WASHINGTON (MarketWatch) – Who killed the American Dream?

Whatever happened to the promise that anyone could build a better life by honest labor? That my life would be better than my parents’, and that my kids’ lives would be better than mine?

That America is gone, now seen only in old Frank Capra movies late at night.

Today in America, the rich are pulling away from the rest of us, taking almost all of the gains for themselves, leaving the middle class scrambling just to stay where they are, and forcing the poor to survive on an increasingly frayed safety net.

The share of national income earned by the top 1% has soared since the 1970s and is back to levels seen in the 1920s. Piketty and Saez

A lot of attention has been given to the issue of the widening of inequality of opportunities and outcomes, in part because a chilling new book by New Yorker writer George Packer, “The Unwinding,” which tells the horrifying story of how the dream was lost.

More recently, an academic debate in a forthcoming issue of the Journal of Economic Perspective has brought inequality back in the news, thanks to a bluntly argued (and titled) paper “Defending the One Percent” by Harvard economist Greg Mankiw (who is a former adviser to George W. Bush, John McCain and Mitt Romney).

In his paper, Mankiw explains why the top 1% are doing so well while the rest of us sprint hopelessly to catch up: The rich are simply better than us. They make more money because they contribute more to society than we do. They are smarter, have the skills that are in high demand, have better entrepreneurial instincts, and work harder. What’s more, their kids inherit these traits genetically.

Not only are the rich better than us, the world is also increasingly becoming their kind of place. Technological changes over the past 30 years have made their advantages even more rewarding than before.

The top 1% really do earn their money, and any effort to reduce inequality would make us all poorer, Mankiw says. We’d have to do without the innovations of people like Steve Jobs, J.K. Rowling and Greg Mankiw.

Mankiw takes it as a given that compensation equals marginal product. The rich earn their money because someone pays it to them, and that someone must have a good reason to pay that much. The markets decide pay, that’s just Econ 101, and on that topic.

Plenty of pundits have responded to Mankiw’s thesis, but none more effectively than Josh Bivens and Larry Mishel of the Economic Policy Institute, who also contributed a paper to the special issue of the JEP.

It turns out that it’s not so much what you know, as Mankiw argues, but how much power you have, especially the power to extract economic rents. Bivens and Mishel show that the increase in the incomes of the top 1% over the past 30 years owes more to successful rent-seeking than it does to efficient and competitive markets rewarding education and skills.

Would you buy a $13,000 TV?

What do economists mean by “rents”? Simply put, it’s the income that’s received over and above what would be required to induce the person to supply their labor or capital.

For instance, Bevins and Mishel say, ”it seems likely that many top-level professional athletes would continue to supply essentially the same amount of labor to their sport, even if their salary was reduced by some substantial fraction, because even the reduced salary would be much higher than their next-best options.”

Do we need to pay superstars exorbitant amounts of money to get them to show up for work every day? Clearly not. LeBron James voluntarily cut his own pay to help the Miami Heat win championships. His primary motivation is to play with a great team and to build his legacy as one of the greatest basketball players of all time, not to earn a few million extra. For James and many other stars, it’s the relative level of their salary that matters most, not the absolute level. They just want to make more than their closest rivals.

One of Mankiw’s own examples argues against his theory that innovators would refuse to work if we dared to raise their taxes.

Author J.K. Rowling wrote the first Harry Potter book without any expectation of getting it published, much less of earning a billion dollars from her imaginative stories. And Rowling very publicly remained in the U.K., even as her taxes were increased, because she said she owed her success to the British welfare state.

All this talk about innovators is a smoke screen, anyway. Most of the increase in income for the top 1% (which means that most of the increase in income for all of the economy) has accrued to two sectors: Corporate executives and workers in the financial industry. Few of the top 1% are superstar athletes, inventors or artists.

Corporate executives receive millions in excess compensation because of rent-seeking. Many executives are mediocre at their jobs, yet receive extravagant pay packages, regardless of their performance. CEO pay increased by 14 times from the late 1970s to 2000, more than twice as fast as stock prices did, Bivens and Mishel found.

CEOs in other countries earn half as much for doing the same job. And we manage to find qualified people to lead other complex organizations without paying them an average of $14 million a year: The president of the United States makes $450,000 a year, including expenses. The chairman of the Federal Reserve makes just under $200,000. The chairman of the Joint Chiefs of Staff makes about $250,000.

Bivens and Mishel’s research further shows that the horrendous widening of equality in America isn’t the result of benign and impersonal market forces, but of conscious policy decisions — for instance, lower tax rates and reduced bargaining power for workers — that increased the ability of a few to capture almost all the benefits of the economy’s growth over the past 30 years.

Ultimately, the next generation at the top will be, the friends, neighbors, classmates and children of the current crop.

The country that once boasted of equal opportunities has re-created a self-perpetuating aristocracy. And that’s not the America I dream of.