September 21, 2013
America's income inequality is growing again. Time to cut subsidies to the rich and invest in the young
A barrage of new statistics on American living standards offers some grounds for optimism. A typical American household's income has stopped falling for the first time in five years, and the poverty rate has stopped rising. At last, it seems, the expansion is strong enough at least to stabilize ordinary people's incomes.
But the main message is a grim one. Most of the growth is going to an extraordinarily small share of the population: 95% of the gains from the recovery have gone to the richest 1% of people, whose share of overall income is once again close to its highest level in a century. The most unequal country in the rich world is thus becoming even more so.
You do not have to be an egalitarian to worry about this trend. Although some degree of inequality is good for an economy, creating incentives to work hard and take risks, the recent concentration of income gains among the most affluent is both politically dangerous and economically damaging. The political worry is a descent into angry populism. Americans are not about to string up the wealthy, but there is growing evidence of fury--witness the Democratic left's vilification of Larry Summers, a progressive economist who this week felt compelled to withdraw his candidacy for the chairmanship of the Federal Reserve, largely because he was seen as too soft on Wall Street.
Inequality can be a symptom of inefficiency. The implicit subsidy provided to banks that governments judge too big to fail allows bankers to overpay themselves. And a highly skewed distribution can lower growth, if it translates into less equality of opportunity for the next generation. This seems to be happening. The gap in test scores between rich and poor children is 30-40% wider than it was 25 years ago: given that the distribution of innate intelligence is unlikely to have shifted so much in a generation that suggests that rich youngsters are benefiting more than ever from their economic and social advantages. Measures of social mobility between generations, already lower than in much of Europe, have stagnated.
Many of the underlying causes of the growing gap between rich and poor--fast technological change and the rapid globalization of the economy--are deep-seated and likely to persist. Tyler Cowen of George Mason University thinks the population will soon be divided into two groups: those who are good at working with intelligent machines, and those who can be replaced by them (see Lexington). The former will prosper; the latter will play a lot of video games.
Plenty of American politicians worry about inequality, but few offer constructive ways of dealing with it. Democrats tend to turn to bromide leftist solutions, whether a higher minimum wage or another rise in tax rates on the rich. Too many Republicans, meanwhile, simply deny that there is a problem.
Inequality is not impervious to government policy, but higher marginal tax rates are not the only or the best way to address it. A two-part agenda drawing on ideas from both left and right, aimed at reducing boondoggles for the affluent and increasing investment in the young, could achieve a lot.
The attack on favors for the wealthy ought to start with the budget. America's tax code is riddled with distortions that favor the rich, from the loopholes benefiting private equity to the mortgage-interest deduction (an enormous subsidy for those who buy big houses). A simpler, flatter code with no exemptions would be more efficient and more progressive. A blast of deregulation would help, too. Many of America's most lucrative occupations are shielded by pointlessly restrictive rules (think doctors and lawyers).
Investment in the young should focus on early education. Pre-school is a crucial first step to improving the lot of disadvantaged children and America is an international laggard. According to the OECD, it ranks only 28th out of 38 leading economies in the proportion of four-year-olds in education. Mr. Obama has a plan to push universal pre-school. The details are iName