Economic Stability Archives

Understanding economic inequality and growth at the bottom of the income ladder

Posted on November 6, 2014April 18, 2018 by Bridget Ansel

Today the official poverty rate in the United States is back to levels we haven’t seen in 20 years, and the incomes of families at or near the bottom of the income ladder are at the same level they were in the early 1970s. Studies show poverty rates on the decline since the beginning of Great Society programs in the 1960s until the late 1990s, but seeing as wages have not improved, this decrease in poverty was almost entirely due to increased government transfers.

Poverty is back up because wages at the bottom have stagnated or fallen. Over the past 40 years, workers in the bottom 40 percent of the wage spectrum experienced negligible wage growth, and wages have fallen for those in the bottom 10 percent, after accounting for inflation. The trends have been worse for men than women, in no small part because women’s increased educational attainment and on-the-job experience have boosted their wages over the past few decades.

Researchers find that the lack of wage-and-income growth for families at the bottom of the income ladder in particular results in serious economic consequences. First, the continued lack of income growth harms low-income children’s development, which affects our nation’s future human capital. Second, a growing body of evidence suggests that the lack of income gains at the bottom have macroeconomic consequences because it either reduces consumption or encourages more debt, both of which are destabilizing.

But there are remedies for these problems, such as raising the minimum wage. Research by economists Daniel Aaronson and Eric French at the Federal Reserve Bank of Chicago and Sumit Agarwal of the University of Singapore find that increasing the minimum wage boosts the consumption of affected workers.And a battery of other research shows that raising the minimum wage does not reduce local employment and reduces employee turnover.

The three essays in this section of our conference report—by Christopher Wimer, a research scientist at Columbia Population Research Center, Arindrajit Dube, an associate professor of economics at the University of Massachusetts-Amherst, and Gavin Kelley, chief executive of the Resolution Foundation in the United Kingdom—look the overall exclusion of low-wage workers from the benefits of economic growth and how that affects the future growth and stability of our economy. They also consider whether the government should focus on raising market wages though policies such as the minimum wage, anti-poverty assistance or some better combination of the two approaches.

Reversing inequality at the bottom: the role of the minimum wage

by Arindrajit Dube

There are many factors affecting the growth in wage inequality in the United States over the past four decades. When it comes to workers on the bottom rungs of the income ladder, one important factor is the minimum wage.

The federal minimum wage reached its high-water mark in 1968, when it stood at $9.59 per hour in 2014 dollars, declining to a still-respectable $8.59 by 1979. During the 1980s, however, the real (inflation-adjusted) minimum wage declined substantially. And over the past 20 years, the minimum wage has largely treaded water, reaching a historical low of $6.07 per hour in 2006 just before the last federal increase in 2009. The minimum wage now stands at $7.25 per hour in today’s dollars.

The failure of the minimum wage to keep up with inflation means that, for workers earning the minimum wage, each hour of labor purchases less goods and services today than it did in the past.

Minimum wage workers are not only (contrary to popular belief) teenagers and young adults whose low wages are supplemented by their families. In fact, between 1979 and 2011, the share of low-wage workers—defined as those with wages of $10 or less in 2011 dollars—under the age of 25 years of age fell to 35.7 percent from 47.1 percent. Instead, minimum wage workers are increasingly adults who must rely exclusively on their meager earnings to support basic household consumption. The decline in the value of the minimum wage affects female workers in particular, as they tend to be paid lower wages.

Low minimum wages are also problematic when they deviate too far from the median wage because that means minimum-wage earners are falling farther behind on the income ladder. This is why economists often use the ratio of the minimum to the median wage. The so-called 50/10 wage gap—the median wage earner compared to those with earnings in the bottom 10 percent of the income ladder— captures this type of wage inequality over time. Since 1979, around a third of the changes in the 50/10 wage gap have been driven by changes in the minimum wage.

There are two main reasons to pay attention to this measure. First, a comparison of the minimum wage to the median offers us a guide to how many workers are affected by a particular minimum wage increase, and what level of minimum wage the labor market can bear. When this ratio is low—say around 0.2—the policy is not raising wages of many workers. In contrast, a high ratio—say around 0.8—indicates a highly interventionist policy where the minimum wage is dramatically compressing differences in wages for nearly half the workforce.

Second, the median wage provides a reference point for judging what is a reasonable minimum wage level. No one expects that the minimum wage should be set equal to the median wage, but fairness concerns matter when the minimum wage falls below say, one-fourth or one-fifth of the median wage.

A natural target is to set the federal minimum wage to half of the median wage for full-time workers. This target has important precedence historically in the United States. In the 1960s, this ratio was 51 percent, reaching a high of 55 percent in 1968. Averaged over the 1960–1979 period, the ratio stood at 48 percent. Today, the ratio stands at 38 percent. Raising the federal minimum wage to around $10/hour would restore the value of the minimum to around half of the median full-time wage, yet efforts at raising the minimum wage have largely stalled in a deeply divided Congress despite widespread political support around the country.

This federal inaction has led to a flurry of activities at the state and local level. States have stepped in during periods with a stagnant federal minimum wage in the past, especially the 2000s, but for the first time in U.S. history we have many major cities establishing citywide minimum wages for all (or most) private-sector workers. The growing list of cities with such a policy now includes Albuquerque, Chicago, San Francisco, San Diego, San Jose, Santa Fe, Seattle, and Washington, DC. Other cities such as Los Angeles and New York are actively exploring possibilities.

This push to increase minimum wages in big cities coincides with organizing by workers in fast-food chains in major metro areas. The target minimum wage in most of these areas is substantially higher in nominal (non-inflation-adjusted) value— with $15/hour a focal point for these campaigns. The confluence of these factors raises the possibility of substantially altering wage standards in the U.S. labor market.

How should we think about these sizable increases in the minimum wage? First, we should be careful not to overstate the size of the increases or the levels of the minimum wages because the cost of living and overall wage levels vary tremendously by region. Setting the minimum wage to half the full-time median wage would produce $10/hour policy nationally, but much higher figures in major metro areas such as Washington, DC ($13.51), San Francisco ($13.37), Boston ($12.85), New York ($12.25), and Seattle ($11.85).

Moreover, these higher nominal wages are usually phased in gradually. In Seattle, the hourly minimum wage will eventually rise to around $14 in 2014 dollars. This constitutes around 59 percent of the median full-time wage in that metro area, which is certainly higher than historical standards but not outlandishly so.

So what we do know about the impact of minimum wages over the past few decades and the importance of particular channels for the higher, local wage standards? First, most careful recent work points to relatively small impact on employment—be it for sectors such as restaurants or retail or for groups such as teens.3 As a result of wage increases and small impact on employment, family incomes rise at the bottom. A 10 percent increase in the minimum would reduce the poverty rate among the non-elderly population by around 2 percent, and generally raises family incomes for the bottom 20 percent of the family income distribution.

It is possible that the much larger increases in minimum wage may induce greater substitution of low-skilled labor with automation, or with fewer but more high-skilled workers? If this is true then we would expect evidence of growing “disemployment” (workers out of a job due to lack of skills or education) from these higher city-wide wage standards. Yet recent research also identifies some additional benefits that may be more important than larger wage increases. A growing body of research shows that while the impact on employment stock is small, there are larger reductions in employment flows or turnover. The reduction in turnover provides additional evidence that search frictions in the low-wage labor market are quantitatively important and offer some clues as to the way cost increases may be absorbed.

Given the cost of recruiting and training new workers, for example, reduction in turnover can be expected to offset about a fifth of the labor-cost increases associated with minimum wage hikes in this range. I think the large city-wide increases will provide us with some additional evidence on this topic. In particular, I believe it should be possible to assess whether the lower turnover regimes lead to substantially different training policies as would be predicted by some models incorporating “search friction”—things that prevent or make it more difficult for workers to find the kind of jobs they want. Moreover, it will be interesting to see whether change comes from the extensive margin (growth in high-training/low-turnover firms) or the intensive margin (change within firms).

