Income Inequality: Why All Americans Should Be Alarmed

Paul Butler

Writing Intern

Is the American Dream on life support? Recent findings on the roots of growing economic inequality suggest that the great promise of equal opportunity – that everyone has a fair shot at success – might be slipping away.

Today, social mobility is connected more than ever to education, and success in school is entwined with parental income and wealth. The fact that the United States has the worst case of income inequality in the developed world means that a large number of our youth are born with the odds stacked against success. Sixty-five percent of US children born in the bottom fifth of incomes, for example, stay in the bottom two-fifths as adults.

The trouble is that many of us don’t realize the true extent of the gap between rich and poor. When a Harvard business professor and a Duke economist surveyed Americans on wealth distribution, respondents of all political stripes estimated our economy to be considerably more equitable than it actually is. On top of this, most Americans picked an even more spread-out distribution of wealth as ideal for the country.

 

Actual wealth distribution compared to perceived and ideal distribution (PPS).

Considering the surprisingly widespread agreement among Americans on an ideal distribution of wealth that differs dramatically from the actual level, why is so little being done to address the issue on a national scale? Disconcertingly, in the midst of a lackluster economy still reeling from the recession, the wealthiest Americans have been insulated from financial loss and are once again gaining wealth, all while the rest of the country struggles to stay afloat.

According to a new study by Facundo Alvaredo, Anthony Atkinson, Thomas Piketty, and Emmanuel Saez in the Journal of Economic Perspectives, the rise of income inequality in the US over the last few decades is largely thanks to Wall Street deregulation, and to a lesser extent, massive tax breaks for the rich. Comparing the economic policies of several countries, the researchers found a connection between reduced top marginal tax rates and changes in the relative pre-tax income of the top 1 percent.

Effect of lower tax rates on top 1 percent pre-tax income share (JEP)

 

The chart shows that the greatest rise in the share of pre-tax income for the top 1 percent occurred in countries that lowered taxes the most. To be clear, the data represents the relative amount the rich made prior to being taxed, indicating that the correlation does not necessarily imply full causation.

How, then, did we manage to surpass the degree of inequality of our fellow developed nations by such a large degree? The researchers speculate that the lower income taxes may have had many secondary effects, such as an increased incentive for executives to bargain for higher personal compensation instead of using profits for employment and growth. They also found that decreased tax rates for the rich had no demonstrable positive impact on per capita GDP; in other words, the wealthy became wealthier without any so-called “trickle-down” effect on the rest of the country.

Perhaps even more importantly, the same legislators who slashed top tax rates did so while promoting deregulation and other neoliberal policies. Democrats and Republicans joined forces to slowly chip away at Depression-era reforms that had helped to create a stable and reasonably equitable postwar economy. Lawmakers broke down the barriers between commercial and investment banking by repealing Glass-Steagall, failed to regulate derivatives, and perversely incentivized corporations to pay executives through stock options.

Meanwhile, many of our best and brightest college grads – from the Ivy Leagues, Stanford, and other elite schools – started choosing lucrative salaries on Wall Street over societally useful occupations, like public service, engineering, and medicine. As the late Yale student Marina Keegan argues, something is genuinely tragic about the reality that so many of her passionate, idealistic peers cast aside their hopes of “saving the world” in favor of “pushing figures around spreadsheets to make more money for those with the most money.” Rather than use their talents to promote the public wellbeing, the incredibly smart people working for Wall Street created the complex derivatives and other high risk financial products that helped lead to our country’s financial collapse.

As a direct result of the expanding reach of Wall Street, the portion of our top 1 percent income earners who work for the financial sector nearly doubled between 1979 and 2005. The systematic favoritism our nation plays toward the biggest banks is unhealthy for all but the richest of Americans. A bloated Wall Street sucks up money from hardworking families without ever benefiting our economy, simply adding to the unhealthy gap between rich and poor.

The ascent of the financial sector has in many ways become a self-perpetuating cycle. Banks and corporations that have benefitted immensely from misguided government policies have discovered that they can simply reinvest that money back into lobbying lawmakers to continue doing their bidding. From Chuck Schumer to Marco Rubio, Wall Street has many key allies who advance their interests in Congress. In response to the financial crisis, for instance, Congress passed the Wall Street bailout to return banks to record profitability but failed to take similarly drastic steps to even begin addressing joblessness, the housing crisis, and student loan debt.

Only once we are willing to take on the entrenched favoritism displayed toward Wall Street and the most fortunate of Americans can we hope to adequately tackle the issue of income inequality. Our nation is fully capable of restoring the fairness and prosperity of our postwar economy; all that we need to do so is a little courage.