candidates.” What do these donors get for their money?  They get policies that reflect their preferences.

Marten Gillens, in an essay drawn from his research, examines the likelihood of any given policy being enacted. He argues that about in about 50% of the cases, the preferences of the rich (top 10%) and the rest coincide.  However, when these preferences diverge, the policies enacted favor the affluent. “Policies favored by 20 percent of affluent Americans have about a one-in-five chance of being adopted, while policies favored by 80 percent of affluent Americans are adopted about half the time. In contrast, the support or opposition of the poor or the middle class has no impact on a policy’s prospects of being adopted.”  He writes, “Greater representational equality would have a substantial effect on several important economic policies. We would have a higher minimum wage, more generous unemployment benefits, stricter corporate regulation (on the oil and gas industries in particular), and a more progressive tax regime.”

Increasing economic inequality damages our hope to be part of the American dream.  Adam Barone writes “The American Dream is the belief that anyone, regardless of where they were born or what class they were born into, can attain their own version of success in a society where upward mobility is possible for everyone.”  But the slowing rate of economic growth coupled with the stagnation of income growth at the bottom has made the American Dream increasingly unattainable.  A Brookings Institute study found that the proportion of children earning more than their parents declined from about 90% of those born in 1940 to 50% of those born in 1984 (see chart below). Moreover, they aver that increasing growth rates alone “Cannot restore absolute mobility to the rates experienced by children born in the 1940s. In contrast, changing the distribution of growth across income groups to the more equal distribution experienced by the 1940 birth cohort would reverse more than 70% of the decline in mobility.

While there is more to the American Dream than living better than one’s parents, that “dream” is a central part of our history and our promise, and the fact that it is no longer true cannot but help to erode Americans’ confidence in our institutions and politics.

Increasing income inequality slows growth, distorts the political process in the favor of the top 10%, and undermines one of the fundamental promises that America offers its citizens — upward mobility,