The nature of high-cost metro areas means that a substantially higher minimum wage may allow more lower-wage workers to live closer to their place of work (inside the city) and reduce commute time. The labor-supply effect from this “in-migration” also can reduce recruitment costs and improve the quality of the service work force. These additional channels will be useful to keep in mind in future research.

Evidence also suggests that, in part, cost increases associated with a higher minimum wage are passed on to customers as price increases, especially for industries that employ high levels of low-wage labor. The best evidence suggests that a 10 percent increase in minimum wage would raise fast food prices by around 0.7 percent. There are reasons to believe that the higher income customers inside major cities are better able to absorb price increases without cutting back on demand. Limited evidence from San Francisco tends to confirm this observation.

Finally, there is some evidence that low-wage workers substantially increase consumption in response to wage hikes. Daniel Aaronson and Eric French at the Federal Reserve argue that the higher marginal propensity to consume among low-wage workers is likely to lead to some short-term increases in economic growth from a minimum wage increase. My reading of the evidence is that it is somewhat difficult to accurately assess the importance of this channel, in part because the relatively small number of minimum wage workers makes any aggregate demand effect fairly small. But I do think that the size of increases and possible in-migration of low-wage workers into urban areas may increase the local demand impact of a city wage standard.

Minimum wage policies are a powerful lever for affecting wage inequality in the bottom half of the labor market. Modest increases in minimum wages can raise the bottom wage, and family incomes, without substantially affecting employment. But minimum wages are limited in their reach, and cannot be expected to solve all our problems when it comes to wage inequality. At the same time, the much higher wage standards being implemented in some of the cities offer the possibility of taking this policy “to scale.”

Along with this greater promise, however, come added risks. The reality is that we do not know very well how these policies will affect the local economy. Future researchers would do well to utilize the careful identification strategies that have been the hallmark of recent minimum wage research to study these high city-wide minimum wage increases. Doing so will deepen our understanding of the functioning of the low-wage labor market, and help us gauge the proper scope of this important public policy.

Economic inequality and growth in the United Kingdom: Insights for the United States

by Gavin Kelley

After an extraordinarily long and deep economic downturn, the United Kingdom is finally enjoying belated but comparatively strong growth. The current recovery is jobs-rich, with employment growth massively outperforming expectations relative to gross domestic product. That’s the good news. In stark contrast, however, pay growth remains unprecedentedly weak and productivity has plummeted. Real (inflation-adjusted) wages have fallen for six years straight, with even nominal wages growing at less than 1 percent in recent months—the lowest increase ever recorded.

This apparent collapse in the link between economic growth and real wage gains is more extreme than anything we have seen before. But the trend has not emerged completely out of the blue. Even as the U.K. economy continued to grow steadily prior to the financial crisis and global recession in 2007-2009, workers across the earnings distribution experienced a major slow-down in wage growth.

This unhappy story about the weakening relationship between wages and growth is all too familiar in the United States. But the U.K. experience is different in important respects—and potentially offers some relevant insights for U.S. policymakers to ponder.

First, let’s look at what happened. The simple ratio of GDP growth to growth in median wages in the United Kingdom weakened markedly in the period from 2003- 2008 compared to the 1990s and 1980s. In those earlier decades, wage inequality grew sharply—those at the top pulled away from the middle, and the middle pulled away from the bottom—but pay was rising across the board. In contrast, a big deceleration in the growth rate of earnings characterized the early 2000s. For the first time, median pay trailed way behind growth in real GDP per capita.

Between 1977 and 2002, average annual real wage growth for workers at the median was around 2 percent, but from 2003 to 2008 it fell to around 0 percent to 1 percent (depending on the measure of inflation used). This stagnation happened even while real GDP per capita had an average annual growth rate of 1.4 percent. The squeeze was broadly felt: the only earners on the income ladder who experienced stronger growth were those near the bottom rungs (buoyed by increases in the minimum wage) and those at the very top (especially due to bonus payments in finance).

In the wake of the financial crisis of 2008 and amid the Great Recession of 2007- 2009, the fall in real wages (around 8 percent) has also been relatively evenly spread across the earnings spectrum, though it is far bigger if we include the self-employed (who are excluded from official data). Younger workers have suffered the most, while older workers have been the least affected.

Wages, however, don’t give the full-picture when it comes to living standards. If we look at household income growth, from 1994-95 to 2011-12, the bottom half of households took just 16 percent of pre-tax growth. Upper-middle households (those in the 50th to 90th percentiles) took 45 percent of household income pre-tax growth (44 percent post-tax), proportionate to their population share. The richest 10 percent of households took 38 percent of pre-tax growth (29 percent post-tax) while the richest 1 percent took 14 percent pre-tax (9 percent post-tax).

In short, redistribution boosted the bottom half’s share of income growth from 16 to 26 percent.

Why has the link between economic growth and wages weakened? The share of GDP flowing to the wages of those on the low and middle part of the income spectrum has fallen markedly since the mid-1970s, from 16 percent to just 12 percent—a decline of 25 percent. In simple accounting terms, this relationship depends on three factors:

How much of GDP growth goes to profit rather than labor?
How much of that share of economic growth goes to labor in the form of non-wage benefits and how much actually gets paid out to workers in wages?
Of this wage share, how much reaches low- and middle-income earners?

It is often assumed that the United Kingdom and the United States alike face a long-term decline in the labor share of GDP as more of our national incomes are sucked up into corporate profits due to a mix of changing globalization, technology, increased financialization and, relatedly, deregulation spurred by the impact of big money on democratic politics.

From the U.K. perspective, there has been a slight shift in this direction over time, though it is an issue that is often overstated. Changes in the U.K.’s labor share of national income accounted for only a fifth of the cleavage that had opened up between pay and productivity since the early 1970s. The decline in the labor share of income has been less marked than in the United States.

Another U.K. perspective is that workers’ wages have primarily been under pressure because of the rising burdens on employers to provide more non-wage compensation such as higher national insurance and pension contributions. These employment costs have certainly risen, but again they can be overstated, with such increases accounting for a bit over a quarter of the gap between productivity and pay. That said, it is true that the rising cost of non-wage compensation appears to have played a more important role in the period of wage stagnation from 2003 in the United Kingdom.

But by far the most important factor explaining the declining share of the cake going to the bottom half of U.K. workers since the 1970s has been rising wage inequality, although this played a smaller role in the immediate pre-crisis period of 2003 to 2008.

How these three trends are likely to evolve over the next decade and beyond is far from clear. The intellectual zeitgeist expects there to be a redistribution of income over time from labor toward capital due to the “rise of the robot” (technology replacing workers) and French economist Thomas Piketty’s now famous observation that “r >g” (returns on capital are greater than the returns on economic growth).

Equally troubling is the outlook for non-wage costs. The tricky balancing act over the past decade of securing adequate pensions savings for an aging society and protecting the wages of today’s workers in the United Kingdom is unlikely to go away. Similarly, most projections anticipate that, following the recent downturn period where wage inequality remained fairly level, it is now likely to increase again as the highest earners pull away from the rest.

Yet the idea that resumed growth is pre-destined to mean ever higher inequality is bogus. It was not long ago, after all, that the United Kingdom experienced broadly shared economic growth. So what observations can we make based on the U.K.’s experience?

First, standing still takes a lot of effort when the ground is shifting. A rising minimum wage and aggressive use of tax-credits made a significant and positive difference in the United Kingdom, but policymakers were pushing against the grain and didn’t do enough to confront the structural economic challenges such as inadequate business investment, lack of employee bargaining power, and weak demand for skilled labor.

