The Layman’s Guide to Understanding Income Inequality in America

Income inequality is one of the biggest issues facing America today. Since the notion of fairness is subjective and debatable, this article will address the practical implications of an economy with gross income inequality and will show why moving towards an economy with a more equitable distribution of income and wealth is not only pragmatic, but necessary.

How do we know we have income inequality?
In the United States over the last 30 years, the gap between the rich and the poor (and the rich and everyone else) has grown dramatically. The share of total income taken home by the top 1% of Americans has gone from 8.9%, in the 1970’s, to 22%, by 2015. The share of total income taken home by the top 100th of 1% of Americans has gone from 0.8%, in the 1970’s, to 5.1% by 2015. Meanwhile, CEO to average worker pay, which in the 1950’s was 20-1, has ballooned to be anywhere from 325-1 to 525-1 (depending on the year).

It is undeniable that the top 1% of Americans are taking home a bigger and bigger piece of the income pie, which leads us to the very important question:

Why is income inequality bad?
Income inequality is bad for the economy. When too much income and wealth rests at the top of the income ladder the economy slows down. Contrary to Republican talking points, economic growth is not created by this idea of “job creators”. Economic growth is created by consumers who demand goods and services. American consumers account for 70% of economic activity. When you shrink the percentage of income going to consumer base, such as we see today, you shrink the demand for goods and services. Less demand for goods and services means less people are needed to deliver those goods and services. Which inevitably means less jobs. “Job creators” don’t create jobs out of thin air. Jobs are created as a result of market demands.

Since the end of 2009, the end of the ‘Great Recession’ and the beginning of the ‘Not-so Great Recovery’, over 95% of the economic gains have gone to the top 1% of the income ladder. With virtually no new economic gains going to the poor, lower and middle classes, the consumers of our economy do not have the purchasing power to drive demand and economic growth.

There are two years in the last 100 when the top 1% took home at least 23.5% of total income. Those 2 years were 1928 and 2007, the years before the ‘Great Depression’ and the ‘Great Recession’. It is not a coincidence that the 2 years of peak inequality are followed by tremendous economic crashes. An economy cannot sustain such gross inequality. So even if we have a disagreement on what a fair distribution of income should be, there is only so much inequality an economy can handle before it collapses. When the top 1% take home such a disproportionate share of income, the lower classes end up racking up big debts, which in turn create huge asset bubbles, which eventually go bust and take down the whole economy.

A more equitable distribution of income and wealth will drive faster economic growth. From the period of the 1950’s through the 1970’s, when the income and wealth distribution was at its most equitable level and the top income tax rate was 70%, the economy grew at its fastest rate in the last hundred years (in terms of Real GDP Growth Rate). In the decades that followed, when economic policy was decidedly low tax, deregulation and increasing levels of inequality, the economy experienced slower growth.

Another consequence of gross income inequality we see today is the anger and divisiveness in our society. There is a direct correlation between income inequality and political polarization in America and it makes sense.

People are working harder than ever before, for less. They are not getting ahead. They are insecure economically and anxious. They see people at the top doing better and better. They see Wall Street getting bailed out while others are being foreclosed on and getting kicked out their houses. They haven’t had a pay increase in years and they see CEO’s taking home enormous pay checks that get bigger every year. People are angry and they are looking for someone to blame. They blame democrats, they blame republicans, they blame the poor, they blame immigrants, they blame minorities and they blame foreign countries. An unequal society is not a safe society.

Lastly, a democracy cannot be sustained with gross income inequality. When too much wealth and income rests at the top of the income ladder, that money will flow into the political system and buy influence. You can call that flow of money whatever you want, political contributions, Super PACs, campaign financing, but what it really is, what it always has been and what it will continue to be forever is corruption. When one class of society is using great amounts of money to influence political decisions and those decisions influence market outcomes, those market outcomes will favor those with lots of money and political power. This flow of money, this corruption, undermines and devalues our democracy. As a result people lose faith in the process and you see that happening today.

How does income inequality come about? How do we fix it?
The distribution of income and wealth in our society is a function of the laws that govern our economy. There is a common fallacy that a free market cannot operate efficiently when government interferes. However, a market only exists when we, through government, set the rules that create the market and the market outcomes (income distribution). There is no such thing as a truly free market.

For example: 
  • How does a free market decide what constitutes property? Are people property? They used to be. Can land be property? The native Americans didn’t think so. 
  • What constitutes a binding contract? Verbal, written?  
  • How do we protect and incentivize inventors and entrepreneurs without laws governing patents, copyrights, intellectual property and trademarks? 
  • Without government, what are the rules of bankruptcies? Who gets paid first in bankruptcies?

You cannot separate government from markets. There is no such thing. Markets exist, because of government and the rules are set to achieve specific end goals. In the United States, the rules have been set, whether intentionally or not, so that a greater share of the wealth is distributed to the top 1% of the population. We can change the rules to determine a different market outcome.

So what are the factors that have led to Inequality? In no particular order: 
  • Trade agreements that allow companies to produce their goods in foreign factories that permit slave labor wages, dangerous work conditions, no benefits, lax labor laws and lax environmental laws.  
  • Technological innovations that eliminated jobs through automation. 
  • Minimum wage laws that have not increased with inflation. 
  • Tax policies that give preferential treatment to investment income over wage income. 
  • Deregulation and loose labor laws. Laws, such as right to work legislation, which successfully seek to damage the bargaining power and existence of labor unions. 
  • Government policies that bail out big banks, but not homeowners facing foreclosure.  
  • Skyrocketing healthcare and college education costs. 
  • Bankruptcy laws that allow businessmen to renegotiate debts after making bad bets, but don’t allow individuals to renegotiate student loan debts.

All of these issues can be addressed one by one, but not until we are able to get big money out of politics. We need campaign finance reform and public funding for major general elections.  

Once the people have control over the government again, we can use government to create the economy that we want. One that operates efficiently, but also creates a moral and fair society.

There is hope and we have seen it in our past, specifically during the progressive era and the era of FDR. We need to make the system work for everybody. Income inequality is a moral issue, but it is also a practical issue.   


** Footnote: this article is largely influenced by the work and writings of Robert Reich, Professor of Public Policy at Berkeley and former Secretary of Labor under President Bill Clinton. Professor Reich is the expert on Inequality in America.  If you are interested in learning more about this topic, I suggest reading Robert Reich’s “Saving Capitalism”, “Beyond Outrage” and “Supercapitalism” **

Comments

  1. Typo:

    It is undeniable (instead of "undeniably") that the top 1% of Americans...

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  2. "Income inequality." Vague term, reeks of Communism. What is defined as an acceptable level of income equality and how do you propose it be reached? Are you measuring income equality only in a vague, broad sense or are you measuring it at worker-level?

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