December 9, 2016

The Cost of Ignoring Economic Inequality

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Concerns about income and wealth inequality drove some voters to cast their ballots as they did in the 2016 general election. But economic disparity is not a new phenomenon. We spoke to Jennifer Pate, associate professor and chair of the Department of Economics in the Bellarmine College of Liberal Arts about the distribution of wealth and income in the United States. She was interviewed via email by Editor Joseph Wakelee-Lynch.

The New York Times reported in early December that in the past three and a half decades, the U.S. economy has doubled in size, yet the share of income collected by the bottom 50 percent of Americans has shrunk from 20 percent in 1980 to 12.5 percent in 2014. Is this what is meant by the hollowing out of the middle class?
Absolutely. Think of the total income generated by the U.S. economy as a big cherry pie. Now divide that pie into 5 pieces (quintiles). If you give each quintile the same amount of pie, they would all have 1/5 of the pie and thus 20 percent of total income. However, what we have in the United States is one really big piece (the wealthiest 20 percent of the population) that collected just over half of the pie in 2015. The next wealthiest group (60th-80th percentile) took a quarter-sized piece. The three lowest quintiles earned progressively less, with the poorest 20 percent earning around 3 percent of total income produced by our economy.

Income inequality is also self-perpetuating. If it takes money to make money, then it becomes more challenging for those in the lower tiers to become wealthy. As a result, since the 1970s, growth in real incomes has also gone to the highest tiers. Using information from tax returns and the Current Population Survey, the Congressional Budget Office reported that gains in income were heavily concentrated among the wealthiest 1 percent, with smaller and smaller income gains as you move down the ladder. The rich are getting richer, no question.

Interestingly enough, this means that income inequality among those in the top 20 percent of the population is also increasing; using the same pie example, that one big piece (the one taking up half the pie) has its own disproportionate distribution of income within its group. In 2015, the top 1 percent of income earners in the Unites States collected around 22 percent of the total pie. The top 0.01 percent collected around 5% of the pie. This tells us that the rich are getting richer, even among the richest.

If wealth is being transferred to the wealthiest to such a degree, why isn’t there a groundswell of support for addressing this problem?
That is always the follow-up question! The answer here is less clear. It seems like there is broader knowledge of the issue than in previous years, and there has certainly been more discussion about it, primarily as a function of the 2016 presidential campaign. I believe there’s enough support for addressing the problem — it’s the “how” question that stumps everyone.

Studies have shown that people believe there is less income inequality than actually exists. Why is that?
Funny enough, with the wealthiest top 20 percent spreading further away from the rest of the population, there is actually less income inequality among the lowest 80 percent than previously, which means there is a smaller gap between the “middle” and those in the lowest quintile.

However, I don’t believe this is why people believe there is less inequality. It appears that people do not recognize how bad the problem truly is. In a 2011 survey of 5,000 Americans, the average estimate for the wealth owned by the top 20 percent of the population was 59 percent, while the true figure is more than 84 percent. People simply do not realize how far out of alignment the distribution of income, and hence economic wealth, has become.

Why is a declining middle class a threat to national economic health?
The U.S. economy thrives on spending, with household consumption generating around 70 jpercent of Gross Domestic Product (GDP). If we continue to return less income to the vast majority of the population (with the exception of a small, wealthy few) then people will have less money to spend, so they will spend less, which could have a catastrophic effect on our GDP and total income generated by the economy in future years (meaning, the pie could get smaller). It could also be the case that more people will give up trying altogether, similar to the discouraged worker who stops seeking employment, which will in turn reduce economic growth. There are many other social issues that could have a negative effect on the U.S. economy (such as destruction from rioting and increased crime rates as a function of civil unrest).

Are there measures that can address the problem?
Yes. Basically, imagine any solution that would result in the economic pie being more evenly shared: a (truly) progressive tax system, higher estate taxes, higher minimum wages, etc., etc. All of those would work. Now, some steps might seem more fair than others, and almost every idea will harm certain people and benefit others. But any policy that results in a more equitable distribution of income would address the problem.

Why do legislative responses fail?
The answer to this question lies partially in the perception of the problem — if most Americans don’t fully understand the extent of income inequality in the U.S., then they won’t be as motivated to work towards finding a solution.

Second, and probably most important, Americans believe that hard work can get you to the top (economists call this upward social economic mobility). Yet, the data show time and again that the rags-to-riches story sold as the American dream does not exist. A child born to parents in the wealthiest 20 percent of the population is more likely to get a better education, have more extensive networks to find employment and be more likely to inherit wealth. Children born to parents in the bottom 20 percent statistically are most likely to end up as adults in the bottom 20 percent (with a small percentage moving up to the next-highest tier).

How can this contribute to legislative failures? Well, imagine that you are voting on a proposal to create an estate tax on people with more than $3,000,000 in assets. You don’t have $3 million now, but you think to yourself to that could possibly have $3 million by the time you die, and you wouldn’t want to pay tax on it, so you vote no. Even though it’s a long shot (and more statistically unlikely than you know), you don’t want to create a system that will penalize you, once you get to the top. Actions like these create cycles of self-defeating actions based on unrealistic perceptions of upward mobility, which stalls legislative action.

Can’t the system right itself without government intervention?
No, with the single exception of significantly large, annual voluntary transfers from the wealthy to the poor. Now that would be the American dream!

How do the notions of the “self-made man” and America as a meritocracy play into the lack of effective action on the decline of the middle class?
Americans, in particular, have been led to believe that we receive what we earn from our own hard work (meaning, we get what we deserve). If we receive less, it’s because we earned less and thus deserve less, but that is simply not the case. Productivity in the United States has increased more than 250 percent, while hourly compensation has remained stagnant since the 1970s. The U.S. economy continues to grow, and yet the portion of income earned by those outside of the top 20 percent continues to shrink. This theory does not hold up, but it does make Americans more tolerant of income inequality than we ought to be.

As a professional economist, what do you think it will to take to reverse or slow the advance of income inequality in the United States?
First, we need to agree that income inequality is a problem that requires a solution. This means educating Americans about the lack of upward economic mobility and its harmful effect on everyone outside of the top 20 percent (which, by the way, will soon shrink to become the top 10 percent as the inequality among the highest quintile continues to rise). Next, we — economists, that is — need to find a better way to communicate the positive impacts of a more equitable distribution of income. If we are going to ask wealthy people to part with their money, we should at the very least make a good case for why this benefits the nation as a whole.

Finally, we would be best off proposing a variety of smaller compromise-based solutions in order to distribute the costs across those of differing income levels and kinds of wealth. This approach helps to minimize the resistance that any given policy proposal is likely to face. Some steps are: a minimum tax rate on individuals making more than $1 million annually (which would affect less than 0.3 percent of taxpayers), decrease the size of the Federal estate tax exemption (currently set at $5.5 million in 2016), small increases in property taxes on non-primary residences, etc.

We also need to find a way to motivate companies to pay their workers more, either in wages and salaries, in non-monetary compensation (like medical care), or both. Historically, unions or other employee collective-bargaining organizations were the primary motivating force for change, but with union membership at an all-time low since the early 1930s, other avenues will have to be explored. Examples include regular increases to minimum wage, employment regulations that dictate standards for overtime pay, sick, vacation, and family leave, and other employee-support services.

Basically, for incomes to be distributed more equitably, we need those with the highest incomes to receive a little less, those with middle or low incomes to be paid a little more, and to find a way to strike a healthy balance where hard work is rewarded, but not to the detriment of those who are worse off at the start.