Second, successive waves of “welfare reform,” together with the long-term decline in labor union collective bargaining, appears to have shifted the wage-unemployment relationship since the early 2000s. Wages have become significantly less responsive to falling unemployment than was the case in the 1980s and 1990s. At the same time, and despite the gains from the minimum wage, working poverty has become far more pervasive. Arguably, these shifts put even more onus on aggressive monetary and fiscal policy to help generate a tight labor market and wage growth.

Third, the U.K.’s policy on the minimum wage was a success but we shouldn’t rest on our laurels. The Low Pay Commission, the body that oversees the minimum wage, is widely judged to have been highly effective if perhaps too cautious. The wage gap between the bottom and middle of the distribution has fallen (slightly) since its introduction. Fifteen years ago the whole notion of the minimum wage was highly partisan. Now each of the political parties jockey for position on this issue.

The Low Pay Commission’s blend of operational independence, technical expertise, and social partnership (employer and union representation) has worked well. And this flexibility has been an advantage; in the UK context, linking the national minimum wage to inflation would be a mistake. But there is now a sense that we need to revise our minimum wage framework to reflect learning over 15 years and to inject more ambition into the process.

Finally, policy wonks need to think hard about the political economy of tax credits. Most experts think tax credits increased the incentive to work (boosting single-parent employment rates in particular), helped bring about a major fall in child poverty, and shored up the post-tax transfer share of income going to the bottom 50 percent of society. Yet the rapid expansion of the policy (around 8 in 10 families with kids were eligible in 2010) raced ahead of popular support, making it surprisingly easy for the current governing coalition of Conservatives and Liberal Democrats to cut them. Tax credits have been characterized as “welfare” for the work-shy, whereas “tax-relief” is generally perceived more positively.

So what is the outlook for wage inequality in the United Kingdom? Broad-based economic growth is very unlikely to return by chance. Securing such an outcome will require a number of elements, including:

A more aggressive strategy for raising the wage floor during the current period of economic recovery, drawing confidence from growing research about the capacity of buoyant labor markets to absorb steady minimum wage rises
Tackling the extraordinary rents that have accrued to small numbers in the finance sector over the past decade as the link between run-away rewards, financial instability, and fiscal retrenchment is all too clear (and is toxic for those on low and modest incomes)
Ditching the notion that increasing payroll taxes (on employees and employers) are a politically cute way of raising extra revenue (not least when large and regressive tax-reliefs remain untouched)
Boosting the woefully inadequate business and public investment as there is no other path to higher labor productivity
Remedying perennial weaknesses in U.K. education policy, especially the awful wage and productivity returns to many low and intermediate level vocational qualifications (respectively, the qualification level that a 16 or 19 year old is expected to attain)

This last point is key. Education may not be the panacea that political leaders claim it to be, but the wage-penalty arising from poor quality sub-degree level vocational qualifications in the United Kingdom is particularly punitive.

More speculatively, there is a desperate need for experimentation with new labor market institutions that could offer employees some greater form of bargaining power, but in a manner that is compatible with the realities of a relatively flexible, heavily service-dominated economy. This is pretty much a policy void in the United Kingdom today.

Recreating more equitable, broad-based economic growth requires as prerequisites a tighter jobs market together with a higher wage floor. But to restore the link between economic growth and wage growth also will involve bold policy experimentation in pursuit of higher wages for those on the low- and middle-income rungs on the economy in the United Kingdom.

Inequality and the wellbeing of the poor in the United States

by Chris Wimer

How does the rise in economic inequality affect workers and their families at the bottom of the income ladder? To begin to approach an answer to such a question, it is important to first understand the facts on the ground. What have these workers and their families experienced over the past several decades? A common but deeply flawed measure of their wellbeing over the years is the official poverty rate, which fluctuates over a fairly narrow band but remained essentially flat since President Lyndon B. Johnson’s declaration of the War on Poverty in the mid-1960s.

This is not the forum to rehearse the litany of reasons why the official poverty rate is fundamentally flawed. But perhaps its biggest shortcoming is that it doesn’t count the many resources directed toward low-income families when measuring income. These resources include in-kind benefits such as supplemental nutrition assistance (what we used to call food stamps) and housing assistance, but also after-tax benefits such as the Earned Income Tax Credit and the Child Tax Credit.

When these resources are properly accounted for in a poverty measure, my colleagues and I at Columbia University demonstrate that poverty rates fell by about 40 percent over the past half century, from 26 percent in 1967 to 16 percent today. We have made more progress than we thought in fighting poverty in the United States since the 1960s. That is the good news. The bad news is that the declines I note above have come entirely because of the work of government policies and programs—not because low-income workers and families have succeeded in the workplace.

Indeed, aside from the latter half of the 1990s, low-income workers and families generally fared poorly relative to their more advantaged peers in the middle class and especially compared to the wealthy in terms of income growth. Absent resources from government programs, poverty (properly measured) would have actually increased between the 1960s and today—from 27 percent to 29 percent, equal to about 37 million people.

Focusing exclusively on numbers and percentages surrounding a specific poverty line, however, obscures other trends in income and the wellbeing of the poor. Recent data that my colleagues and I are collecting for a new longitudinal study of New York City residents tells us that actual levels of material hardship—the inability to meet one’s routine expenses—are actually quite a bit higher than poverty rates, even as properly measured. This means we need to think about those at the bottom of the income spectrum as not just those who fall below some predetermined poverty line but also those who find themselves consistently struggling to keep pace with what it costs to get by in contemporary society.

So a key question is whether the run-up in income inequality over the past five decades is a driving force of the economic woes of the less fortunate or simply another measure of it. The poor are doing better than in the past thanks to government programs that help alleviate poverty and give them the opportunity to climb the bottom rungs of the income ladder, but at the same time we know the fortunes of those at the top are far outpacing those at the bottom.

If, as some contend, the wellbeing of the poor is dampened by the rise in inequality, then we are justified in attempting to reduce income inequality in order to improve the lots of the less fortunate. But if the two are merely jointly determined—say by the rising returns on a better education that are (partially) the result of market forces—then reducing income inequality by itself is likely do little to improve the long-run wellbeing of the poor aside from helping the poor to get by and consume more from their income.

What do we know about whether rising income inequality in the United States reduces the wellbeing of the poor? Unfortunately, not very much. Cornell University economist Robert Frank argues that as inequality rises we see a pattern of so-called “expenditure cascades” as people further down the economic ladder essentially try to consume enough to “keep up with the Jones’” just above them. University of Chicago economist Marianne Bertrand finds that rising inequality leads to reductions in disposable income further down the income ladder, though she is not explicitly focused on the wellbeing of the poor.

But these studies spark very provocative questions. Does increased inequality not only lead to an increase in consumer prices but also changes in consumption patterns in a way that causes income to not go as far for the poor as it might? And do these processes have actual negative effects on the overall wellbeing of the poor? Identifying such effects using common econometric methods, however, remains challenging.

So it is still an open question whether rising levels of inequality harm less-skilled and lower-earning families. Even if government programs and policies keep disadvantaged individuals and families afloat, sociologists still might question whether income that comes once a year in the form of tax refunds or once a month in the form of a Supplemental Nutrition Assistance Program card is as useful as income from a regular paycheck, which provides benefits both remunerative and potentially cumulative, given that over time, that job may turn into a career.

What is ultimately most important is not whether people have enough resources over the course of a year to meet a somewhat arbitrary line of what experts think they need. Rather, we need to know whether people are truly able to harness their resources to meet both their daily and monthly expenses while simultaneously investing in their own and their children’s future.

In short, understanding whether and how economic inequality affects those at the bottom of the income spectrum is central to the success and wellbeing of our nation.

