ECONOMICS + CULTURE AND SOCIETY
LAURA TYSON
Laura Tyson, a former chair of the US President's Council of Economic Advisers, is a professor at the Haas School of Business at the University of California, Berkeley, a senior adviser at the Rock Creek Group, and a member of the World Economic Forum Global Agenda Council on Gender Parity. READ MORE
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NOV 30, 2014
The Rising Costs of US Income Inequality
BERKELEY
– During the last several decades, income inequality in the United
States has increased significantly – and the trend shows no sign of
reversing. The last time inequality was as high as it is now was just
before the Great Depression. Such a high level of inequality is not only
incompatible with widely held norms of social justice and equality of
opportunity; it poses a serious threat to America’s economy and
democracy.
Underlying
the country’s soaring inequality is income stagnation for the majority
of Americans. With an expanding share of the gains from economic growth
flowing to a tiny fraction of high-income US households, average family
income for the bottom 90% has been flat since 1980. According to a recent report
by the Council of Economic Advisers, if the share of income going to
the bottom 90% was the same in 2013 as it was in 1973, median annual
household income (adjusted for family size) would be 18%, or about
$9,000, higher than it is now.
The disposable
(after tax and transfer) incomes of poor families in the US have trailed
those of their counterparts in other developed countries for decades.
Now the US middle class is also falling behind.
During
the last three decades, middle-income households in most developed
countries enjoyed larger increases in disposable income than comparable
US households. This year, the US lost the distinction of having the
“most affluent” middle class to Canada, with several European countries
not far behind. Once the generous public benefits in education, health
care, and retirement are added to estimates of disposable family income
in these countries, the relative position of the US middle class slips even further.
The
main culprit behind the languishing fortunes of America’s middle class
is slow wage growth. After peaking in the early 1970s, real
(inflation-adjusted) median earnings of full-time workers aged 25-64
stagnated, partly owing to a slowdown in productivity growth and partly
because of a yawning gap between productivity and wage growth.
Since
1980, average real hourly compensation has increased at an annual rate
of 1%, or half the rate of productivity growth. Wage gains have also
become considerably more unequal, with the biggest increases claimed by
the top 10% of earners.
Moreover,
technological change and globalization have reduced the share of
middle-skill jobs in overall employment, while the share of lower-skill
jobs has increased. These trends, along with a falling labor-force
participation rate during the last decade, explain the stagnation of
middle-class incomes.
For
most Americans, wages are the primary source of disposable income,
which in turn drives personal consumption spending – by far the largest
component of aggregate demand. Over the past several decades, as growth
in disposable income slowed, middle- and lower-income households turned
to debt to sustain consumption.
The
moment of reckoning arrived with the 2007-2008 financial crisis. Since
then, aggregate consumption growth has been lackluster, as middle- and
lower-income families have been forced to reduce their borrowing and pay
down their debt, often through painful defaults on their homes – their
primary (and often their only) asset.
As
these families have tightened their belts, the pace of consumption
spending and economic growth has become more dependent on earners at the
top of the income distribution. Since the recession ended in 2009, real
consumption spending by the top 5% has increased by 17%, compared to
just 1% for the bottom 95%.
The recovery’s pattern has reinforced longer-run trends.
In 2012, the top 5% of earners accounted for 38% of
personal-consumption expenditure, compared to 27% in 1995. During that
period, the consumption share for the bottom 80% of earners dropped from
47% to 39%.
Looking
to the future, growing income inequality and stagnant incomes for the
majority of Americans mean weaker aggregate demand and slower growth.
Even more important, income inequality constrains economic growth on the
supply side through its adverse effects on educational opportunity and
human-capital development.
Children
born into low- and high-income families are born with similar
abilities. But they have very different educational opportunities, with
children in low-income families less likely to have access to early
childhood education, more likely to attend under-resourced schools that
deliver inferior K-12 education, and less likely to attend or complete
college.
The
resulting educational-attainment gap between children born into low and
high-income families emerges at an early age and grows over time. By
some estimates, the gap today is twice as large as it was two decades ago.
So the US is caught in a vicious circle: rising income inequality
breeds more inequality in educational opportunity, which generates
greater inequality in educational attainment. That, in turn, translates
into a waste of human talent, a less educated workforce, slower economic
growth, and even greater income inequality.
Although
the economic costs of income inequality are substantial, the political
costs may prove to be the most damaging and dangerous. The rich have
both the incentives and the ability to promote policies that maintain or enhance their position.
Given
the US Supreme Court’s evisceration of campaign-finance restrictions,
it has become easier than ever for concentrated economic power to
exercise concentrated political power. Though campaign contributions do
not guarantee victory, they give the economic elite greater access
to legislators, regulators, and other public officials, enabling them
to shape the political debate in favor of their interests.
As
a result, the US political system is increasingly dominated by money.
This is a clear sign that income inequality in the US has risen to
levels that threaten not only the economy’s growth, but also the health
of its democracy.
