Here's Why U.S. Income Inequality Won't Be an Easy Fix


Wall Street Cheat Sheet
By: Meghan Foley
May 15, 2014

The social progress made by the United States in the 20th century dramatically remade the country. The years between the 19th and 20th centuries gave birth to the Haymarket riots, provided the backdrop for Upton Sinclair's The Jungle and Karl Marx's Communist Manifesto, and saw massive strikes. In 1886 alone, workers staged 1,500 strikes. It was an era that saw the richest 1 percent of Americans amass nearly one in five dollars generated by the economy and own almost half its wealth, while inflation ate away at the earnings of the average worker.

Then came the 1900s and with it, the Progressive Era: women got the right to vote, the Sherman Antitrust Act was passed by Congress, the progressive federal income tax was implemented, and in 1914, Henry Ford raised his workers' wages to $5 per day, more than doubling the pay of a majority of this employees. With the Great Depression came Franklin D. Roosevelt's New Deal Reforms, which included Social Security and the 1960s brought Medicaid and Medicare.

But despite the massive changes the United States experienced in the last century, the elastic band of income equalization has begun to snap back. While the progressive federal income tax has done much to mitigate income inequality in the years since it was first enacted by constitutional amendment in 1913, it has proven to be not powerful enough to slow down the gap between the nation's rich and poor that has been widening over the past several decades.

In the 30 years following World War II, the U.S. economy grew at a faster rate than it ever had before, largely because the country was creating the largest middle class in history. In an op-ed published in the Detroit Free Press, economist Robert Reich described just how that process began. He said business boomed in that era largely because workers were earning raises that gave them the purchasing power to buy the goods and services provided by those expanding businesses.

That relationship between business and workers was supported by labor unions, which "ensured the American workers got a fair share of the economy's gains," he wrote. In fact, earnings of most workers doubled, with chief executives rarely being paid 40 times the average worker's wage, and the top marginal income tax rate on America's highest earners never falling below 70 percent. That left the rich with a smaller share of the rapidly growing economy.

Change began when "many of us bought the snake oil of 'supply-side' economics," Reich wrote in the Detroit Free Press. That economic theory argues that large corporations and the wealthy are the job creators, so if taxes on corporations and the richest Americans are cut, the benefits will "trickle down" to the rest of the population. "But nothing trickled down," he said.

Reich has his critics. In a Forbes piece, Paul Roderick Gregory, a research fellow at the Hoover Institution, argued that Reich's social contract is merely a "hackneyed reprise of Karl Marx." He went on to argue that Reich is wrong on several counts, one being that the United States had become the world's richest country well before Henry Ford gave his workers that raise. Furthermore, Gregory says, that raise was the result of increased worker productivity, not Ford's desire to create customers. He cites government statistics that show how employee compensation as a share of national income rose immediately preceding and during the post-war recessions, meaning the long-term trend in labor's share of economic gains is moving upward, not downward, as Reich suggests.

Economic theories aside, the fact remains that the U.S. middle class is not what it once was. "The idea that the median American has so much more income than the middle class in all other parts of the world is not true these days," Harvard's Lawrence Katz told The New York Times. "In 1960, we were massively richer than anyone else. In 1980, we were richer. In the 1990s, we were still richer. That is no longer the case."

Data compiled by LIS, a group that maintains the Luxembourg Income Study Database, and analyzed by the Times presents a new paradigm. While economic growth in the United States remains as strong as or stronger than it has been in the recent past, a smaller percentage of the population is benefiting from that expansion. That means income inequality is growing.

Average per capita income amounted to $18,700 in the United States in 2010, equivalent to approximately $75,000 for a household of four after taxes. That represents a 20 percent increase since 1980, but virtually little change since 2000. By comparison, the same measure rose approximately 20 percent in Britain between 2000 and 2010, and 14 percent in the Netherlands.

Publicly available numbers from LIS show that median incomes in the United States may be still slightly higher than most other western countries, but Canada pulled even in 2010 and nations like Britain, the Netherlands and Sweden have narrowed the earnings gap over the past decade. Now, average, after-tax incomes in Canada appear to be higher than in the U.S., where the poor earn much less than the poor of Europe.

Because the most important measures of economic strength -- including per capita gross domestic product -- show that the United States continues to the be the richest country in the world, the weakness of the country's median income growth becomes all the more glaring. It is important to remember that per capita GDP is an average: distribution of income is a far different statistic and a far more telling measure of the economic health of the country. Of course, U.S. economic growth is historically rather anemic, further limiting the size of raises in this country.

The LIS analysis may not have provided a solid explanation as to why Americans are earning a smaller share of the economy's gains than they did in the past, but it did address why average income earners in certain nations in Western Europe are catching up to the United States. First, educational attainment in the United States has grown much more slowly than in much of the industrialized world, meaning that the U.S. cannot maintain its share of highly skilled, well-paying jobs.

According to a recent study by the Organization for Economic Co-operation and Development, younger Americans rank near the bottom among so-called rich countries in terms of literacy, numeracy, and technology skills. A further contributing factor is that companies in the United States distribute a smaller portion of their profits to the middle class and poor than comparable businesses in many other industrialized countries: chief executives make more money, minimum wage is lower, and labor unions are weaker. Plus, governments in Canada and Western Europe take more aggressive measures to redistribute income.

The Obama administration has put forward initiatives to breach the United States' income inequality gap, and the Great Recession helped make the case for redistribution. As U.S. Chief Economic Adviser Jason Furman told The New York Times, measures like higher income tax rates, subsidies to buy insurance through the Affordable Care Act's exchanges, and greater tax breaks for poor families with children have "created the most significant policy-induced reduction in inequality in at least 40 years." Nevertheless, the income gap keeps growing.

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This page contains a single entry by CFED published on May 16, 2014 3:01 PM.

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