State-by-state minimum to median wage ratios

Posted on November 5, 2014April 18, 2018 by David Evans

The data

Under “Downloads”, to your right, you will find the data used to create the interactive “Where does your state’s minimum wage rank against the median wage?”. Please cite the Washington Center for Equitable Growth if you use the data.

Methodology

The state-level minimum-to-median wage ratio is the ratio of the average of the state minimum wage to the state’s median wage in that year. The median wage is the median hourly wage in the Outgoing Rotation Group of the Current Population Survey of earners who work at least 35 hours per week and who are not self-employed. The national minimum-to-median wage ratio is the population-weighted mean of state minimum wages divided by the median national wage.

Stable families, prosperous economy

Posted on October 30, 2014April 18, 2018 by Casey Schoeneberger

The American Enterprise Institute published a new report earlier this week on the importance of marriage in the growth of family incomes. The topline data point that many news organizations picked up was this—“family incomes would be 44 percent higher if Americans weren’t shying away from the altar,” as U.S. News & World Report put it. The authors of the report— Urban Institute economist Robert I. Lerman and University of Virginia sociologist W. Bradford Wilcox, a visiting scholar at AEI—marshaled an impressive array of new data to examine the importance of family structure on rising income inequality in the United States.

Equally important is the need for further research on whether and how income inequality fosters the conditions that make achieving strong, stable marriages difficult for more and more Americans. Marriages do not happen in an economic vacuum, and inevitably must be sustained amid tough economic times. What’s more, the increasing diversity of family structures means these kinds of economic issues are important for all adults, regardless of marital status.

Research on how economic inequality affects the prospects for marriage among low- and middle-income Americans points to several equally telling trends. Economists Eric Gould at the Center for Economic Policy Research and Boston University’s M. Daniele Paserman detail that marriage rates fall in cities where wage inequality is highest. Economists Melissa S. Kearney at the University of Maryland and Phillip B Levine at Wellesley College find that the proportion of young women having children out of wedlock is greatest in cities with the highestincome inequality. And economist David S. Loughran at the Rand Corporation finds that rising male wage inequality explains 7 to 18 percent of the fall in marriage for white women between 1970 and 1990.

In short, growing economic uncertainty and wage stagnation among the bottom 90 percent of income earners means greater family instability. Indeed, sociologists Kathryn Edin at Johns Hopkins University and Maria Kefalas at St. Joseph’s University find that the main reason unmarried women hesitate to marry—even if they have a stable partner—is because they see family economic instability and the fear of divorce as a bigger threat than being single. What’s more, Levine and Kearney also find that out-of-wedlock teen pregnancy is often driven by economic despair.

The release of yesterday’s AEI report by Lerman and Wilcox is a timely reminder that marriage matters amid the swift-changing economic landscape for most families in the United States, but we must also keep in mind that economic inequality plays a big role in the decline in marriages. Without question, families today are more financially and socially unstable than they were 40 years ago, when the rise of economic inequality to near Roaring Twenties-levels today first began. And this instability is now part of a feedback loop that makes it more likely for the next generation of American families to be even more stressed and increasingly not married.

But there are policies that those across the political spectrum can agree on—policies that could create conditions that foster healthy relationships and family life. Lerman and Wilcox’s paper provides an excellent starting place for a conversation about an economic policy agenda that supports strong and stable families. In particular, their recommendations regarding the expansion of the earned income tax credit and the child tax credit merit more attention because they have the potential to incentivize work and stabilize the economic lives of low- and middle-class Americans. Similarly, the recommendation to expand vocational education and apprenticeship opportunities for young Americans holds promise for strengthening the employment and earnings prospects of low and moderate income Americans, especially men.

Additional ideas belong on the table as well. A higher minimum wage would boost the take-home pay of millions of young workers. Policies to address work-life conflicts (especially for young parents) would provide much-needed stability for individuals seeking to establish and maintain healthy relationship with their partner. And reliable, high-quality early child-care, preschool, and after-care would remove a major stress from many family relationships.

Then there are health and criminal issues that need addressing. Providing easy access to effective and inexpensive contraception would help prevent unintended pregnancies, allowing couples to plan stable, secure family formation. Addressing the incarceration rate and the life-long consequences of imprisonment is a key point of policy intervention as well, particularly for low-income African-American men.

On both sides of the political aisle, there are signs of a commitment to the idea of strong, stable families as a critical element of our economy’s long-term success. Yesterday’s report suggests an opening for a policy agenda that could address this challenge head-on.

Understanding economic inequality and growth at the middle of the income ladder

Posted on October 23, 2014April 18, 2018 by Heather Boushey

Recent shifts in our economy hit middle class families in ways that may directly affect both current and future productivity. Families in the middle of the income spectrum experienced very little income growth over the past several decades despite working more and often irregular hours. Between 1979 and 2007, the incomes of these families grew by just under 40 percent (after adjusting for inflation), but over that same time period their hours of work also increased.

Compared to 1979, middle class married couples in 2007 put in an average of 11 extra hours of work per week.Much of this added employment is due to the increased employment rates of women and mothers. Most dramatic is the increase in the share of mothers who work full-time, full-year (at least 50 weeks per year and at least 35 hours a week), which rose from 27.3 percent of mothers in 1979 to 46 percent of mothers in 2007 before declining somewhat to 44.1 percent, in the wake of the 2007-2009 recession.

The dramatic increase in women’s working hours certainly boosted household earnings. Middle class households would have substantially lower earnings today if women’s employment patterns had remained unchanged. And U.S. gross domestic product—the largest measure of economic growth—would have been roughly 11 percent lower in 2012 if women had not increased their working hours as they did. In today’s dollars, this translates to over $1.7 trillion less in output—roughly equivalent to total U.S. spending on Social Security, Medicare, and Medicaid combined in 2012.

But as more women enter the workforce and most men continue to work outside the home, parents are increasingly strapped for time. Given the importance of early childhood for a child and our nation’s future human capital, understanding how trends in our economy affect the next generation of workers is key to future economic growth. Economists have spilled a great deal of ink seeking to understand female employment patterns and what greater maternal employment means for families and, particularly, children’s wellbeing and development. Over the past decades, economists have begun focusing on how a child’s experiences between birth and starting kindergarten affect their future employment and earnings.

The three essays in this section of our conference report—by Stanford University sociologist Sean Reardon, Stanford’s Clayman Institute sociologist Marianne Cooper, and the Vice President and Director of the Children & Families Program at Next Generation, Ann O’Leary—explore how middle-income families are trying to balance work/life while providing their kids with the best opportunities available and how government policy can help create institutions that allow all workers to both contribute in the workplace and at home. —Heather Boushey is executive director and chief economist of the Washington Center for Equitable Growth

Download the full 2014 conference booklet, with full citations included for all of the essays, including those addressing the top of the income ladder on this page

Income inequality affects our children’s educational Opportunities

by Sean F. Reardon

One of the clearest manifestations of growing economic inequality in our nation today is the widening educational achievement gap between the children of the wealthiest and the children of everyone else. At first glance, this sounds like an obvious outcome. After all, wealthier families are able to afford expensive private schools, or homes in wealthy public school districts with more educational resources.

But a closer look at this education achievement gap over the past 50 years or so shows that the gap only began to widen in the 1970s, right about the time that wealth and income inequality in our nation also began to grow. The past 30 years have seen a sustained rise in inequality in wages, incomes, and wealth, leading to more and more income and wealth accruing to those at the top of the economic ladder, pulling the rich further away from those on the other rungs.

