Why income inequality matters
Liam O'Connor | Friday, February 5, 2016
When Alexis de Tocqueville visited America almost 200 years ago, he was struck by Americans’ simultaneous loves of equality and liberty, of fairness and freedom. How do we overcome these apparent contradictions? In economics, we believe in equality of opportunity — not outcome. If you work hard, you can succeed and provide a better life for your children — regardless of who you are, what you have or where you come from. That’s our American Dream.
One American’s economic gains over time do not necessitate another’s losses. Imagine the American economy is a pie cut into three unequal slices — for the “top 20” percent of income-earning households, the “middle 60,” and the “bottom 20.” In 1979, the bottom slice was 6.2 percent of the pie, the middle was 49.0 percent, and the top was 44.9 percent. But by 2011, the bottom had shrunk to 5.3 percent and the middle to 44.1 percent, while the top had grown to 51.3 percent — larger than the other two slices combined.
But none of the slices shrunk, because the entire pie grew. Since the total income of our economy increased at a faster rate than our inequality, each group actually experienced an increase in income. The average before-tax income of the bottom increased 40.0 percent to $24,600, while the top’s swelled 78.4 percent to $245,700. Furthermore, our progressive taxes and transfer payments made incomes slightly less unequal. The top quintile paid two-thirds (68.7 percent) of our federal income taxes, and while the top one percent took home 14.6 percent of our nation’s income, they also paid almost a quarter (24.0 percent) of our federal income taxes.
Income inequality isn’t inherently wrong; nor is it necessarily bad for our economy. In fact, economic theory tells us the potential of large financial rewards encourages risky entrepreneurship and innovation. So, should we care about income inequality in the United States? Well, yeah.
To begin, extreme income inequality may stunt economic growth. A recent International Monetary Fund (IMF) report had two important findings: First, lower net income inequality (after taxes and transfer payments) is “robustly correlated with faster and more durable growth, for a given level of redistribution”; second, “only in extreme cases is there some evidence that [redistribution] may have direct negative effects on growth.” Likewise, the Organization for Economic Co-operation and Development (OECD) recently found a “negative and statistically significant” correlation between income inequality and economic growth in a long-term study of its member countries.
Why? When low incomes serve as barriers to education and health for a large portion of the population, there is a loss of human capital. As a whole, the economy is less skilled and less productive. In addition, the wealthiest members of society — those who receive the majority of its income — have a lower marginal propensity to consume; they’re likely to spend less of their earnings in the economy. I will be the first to admit I do not have the economic knowledge or intelligence to prescribe an ideal level of income inequality. (Some economists refer to the post-WWII period, when “incomes grew rapidly and at roughly the same rate up and down the income ladder.”) But if the slices of our pie were a little less unequal, maybe our entire pie could grow faster and larger.
Second: 46, 269,000. That’s roughly equal to the populations of California and New York City combined. It’s also the number of Americans living in poverty — 14.8 percent of our total population, one of every five children (21.5 percent), and one out of every four blacks (25.2 percent) and Hispanics (24.7 percent). These households and individuals living below the poverty thresholds ($24,008 for a family of four, $12,071 for an individual) struggle to secure life’s most basic necessities — housing, food and healthcare — and, therefore, a decent standard of living.
Fortunately, extensive data suggests our safety net is working. In 2014, the raw poverty rate before government assistance was 27.3 percent, but our safety net effectively lifted 38 million people out of poverty to cut that rate nearly in half to 15.3 percent (according to the Supplemental Poverty Measure). Our safety net helps those who need it the most: Nine of every 10 recipients of government assistance are either elderly, have serious disabilities or are members of a working family struggling to make ends meet.
Third, income inequality is connected with inequality of opportunity. While there is no objective measure of “opportunity,” social mobility — the degree to which households and individuals move up and down the socio-economic ladder — is one indicator of economic outcome. To this end, the Great Gatsby curve demonstrates there is an inverse relationship between the concentration of wealth in one generation and social mobility in the next.
Why? Consider the correlation between one’s income and one’s access to quality education and healthcare. Only three of out of every four “economically disadvantaged” students (74.6 percent) graduate from high school, and a child’s family income almost perfectly predicts his or her chances of going to college. Income level is also correlated with health insurance coverage and life expectancy. One in six people in households with incomes of 25,000 or less (16.6 percent) are uninsured, compared to just one in 19 people in households with $100,000 or more (5.3 percent). As the Affordable Care Act took full effect in 2014, 11 million Americans gained health coverage, but 55 million others — 10.4 percent of our population — remain uninsured.
According to President Barrack Obama, “A child’s course in life should be determined not by the zip code she’s born in, but by the strength of her work ethic and the scope of her dreams.” Along these lines, Harvard’s Equality of Opportunity Project has found intergenerational economic mobility to be strongly correlated with racial segregation, income inequality, local school quality, social capital and family structure within American communities. In short, “The U.S. is better described as a collection of societies, some of which are ‘lands of opportunity’ with high rates of mobility across generations, and others in which few children escape poverty.”
Fourth, the connection between income and political influence threatens the fairness and legitimacy of our democracy. Income accurately predicts your likelihood to vote and contribute to political campaigns. As one might expect, barriers to voting, such as voter ID laws and felon disenfranchisement (which strips the voting rights of 5.85 million Americans), disproportionately affect low-income individuals. The income gap at the polls is important, because inequality of turnout is negatively related to wealth redistribution. In terms of campaign contributions, in the 2014 midterms, the top one percent of one percent (0.01 percent) contributed over one billion dollars to campaigns at the federal level — 28.6 percent of the total. Unsurprisingly, affluence leads to influence, and income inequality exacerbates political polarization.
Yes, income is a measure of economic utility. But I fear we, in America, have a tendency to conflate economic utility with social utility. Surely, an enlisted soldier in Iraq, a social worker in South Bend, a volunteer firefighter and a stay-at-home parent make significant social contributions that are not reflected by their income. And I fear we, in America — where a full time employee earns just $15,080 a year at the federal minimum wage — have a tendency to conflate economic utility with the value of a human life.
In an attempt to negate our biases due to our personal circumstances, we may borrow from John Rawls’s veil of ignorance. Imagine you are a child in the womb who is to be born tomorrow, somewhere in United States. But imagine you have no idea of your future sex, race, household income, zip code, sexual orientation, family structure or condition of health. Rawls thinks you would want a society with universal, equal basic rights and liberties and fair equality of educational and employment opportunities. And perhaps, you would even want a decent minimum standard of living that would allow all “to pursue their interests and to maintain their self-respect as free and equal persons.”
Views on poverty and income inequality diverge along party lines. Most Democrats believe poverty is primarily due to circumstances beyond one’s control, while most Republicans believe individual laziness is to blame. But only a quarter of Republicans (26 percent) believe the gap between the rich and the poor is “not a problem.” Two out of every three Americans (65 percent) believe it is “a problem that needs to be addressed now,” and the majority (57 percent) believe “the government should do more” to reduce this gap.
Saying income inequality is not a problem detracts attention from some of the most important economic, social, political and moral issues we face. We should focus on our extreme income inequality, if only because it will shed light on these issues — issues that are of such great size and importance they cannot be solved without bipartisan cooperation and public and private efforts at every level of society. Hopefully, this viewpoint has demonstrated that — if we believe in broadly shared economic growth, if we believe in a decent standard of living for all Americans, if we believe in equality of opportunity and if we believe in equal political representation — our income inequality matters.