With Income Gap at 80-Year High, Solutions Remain Elusive

Created: July 08, 2010 06:00 | Last updated: July 31, 2020 00:00

A new report shows that the income gap between rich and poor in America is at an eight-decade high — the largest differential since the period immediately preceding the Great Depression. And economists fear that the education and job-creation programs that could bridge this gap are lacking in the recessionary economy.

[Economy1] On June 25, the Center on Budget and Policy Priorities released a report on the growing income gap in the United States. While the data it studies are not new — the income stats end at 2007, just before the advent of the current recession — the report synthesizes both census and Internal Revenue Service information to paint a more complete picture of the finances of the various strata of American society.

“It’s given us the first clear, comprehensive picture of income distribution over the economic cycle that ended in 2007,” said Arloc Sherman, senior researcher at the CBPP. “Now we know definitively that income inequality grew in that cycle. Just before the recession hit, we know that inequality was heading into record-breaking territory.”

In 2007, 17.1 percent of all after-tax income in the country went to the top one percent of earners. According to Emmanuel Saez, an economist at the University of California, Berkeley, who used a slightly different methodology in calculating his figures, the proportion of the country’s income going to the top one percent is at its highest since 1928.

The CBO data studied by the CBPP show that in just under three decades, the after-tax income for the top one percent rose by 281 percent. By contrast, incomes for the middle quintile of income distribution rose a much more modest 25 percent over the same time period, while incomes for the bottom fifth increased by only 16 percent. If Americans in the middle fifth of the income distribution curve had seen their incomes rise at the same rate as those of the top one percent, that would equal an extra $13,000 in annual income for middle-class households, says Sherman.

A variety of factors, some stretching back a generation or more, have played a role in cultivating this inequality. Throughout the generation following World War II, incomes rose in a more evenly distributed manner, and a broad middle class was established. This trend reversed itself in the 1970s, when the income gains of the rich started outpacing those of the rest of the country.

Economists say there were several factors at play, some of which might have been unavoidable. The growth of technology rendered low-skill manufacturing jobs redundant. Globalization accelerated this decline as companies moved their production facilities offshore to take advantage of lower labor costs. The shift from a manufacturing to a service economy weakened the collective bargaining power of unions, a key force in establishing the wages on which America’s mid-century middle class was built.

“Union contracts helped bolster wages across the distribution, and the manufacturing sector was historically a highly unionized sector,” said Heidi Shierholz, an economist at the Economic Policy Institute, a think tank. Declining union membership since the 1950s has eroded manufacturing wages.

Industrial and corporate deregulation added fuel to the fire. Executive compensation swelled even as the minimum wage failed to keep pace with the rising cost of living. Shierholz said a robust minimum wage doesn’t only benefit those who are paid minimum wage. Rather, that baseline impacts lower-income wages across the board.

Tax policies also widened the income gap. While many point to George W. Bush’s tax cuts as a key accelerant in the runaway income growth of the wealthy, economists note that other, long-standing parts of the federal tax code played a role as well.

“Our housing policy, with the mortgage interest reduction, is absolutely ridiculous in that most of the subsidies go to the richest people,” said Dean Baker, co-director of the progressive Center for Economic and Policy Research.

The net result is that the middle class today is in a precarious position, and the working class even more so. For much of the past decade, loosening credit standards and rampant consumer lending fueled by the housing bubble camouflaged the increasingly skewed dispersal of resources.

“The notion that ever-increasing home prices are going to provide us with wealth is clearly not sustainable,” said Lawrence Katz, a professor of economics at Harvard University. “There was a mirage of consumption growth, so some of the growth of inequality didn’t fully show up in consumption rates,” he said.

While the drop taken by the stock market during the recession has diminished the level of inequality from the 2007 levels shown in the CBPP report, the middle class is struggling more than ever as a result of the housing crash. “It’s a huge issue,” said Baker. “They’re getting to retirement and seeing most of their wealth vanish, since most of that wealth was in their house.”

As problematic as this is for the middle class, the households at the bottom of the income ladder are even worse off.

“One of the things we know about the bottom fifth is that it’s harder for them to move up,” said Heather Boushey, senior economist at the Center for American Progress. “We talk a lot about encouraging people to work their way out of poverty, but without middle-class jobs, this consigns those at the bottom to staying there.”

Economists fret that the legacy of the wealth chasm will be greater than simply a shaky foundation for the country’s already-slowing recovery. Profound inequality sows the seeds for social unrest and widespread disenfranchisement.

“Politics have become increasingly rife with class conflict,” Boushey said.

The EPI’s Shierholz concurs. “When you have both high inequality and low mobility, we’ve turned into a place that’s inconsistent with American values,” she said. “It becomes a set class system.”

Even though the recession has put a small dent in the income gap, most economists agree that if the status quo holds, the trend will continue apace when the economy rebounds. Following the dot-com crash and 2001 recession, the incomes of the top one percent dropped from 20.6 times that of the middle fifth to 14.3 times as high. But this flattening of the income distribution disappeared when the economy recovered. In 2007, the top one percent earned 24 times as much as the middle fifth.

Economists say there’s no silver bullet for narrowing the income gap, but a number of policies and programs could help. First up, says Chad Stone of the CBPP, is letting the Bush-era tax cuts expire on schedule. “That will return rates at the top to approximately where they were at the boom of the 90s,” he said. Some say the imbalance could be partially offset by a more progressive federal tax code, a higher minimum wage and legislation that gives workers more bargaining power, while CEPR’s Baker suggests what he terms a “financial speculation” tax to capture some of the outsize profits generated by Wall Street and the financial sector.

But economists say the real key to regaining lost ground, especially for the middle class, is cultivating large numbers of jobs in new and growing industries like green technology and health care, and providing unfettered access to higher education so middle- and lower-income Americans can train for these careers.

“I think it’s widely agreed that education plays a huge role here and more so than in the past,” said Ron Haskins, an economist at the Brookings Institution. “The problem is a lot of people don’t have skills, and that’s because our high school dropout rates are high and people don’t go to college.”

The flip side of that coin is having jobs available for young people after they’ve invested in their education. “There’s potentially a lot of growth in health care and skilled manufacturing, but we need to do a much better job of providing access to training,” said Harvard’s Katz. “The traditional jobs that have provided wages to the middle class are clearly not doing well in today’s economy and are unlikely to come back. We need to think about a different middle class.”

“What we need is a policy conducive to innovation and entrepreneurship,” said Will Marshall, president of the Progressive Policy Institute, a think tank. “You need the energy of invention just as we saw in the late 90s. We need another spurt of innovation-fueled growth.”

“Inequality is one of the great structural challenges facing America,” Marshall continued. “It raises questions about whether the American dream still works. … That’s why it demands attention from policymakers as something we’ve got to squarely face.”