At the same time, the growing educational gap became ever more apparent. In the 1980s, the gap between the reading and math skills of the wealthiest 10 percent of kids and poorest 10 percent was about 90 points on an 800-point SAT-type scale. Three decades later, the gap has grown to 125 points. This widening gap is largely due to differences in how well prepared children are for school before they enter kindergarten or even pre-kindergarten. In this era of economic inequality, wealthier parents have far more resources, both in terms of time and money, to better prepare their children to succeed in school and later in life.

This widening educational achievement gap may threaten our future economic growth. With only a select few individuals receiving the best education and enrichment, we are not effectively developing the economic potential of our future workforce. To grow our economy we must provide educational and enrichment opportunities for children across the income spectrum, rather than only a select few at the top.

Wealth and income largely define the educational gap today, more so than race and ethnicity. In the 1950s and 1960s, the opposite was true. Back then, racial discrimination in all aspects of life led to deep racial inequality. Economic inequality, in contrast, was lower than at any time in U.S. history, according to extensive research done by economists Thomas Piketty at the Paris School of Economics and Emmanuel Saez at the University of California-Berkeley. But anti-discrimination and civil rights legislation and school desegregation led to improved economic, social, and educational conditions for African Americans and other minorities beginning in the late 1960s. As a result, the gap today between white and black children is about 70 points on an 800- point SAT-type scale, 40 percent smaller than it was in the 1970s, and about half the size of the gap between rich and poor children, but still unacceptable.

The growth of the socioeconomic achievement gap appears to be largely because more affluent parents are increasingly investing more time and money in their kids’ educational enrichment—and at earlier periods in their children’s lives—than hard-pressed low-income and middle class families. Indeed, surveys show that the amount of time and money parents invest in their children has grown sharply over the past four decades among both affluent and non-affluent parents. But the increase in these investments has been two to three times greater among high-income families. Economists Richard Murnane of Harvard University and Greg Duncan at the University of California-Irvine find that between 1972 and 2006 the amount high-income families spent on their children’s enrichment activities grew by 150 percent, while the amount spent by low-income families grew by 57 percent. In part, parents are spending more on their kids because they understand that educational success is increasingly important in today’s uncertain economic times, a point that sociologist Marianne Cooper at the Clayman Institute makes in her recent book “Cut Adrift.” But low- and middle-income families can’t match the resources—both the money and flexible time—of the rich.

As a result, rich and poor children score very differently on school readiness tests before they enter kindergarten. Once they are in school, however, the gap grows very little—by less than 10 percent between kindergarten and high school. Thus, it appears that the academic gap is widening because rich students are increasingly entering kindergarten much better prepared to succeed in school than low- and middle-class students. To be sure, there are important differences in the quality of schools serving low- and high-income students, but these differences do not appear to be as salient as the differences in children’s experiences prior to kindergarten.

The socioeconomic education gap is likely to affect us for decades to come. Think of it as a leading indicator of disparities in civic engagement, college enrollment, and adult success. Indeed, family income and wealth have become increasingly correlated with a variety of positive adolescent activities, such as sports participation, school leadership, extracurricular activities, and volunteer work, according to research conducted by Harvard University political scientist Robert D. Putnam and his colleagues.

Not only are the children of the rich doing better in elementary and high school than the children of the poor, they also are cornering the market on the seats in the best colleges. In a study that I conducted with several of my graduate students, we found that 15 percent of high-income students from the 2004 graduating class of high school enrolled in a highly selective college or university compared to only 5 percent of middle-income graduates and 2 percent of low-income graduates. Because these colleges provide educational opportunities and access to social networks that often lead to high-paying jobs, children from low-income families risk are being locked out of the upper end of the economic spectrum. For low-income children, the American Dream is further out of reach.

This is bad news for our future economy and society because we need well-educated workers in order to sustainably boost economic productivity and grow the economy. So how can we prepare every child, not just those most affluent ones, to be productive members of society? First of all, we must acknowledge that educational problems cannot be resolved by school alone. The achievement gap begins at an early age. To close it, we must invest in children’s early childhood educational opportunities. This means investing not only in preschool but also in parents. Specifically, we need to:

Invest in high-quality early childhood education programs (pre-schools, day care) and make them affordable for all families.
Invest in programs that help parents become their children’s first and best teacher.
Provide policy solutions to help all parents have the time to be teachers through paid leave, paid sick days, workplace flexibility, and income support programs that ensure that families can focus on their children even in hard economic times.

In short, we can narrow the socioeconomic education gap through public policies that help parents of all incomes provide enriching educational opportunities for their children in the way that only affluent parents can do today. —Sean F. Reardon is a sociologist at Stanford University

One nation under worry

by Marianne Cooper

As study after study shows, the rich are doing better than the rest of us. But surprisingly, they don’t always presume that their wealth will protect them or guarantee their children’s futures. In talking with families across the class spectrum about how they coping in an uncertain age for my new book, “Cut Adrift: Families in Insecure Times,” I learned that even the affluent families don’t think they have enough and strive to attain more. In contrast, the working- and middle-class families I spoke with realize they can’t do much to improve their situations so they lower their expectations and try to get by on less.

This is the new face of economic inequality in the United States today. Most everyone is dealing with economic insecurity, yet the ways in which families on different rungs of the income ladder are doing so may be fueling greater economic inequality.

Take Paul Mah, a technology executive with assets of more than $1 million. “We are probably in the top 1 percent of all American households,” says Mah, “so I can’t complain, but I still don’t feel rich.” Only accumulating millions more, he says, would enable him to stop feeling anxious about his financial future and the prospects of his children.

In contrast, Laura Delgado, a struggling single mother of three who works as a cashier, has zero savings, but in many ways is less concerned. “Having nothing isn’t always a bad thing,” she says, noting that things could always be worse. To cope with her financial trouble, Delgado scales back her definition of security to just the basics (food, shelter, clothing) and filters out bad news by always trying to look on the bright side of things. Her approach enables her to control the anxiety she feels about her difficult economic situation.

These are just two of the emotional stories behind the statistics documenting that we live in precarious times. As Americans scramble to hold on to jobs, deal with pay cuts, afford rising college tuition, fund retirements, manage debt, weather the costs of medical emergencies, and give their children an edge in an increasingly competitive world, there are deep psychological reverberations—for us all.

Of course these reverberations look and feel differently for different groups of Americans. As economic insecurity grows—a reflection of the many changes and challenges in our economy today—so too has the divide in our country between the haves and the have-nots. This means families face different obstacles and can overcome them, or not, depending on the resources at their disposal.

Like Laura Delgado, many middle- and working-class families I talked with are so beaten down that they are letting go of their dreams for a better life. Instead, they try to make the insecurity they face more tolerable. When Laura must choose whether to pay the power bill or put food on the table for example, she makes light of the lack of heat in her home by telling her kids it’s just “camping.”

Affluent families respond differently. Rather than trying to adjust to greater insecurity, they seek to protect their families by continuing to climb the wealth-and-income ladder. Security for some of the wealthiest families I talked with meant accumulating a net worth of more than $10 million. Such eye-popping definitions of security leave many affluent families more worried at times than their less fortunate compatriots further down the ladder.

In our go-it-alone age, we all adopt ways of coping—ways of thinking and feeling—that help us navigate through choppy and dangerous waters. These different approaches to managing insecurity reveal that in hard times the divisions among us are not just economic, they are also emotional.

Emotional disparities like these have real consequences. As the rich push for more and everyone else tries to accommodate to less, we actually make inequality worse. Because we treat economic insecurity as a personal problem rather than a social problem that we can solve collectively, we are unable to muster the will to stop it. —Marianne Cooper a sociologist at The Clayman Institute, Stanford University

Our future depends on early childhood investments

by Ann O’Leary

It is startling to think that even before a child sits down on her first day of kindergarten and reaches for her crayons, we can already reasonably predict what she will earn as an adult. Research shows that early language development, understanding of math concepts, and social emotional stability at age five are the greatest predictors of academic success in school. In fact, skills learned before age five can forecast future adult earnings, educational attainment, and employment.

