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There is no doubt that incomes are unequal in the United States — far more so than in most European nations. This fact is part of the impulse behind the Occupy Wall Street movement, whose members claim to represent the 99 percent of us against the wealthiest 1 percent. It has also sparked a major debate in the Republican presidential race, where former Massachusetts governor Mitt Romney has come under fire for his tax rates and his career as the head of a private-equity firm.
And economic disparity was the recurring theme of President Obama’s State of the Union address on Tuesday. “We can either settle for a country where a shrinking number of people do really well, while a growing number of Americans barely get by,” the president warned, “or we can restore an economy where everyone gets a fair shot and everyone does their fair share.”
But the mere existence of income inequality tells us little about what, if anything, should be done about it. First, we must answer some key questions. Who constitutes the prosperous and the poor? Why has inequality increased? Does an unequal income distribution deny poor people the chance to buy what they want? And perhaps most important: How do Americans feel about inequality?
To answer these questions, it is not enough to take a snapshot of our incomes; we must instead have a motion picture of them and of how people move in and out of various income groups over time.
The “rich” in America are not a monolithic, unchanging class. A study by Thomas A. Garrett, economist at the Federal Reserve Bank of St. Louis, found that less than half of people in the top 1 percent in 1996 were still there in 2005. Such mobility is hardly surprising: A business school student, for instance, may have little money and high debts, but nine years later he or she could be earning a big Wall Street salary and bonus.
Mobility is not limited to the top-earning households. A study by economists at the Federal Reserve Bank of Minneapolis found that nearly half of the families in the lowest fifth of income earners in 2001 had moved up within six years. Over the same period, more than a third of those in the highest fifth of income-earners had moved down. Certainly, there are people such as Warren Buffett and Bill Gates who are ensconced in the top tier, but far more common are people who are rich for short periods.
And who are the rich? Affluent people, compared with poor ones, tend to have greater education and spouses who work full time. The past three decades have seen significant increases in real earnings for people with advanced degrees. The Bureau of Labor Statistics found that between 1979 and 2010, hourly wages for men and women with at least a college degree rose by 33 percent and 20 percent, respectively, while they fell for all people with less than a high school diploma — by 9 percent for women and 31 percent for men.
“Making the poor more economically mobile has nothing to do with taxing the rich and everything to do with finding and implementing ways to encourage parental marriage, teach the poor marketable skills and induce them to join the legitimate workforce.”–James Q. Wilson
Also, households with two earners have seen their incomes rise. This trend is driven in part by women’s increasing workforce participation, which doubled from 1950 to 2005 and which began to place women in well-paid jobs by the early 1980s.
We could reduce income inequality by trying to curtail the financial returns of education and the number of women in the workforce — but who would want to do that?
The real income problem in this country is not a question of who is rich, but rather of who is poor. Among the bottom fifth of income earners, many people, especially men, stay there their whole lives. Low education and unwed motherhood only exacerbate poverty, which is particularly acute among racial minorities. Brookings Institution economist Scott Winship has argued that two-thirds of black children in America experience a level of poverty that only 6 percent of white children will ever see, calling it a “national tragedy.”
Making the poor more economically mobile has nothing to do with taxing the rich and everything to do with finding and implementing ways to encourage parental marriage, teach the poor marketable skills and induce them to join the legitimate workforce. It is easy to suppose that raising taxes on the rich would provide more money to help the poor. But the problem facing the poor is not too little money, but too few skills and opportunities to advance themselves.
Income inequality has increased in this country and in practically every European nation in recent decades. The best measure of that change is the Gini index, named after the Italian statistician Corrado Gini, who designed it in 1912. The index values vary between zero, when everyone has exactly the same income, and 1, when one person has all of the income and everybody else has none. In mid-1970s America, the index was 0.316, but it had reached 0.378 by the late 2000s. One of the few nations to see its Gini value fall was Greece, which went from 0.413 in the 1970s to 0.307 in the late 2000s. So Greece seems to be reducing income inequality — but with little to buy, riots in the streets and economic opportunity largely limited to those partaking in corruption, the nation is hardly a model for anyone’s economy.
Poverty in America is certainly a serious problem, but the plight of the poor has been moderated by advances in the economy. Between 1970 and 2010, the net worth of American households more than doubled, as did the number of television sets and air-conditioning units per home. In his book “The Poverty of the Poverty Rate,” Nicholas Eberstadt shows that over the past 30 or so years, the percentage of low-income children in the United States who are underweight has gone down, the share of low-income households lacking complete plumbing facilities has declined, and the area of their homes adequately heated has gone up. The fraction of poor households with a telephone, a television set and a clothes dryer has risen sharply.
In other words, the country has become more prosperous, as measured not by income but by consumption: In constant dollars, consumption by people in the lowest quintile rose by more than 40 percent over the past four decades.
Income as measured by the federal government is not a reliable indicator of well-being, but consumption is. Though poverty is a problem, it has become less of one.
Historically, Americans have had an unusual attitude toward income inequality. In 1985, political scientists Sidney Verba and Gary Orren published a book that compared how liberals in Sweden and in the United States viewed such inequality. By four or five to one, the Swedish liberals were more likely than the American ones to believe that it was important to give workers equal pay. The Swedes were three times more likely than the Americans to favor putting a top limit on incomes. (The Swedes get a lot of what they want: Their Gini index is 0.259, much lower than America’s.)
Sweden has maintained a low Gini index in part by having more progressive tax rates. If Americans wanted to follow the Swedish example, they could. But what is the morally fair way to determine tax rates — other than taxing everyone at the same rate? The case for progressive tax rates is far from settled; just read Kip Hagopian’s recent essay in Policy Review, which makes a powerful argument against progressive taxation because it fails to take into account aptitude and work effort.
American views about inequality have not changed much in the past quarter-century. In their 2009 book “Class War? What Americans Really Think About Economic Inequality,” political scientists Benjamin Page and Lawrence Jacobs report that big majorities, including poor people, agree that “it is ‘still possible’ to start out poor in this country, work hard, and become rich,” and reject the view that it is the government’s job to narrow the income gap. More recently, a December Gallup poll showed that 52 percent of Americans say inequality is “an acceptable part” of the nation’s economic system, compared with 45 percent who deemed it a “problem that needs to be fixed.” Similarly, 82 percent said economic growth is “extremely important” or “very important,” compared with 46 percent saying that reducing the gap between rich and poor is extremely or very important.
Suppose we tax the rich more heavily — who would get the money, and for what goals?
Reducing poverty, rather than inequality, is also a difficult task, but at least the end is clearer. One new strategy for helping the poor improve their condition is known as the “social impact bond,” which is being tested in Britain and has been endorsed by the Obama administration. Under this approach, private investors, including foundations, put up money to pay for a program or initiative to help low-income people get jobs, stay out of prison or remain in school, for example. A government agency evaluates the results. If the program is succeeding, the agency reimburses the investors; if not, they get no government money.
As Harvard economist Jeffrey Liebman has pointed out, for this system to work there must be careful measures of success and a reasonable chance for investors to make a profit. Massachusetts is ready to try such an effort. It may not be easy for the social impact bond model to work consistently, but it offers one big benefit: Instead of carping about who is rich, we would be trying to help people who are poor.
James Q. Wilson is the chairman of AEI’s Council of Academic Advisers
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