These findings have real implications for our economy. Human capital—the level of education, skills, and talents of our workforce—is a main driver of economic growth, so in order to ensure we have a healthy workforce and thriving economy in the decades to come, we must begin by developing human capital during early childhood.

Yet rising economic inequality and unstable economic growth define our society today. Children have different enrichment experiences during this critical time period based on where their families sit on the income ladder. About half of children In the United States receive no early childhood education. These different experiences translate into a growing educational achievement gap between poor and rich children.

One study—often referred to as the famous “30 million word gap” study by University of Kansas child psychology professors Betty Hart and Todd R. Risley—finds that children living in poverty hear 30 million fewer words by age four than higher-income children.3 On average, a child from a low-income family knows 500 words by the age of 3, compared with 700 words for a child from a working-class family and 1,100 for a child from a professional family. Research by Stanford University infant psychology professor Anne Fernald and her colleagues found that by even age two, there is a six-month gap in language proficiency between lower-income and higher-income children.

In short, the educational achievement gap between poor and rich children begins well before kindergarten.

How can we better prepare our nation’s youngest generation for success? According to University of Chicago economist James J. Heckman, educational and enrichment investments during early childhood yield the highest return in human capital compared to other investments over time. Why? Because as the brain forms, children learn cognitive skills such as language and early math concepts as well as “soft” skills such as curiosity, self-control, and grit. Both skillsets are critical for later academic and workplace success. By the time a child enters Kindergarten, the gap in school readiness is large and well established, growing by less than 10 percent between Kindergarten and high school.

School readiness is enhanced by what happens in preschool, but the two factors that most explain the achievement gaps are parenting styles and home-learning environments. Yet many parents are unaware of the importance of early brain development and of the tremendous impact they can have in building their young child’s brain and early vocabulary with simple actions such as talking, reading and singing.

Even if parents are aware of the importance of these activities, they may have difficulty carving out time at home with their children as they juggle jobs and their children’s needs. Today, more children than ever are raised in single-parent families or in homes where both parents work. Parents today are constantly balancing work and family care often without access to family-friendly workplace policies to balance the two.

To be sure, if parents are unable to provide enriching home experiences then children can gain valuable developmental and learning support in quality child care and preschool settings. Yet many simply cannot afford childcare. In 2011, the average cost for a 4-year-old in professional childcare ranged from about $4,000 to $15,000 a year. Such costs put a major strain on family budgets, especially for low-income families, which spent nearly a third of their income on childcare (30 percent) in 2011, compared to middle- and higher-income families, which spent less than one-tenth (8 percent) of their income.

What’s more, low-income families who do strain to pay for child care often find that the care they can afford is, at best, a safe place for their child to stay while they are at work rather than an enriching environment for their young child to learn critical skills. Sadly, these families often discover that the affordable childcare provider offers poor or mediocre support to help their child in the critical stages of early childhood development.

In order to have a productive workforce and thriving economy tomorrow, we need to invest in our children today. There are viable policy solutions that could expand early childhood education and enrichment opportunities to all, rather than a select few at the top. First, voluntary home visits by child development professionals could increase awareness among working-class parents of how they can foster their children’s development at home, such as talking, reading, and singing to their children before bedtime.

Second, it is important to expand access to high-quality, affordable early childhood education. These programs better prepare children for school, putting children more than a year ahead in mathematics and other subjects. Low-income families would greatly benefit from expanded access to quality childcare, Early Head Start, and high-quality preschool programs.

Lastly, parents can only be better first teachers of their children if they have the time to be with their children. Policies such as workplace flexibility, paid family and medical leave, and paid sick days could help all working parents better manage work and family obligations and spend more time with their children. Today, professional workers are the most likely to have access to these policies, often considered additional employee “perks” by employers.

The importance of investing in early childhood matters for our overall economic competitiveness. The United States should be making smart economic investments in early childhood to ensure that all children have an equitable start before their first day of school. For the American Dream to shine well into the 21st century, it is no exaggeration to say that every American, young and old, needs our youngest ones to be the best and the brightest as adults no matter their family background and income level. —Ann O’Leary is vice president and director of the Children and Families Program at NextGeneration

Thomas Piketty, depreciation and the elasticity of substitution

Posted on October 20, 2014April 18, 2018 by Nick Bunker

When “Capital in the 21^st Century” was published in English earlier this year, Thomas Piketty’s book was met with rapt attention and constant conversation. The book was lauded but also faced criticism, particularly from other economists who wanted to fit Piketty’s work into the models they knew well (Equitable Growth’s Marshall Steinbaum replied to many of those criticism here.) Now, a new working paper by the National Bureau of Economic Research shows how one of the more effective critiques of the book might not be as powerful as once thought.

A particularly technical and effective critique of Piketty is from Matt Rognlie, a graduate student in economics at the Massachusetts Institute of Technology. Rognlie points out that for capital returns to be consistently higher than the overall growth of the economy—or “r > g” as framed by Piketty—an economy needs to be able to easily substitute capital such as machinery or robots for labor. In the terminology of economics this is called the elasticity of substitution between capital and labor, which needs to be greater than 1 for r to be consistently higher than g. Rognlie argues that most studies looking at this particular elasticity find that it is below 1, meaning a drop in economic growth would result in a larger drop in the rate of return and then g being larger than r. In turn, this means capital won’t earn an increasing share of income and the dynamics laid out by Piketty won’t arise.

Here are the technical details for Rognlie’s critique. He argues that Piketty doesn’t account for depreciation, or the wearing down of capital and machinery over time. Because firms need to replace this old capital, net investment in capital is lower than gross investment. This in turn means the net elasticity of substitution between capital and labor is necessarily lower than the gross elasticity. Rognlie argues that because Piketty cares about net measures, the elasticity of substitution between net capital and labor needs to be greater than 1. But if Piketty’s story depends upon an assumption of a net elasticity that is higher than 1, then that is far too high given what Rognlie finds in the empirical evidence.

Enter the new paper by economists Loukas Karabarbounis and Brent Neiman, both of the University of Chicago. Karabarbounis and Neiman previously documented the global decline in the share of income going to labor. The pair of scholars find that technology, through declines in the prices of investment goods, is responsible for the decline in the labor share.

Their new paper investigates how depreciation affects the measurement of labor share and the elasticity between capital and labor. Using their data set of labor shares income and a model, Karabarnounis and Neiman show that the gross labor share and the net labor share move in the same direction when the shift is caused by a technological shock—as has been the case, they argue, in recent decades. More importantly for this conversation, they point out that the gross and net elasticities are on the same side of 1 if that shock is technological. In the case of a declining labor share, this means they would both be above 1.

This means Rognlie’s point about these two elasticities being lower than 1 doesn’t hold up if capital is gaining due to a new technology that makes capital cheaper. To be clear, Rognlie is aware that this could happen, but Karabarbounis and Neiman’s data shows that it is happening. And as Karabournis and Neiman find a gross elasticity greater than 1, the net elasticity is greater than 1 as well.

In short, this new paper gives credence to one of the key dynamics in Piketty’s “Capital in the 21^st Century”—that the returns on capital can be higher than growth in the economy, or r > g. But this isn’t to say the case is closed. Far from it. The results as detailed by Karabournis and Neiman don’t hold up if the share of labor has declined for reasons other than technological change, such as globalization or institutional changes.

But for the second time in two weeks, a new empirical paper shows that Piketty’s work has strong empirical grounding.

Exploding wealth inequality in the United States

Posted on October 20, 2014April 18, 2018 by Ed Paisley

There is no dispute that income inequality has been on the rise in the United States for the past four decades. The share of total income earned by the top 1 percent of families was less than 10 percent in the late 1970s but now exceeds 20 percent as of the end of 2012. A large portion of this increase is due to an upsurge in the labor incomes earned by senior company executives and successful entrepreneurs. But is the rise in U.S. economic inequality purely a matter of rising labor compensation at the top, or did wealth inequality rise as well?

Before we answer that question (hint: the answer is a definitive yes, as we will demonstrate below) we need to define what we mean by wealth. Wealth is the stock of all the assets people own, including their homes, pension saving, and bank accounts, minus all debts. Wealth can be self-made out of work and saving, but it can also be inherited. Unfortunately, there is much less data available on wealth in the United States than there is on income. Income tax data exists since 1913—the first year the country collected federal income tax—but there is no comparable tax on wealth to provide information on the distribution of assets. Currently available measures of wealth inequality rely either on surveys (the Survey of Consumer Finances of the Federal Reserve Board), on estate tax return data, or on lists of wealthy individuals, such as the Forbes 400 list of wealthiest Americans.

Download the pdf version of this brief for a complete list of sources

In our new working paper, “Wealth Inequality in the United States since 1913: Evidence from Capitalized Income Tax Data,” we try to measure wealth in another way. We use comprehensive data on capital income—such as dividends, interest, rents, and business profits—that is reported on individual income tax returns since 1913. We then capitalize this income so that it matches the amount of wealth recorded in the Federal Reserve’s Flow of Funds, the national balance sheets that measure aggregate wealth of U.S. families. In this way we obtain annual estimates of U.S. wealth inequality stretching back a century.

Wealth inequality, it turns out, has followed a spectacular U-shape evolution over the past 100 years. From the Great Depression in the 1930s through the late 1970s there was a substantial democratization of wealth. The trend then inverted, with the share of total household wealth owned by the top 0.1 percent increasing to 22 percent in 2012 from 7 percent in the late 1970s. (See Figure 1.) The top 0.1 percent includes 160,000 families with total net assets of more than $20 million in 2012.

Figure 1

Figure 1 shows that wealth inequality has exploded in the United States over the past four decades. The share of wealth held by the top 0.1 percent of families is now almost as high as in the late 1920s, when “The Great Gatsby” defined an era that rested on the inherited fortunes of the robber barons of the Gilded Age.

In recent decades, only a tiny fraction of the population saw its wealth share grow. While the wealth share of the top 0.1 percent increased a lot in recent decades, that of the next 0.9 percent (families between the top 1 percent and the top 0.1 percent) did not. And the share of total wealth of the “merely rich”—families who fall in the top 10 percent but are not wealthy enough to be counted among the top 1 percent—actually decreased slightly over the past four decades. In other words, family fortunes of $20 million or more grew much faster than those of only a few millions.

The flip side of these trends at the top of the wealth ladder is the erosion of wealth among the middle class and the poor. There is a widespread public view across American society that a key structural change in the U.S. economy since the 1920s is the rise of middle-class wealth, in particular because of the development of pensions and the rise in home ownership rates. But our results show that while the share of wealth of the bottom 90 percent of families did gradually increase from 15 percent in the 1920s to a peak of 36 percent in the mid-1980, it then dramatically declined. By 2012, the bottom 90 percent collectively owns only 23 percent of total U.S. wealth, about as much as in 1940 (see Figure 2.)

Figure 2

The growing indebtedness of most Americans is the main reason behind the erosion of the wealth share of the bottom 90 percent of families. Many middle class families own homes and have pensions, but too many of these families also have much higher mortgages to repay and much higher consumer credit and student loans to service than before. For a time, rising indebtedness was compensated by the increase in the market value of the assets of middle-class families. The average wealth of bottom 90 percent of families jumped during the stock-market bubble of the late 1990s and the housing bubble of the early 2000s. But it then collapsed during and after the Great Recession of 2007-2009. (See Figure 3.)

Figure 3

Since the housing and financial crises of the late 2000s there has been no recovery in the wealth of the middle class and the poor. The average wealth of the bottom 90 percent of families is equal to $80,000 in 2012—the same level as in 1986. In contrast, the average wealth for the top 1 percent more than tripled between 1980 and 2012. In 2012, the wealth of the top 1 percent increased almost back to its peak level of 2007. The Great Recession looks only like a small bump along an upward trajectory.

How can we explain the growing disparity in American wealth? The answer is that the combination of higher income inequality alongside a growing disparity in the ability to save for most Americans is fuelling the explosion in wealth inequality. For the bottom 90 percent of families, real wage gains (after factoring in inflation) were very limited over the past three decades, but for their counterparts in the top 1 percent real wages grew fast. In addition, the saving rate of middle class and lower class families collapsed over the same period while it remained substantial at the top. Today, the top 1 percent families save about 35 percent of their income, while bottom 90 percent families save about zero.

The implications of rising wealth inequality and possible remedies

If income inequality stays high and if the saving rate of the bottom 90 percent of families remains low then wealth disparity will keep increasing. Ten or twenty years from now, all the gains in wealth democratization achieved during the New Deal and the post-war decades could be lost. While the rich would be extremely rich, ordinary families would own next to nothing, with debts almost as high as their assets. Paris School of Economics professor Thomas Piketty warns that inherited wealth could become the defining line between the haves and the have-nots in the 21^st century. This provocative prediction hit a nerve in the United States this year when Piketty’s book “Capital in the 21^st Century” became a national best seller because it outlined a direct threat to the cherished American ideals of meritocracy and opportunity.

What should be done to avoid this dystopian future? We need policies that reduce the concentration of wealth, prevent the transformation of self-made wealth into inherited fortunes, and encourage savings among the middle class. First, current preferential tax rates on capital income compared to wage income are hard to defend in light of the rise of wealth inequality and the very high savings rate of the wealthy. Second, estate taxation is the most direct tool to prevent self-made fortunes from becoming inherited wealth—the least justifiable form of inequality in the American meritocratic ideal. Progressive estate and income taxation were the key tools that reduced the concentration of wealth after the Great Depression. The same proven tools are needed again today.

There are a number of specific policy reforms needed to rebuild middle class wealth. A combination of prudent financial regulation to rein in predatory lending, incentives to help people save—nudges have been shown to be very effective in the case of 401(k) pensions—and more generally steps to boost the wages of the bottom 90 percent of workers are needed so that ordinary families can afford to save.

One final reform also needs to be on the policymaking agenda: the collection of better data on wealth in the United States. Despite our best efforts to build wealth inequality data, we want to stress that the United States is lagging behind in terms of the quality of its wealth and saving data. It would be relatively easy for the U.S. Treasury to collect more information—in particular balances on 401(k) and bank accounts—on top of what it already collects to administer the federal income tax. This information could help enforce the collection of current taxes more effectively and would be invaluable for obtaining more precise estimates of the joint distributions of income, wealth, saving, and consumption. Such information is needed to illuminate the public debate on economic inequality. It is also required to evaluate and implement alternative forms of taxation, such as progressive wealth or consumption taxes, in order to achieve broad-based and sustainable economic growth.

Emmanuel Saez is a professor of economics and director of the Center for Equitable Growth at the University of California-Berkeley. Gabriel Zucman is an assistant professor of economics at the London School of Economics.

Understanding economic inequality and growth at the top of the income ladder

Posted on October 15, 2014April 18, 2018 by Heather Boushey

Thanks in large part to the ground-breaking work of Paris School of Economics professor Thomas Piketty, and his co-authors, including University of California-Berkley economics professor Emmanuel Saez, we know that we are living in an era of widening inequality. The share of post-tax-and-transfer income going to the top 1 percent of earners increased from nearly 8 percent in 1979 to about 17 percent in 2007. Over the course of the current economic recovery, the top 1 percent has received 95 percent of all pre-tax income gains—seeing a 31 percent increase in their incomes—while the bottom 99 percent saw a meager 0.4 percent increase.

Economists hypothesize several reasons for this sharp increase in income inequality, among them rising pay for chief executives and other senior executives, increasing returns to superstar workers, the rise of the financial industry, and the decline in top-income tax rates.But this debate is far from over. And the issue is not just income inequality. Economic inequality is on the rise across a variety of dimensions, including wealth. According to research by Saez and Gabriel Zucman, assistant professor of economics at the London School of Economics, the share of wealth owned by the top 0.01 percent has increased 4-fold over in the past 35 years.

Piketty’s data makes the case that the steady accumulation of wealth at the top of the income spectrum is one of the most important ways that income inequality affects our economy. While there may be a theoretical argument for why higher incomes provide greater incentives for individual effort or inventing the next “big thing,” it may also be that, beyond a certain point, income and wealth inequality dampens incentives as the wealthy increasingly seek to preserve their wealth rather than risk it in potentially productive endeavors while the non-wealthy are locked out due to “opportunity hoarding” by those at the top.

One fundamental issue that Piketty’s book, “Capital in the 21st Century,” compels us to consider is the interaction between the flow of income and the stock of wealth. Does today’s flow of income to the very top of the economic ladder calcify into tomorrow’s wealth inequality? After all, the very high incomes that some people earn will allow them to build larger and larger stocks of capital over time.

Do we need to address rising income or wealth inequality in order to save our capitalist economy? How can we do so without hurting the vibrancy of today’s economy? The three essays in this section of our conference report—by UC-Berkeley economist Emmanuel Saez, Michael Ettlinger, founding director of the University of New Hampshire Carsey School of Public Policy, and Northwestern University sociology PhD candidate Fiona Chin—discuss the state of top incomes, the consequences of their rise, and possible policies to promote more widely shared economic growth. —Heather Boushey

Download the full 2014 conference booklet, with full citations included for all of the essays, including those addressing the top of the income ladder on this page

The Explosion of U.S. Income and Wealth Inequality

by Emmanuel Saez

In the United States today, the share of total pre-tax income accruing to the top 1 percent has more than doubled over the past five decades. The wealthy among us (families with incomes above $400,000) pulled in 22 percent of pre-tax income in 2012, the last year for which complete data are available, compared to less than 10 percent in the 1970s. What’s more, by 2012 the top 1 percent income earners had regained almost all the ground lost during the Great Recession of 2007-2009. In contrast, the remaining 99 percent experienced stagnated real income growth—after factoring in inflation—after the Great Recession.

Another less documented but equally alarming trend has been the surge in wealth inequality in the United States since the 1970s. In a new working paper published by the National Bureau of Economic Research, Gabriel Zucman at the London School of Economics and I examined information on capital income from individual tax return data to construct measures of U.S. wealth concentration since 1913. We find that the share of total household wealth accrued by the top 1 percent of families— those with wealth of more than $4 million in 2012—increased to almost 42 percent in 2012 from less than 25 percent in the late 1970s. Almost all of this increase is due to gains among the top 0 .1 percent of families with wealth of more than $20 million in 2012. The wealth of these families surged to 22 percent of total household wealth in the United States in 2012 from around 7.5 percent in the late 1970s.

The flip side of such rising wealth concentration is the stagnation in middle-class wealth. Although average wealth per family grew by about 60 percent between 1986 and 2012, the average wealth of families in the bottom 90 percent essentially stagnated. In particular, the Great Recession reduced their average family wealth to $85,000 in 2009 from $130,000 in 2006. By 2012, average family wealth for the bottom 90 percent was still only $83,000. In contrast, wealth among the top 1 percent increased substantially over the same period, regaining most of the wealth lost during the Great Recession.

For both wealth and income, then, there is a very uneven recovery from the losses of the Great Recession, with almost no gains for the bottom 90 percent, and all the gains concentrated among the top 10 percent, and especially the top 1 percent. How can we explain such large increases in income and wealth concentration in the United States and what should be done about it?

Contrary to the widely held view, we cannot blame everything on globalization and new technologies. While large increases in income concentration occurred in other English-speaking countries such as the United Kingdom or Canada, other developed-nation members of the Organisation for Economic Cooperation and Development, such as those in continental Europe or Japan, experienced far smaller increases in income concentration. At the same time, income tax rates on upper income earners have declined significantly since the 1970s in many OECD countries, particularly in English-speaking ones. Case in point: Top marginal income tax rates in the United States and the United Kingdom were above 70 percent in the 1970s before President Ronald Reagan’s administration and Prime Minister Margaret Thatcher’s government drastically cut them by 40 percentage points within a decade.

New research I published this year with Paris School of Economics professor Thomas Piketty and Stefanie Stantcheva at the Massachusetts Institute of Technology shows that, across 18 OECD countries with sufficient data, there is indeed a strong correlation between reductions in top tax rates and increases in the top 1 percent’s share of pre-tax income from the 1960s to the present. Our research shows that the United States experienced a 35-percentage point reduction in its top income tax rate and a ten-percentage point increase in the share of pre-tax income earned by the top 1 percent. In contrast, France and Germany saw very little change in their top tax rates and the share of pre-tax income accrued by the top 1 percent over the same period.

The evolution of top tax rates is a good predictor of changes in pre-tax income concentration. There are three scenarios to explain the strong response of top pre-tax incomes to top tax rates. They have very different policy implications and can be tested in the data.

First, higher top tax rates may discourage work effort and business creation among the most talented—the so-called supply-side effect of higher taxes. In this scenario, lower top tax rates would lead to more economic activity by the rich and hence more economic growth. Yet the overwhelming evidence shows that there is no correlation between cuts in top tax rates and average annual real (inflation-adjusted) GDP-per-capita growth since the 1960s. Countries that made large cuts in top tax rates, such as the United Kingdom and the United States, have not grown significantly faster than countries that did not, such as Germany and Denmark.

Second, higher top tax rates could increase tax avoidance. In that scenario, increasing top rates in a tax system riddled with loopholes and tax avoidance opportunities is not productive. A better policy would be first to close loopholes in order to eliminate most opportunities for tax avoidance and only then increase top tax rates. Conservative commentators argue that the surge in pre-tax incomes discussed above could be indicative of tax avoidance in the 1970s, when top earners were presumably hiding a large fraction of their income amid high taxes.

If this tax avoidance scenario were true, then charitable giving among top earners should have decreased once top tax rates were cut. After all, charitable giving is tax deductible and thus is more advantageous precisely when top tax rates are high. In fact, charitable giving among the rich surged pretty much in the same proportion as their reported incomes over the past several decades. If the rich are able to give so much more today than in the 1970s, it must be the case that they are truly richer.

Third, while standard economic models assume that pay reflects productivity, there are strong reasons to be skeptical, especially at the top of the income ladder where the actual economic contribution of managers working in complex organizations is particularly difficult to measure. In this scenario, top earners might be able partly to set their own pay by bargaining harder or influencing executive compensation committees. Naturally, the incentives for such “rent-seeking” are much stronger when top tax rates are low.

In this scenario, cuts in top tax rates can still increase the share of total household income going to the top 1 percent at the expense of the remaining 99 percent. In other words, tax cuts for the wealthiest stimulate rent-seeking at the top but not overall economic growth—the key difference from the supply-side scenario that justified tax cuts for high income earners in the first place.

Up until the 1970s, policymakers and public opinion probably considered—rightly or wrongly—that at the very top of the income ladder pay increases reflected mostly greed or other socially wasteful activities rather than productive work. This is why policymakers were able to set marginal tax rates as high as 80 percent in the United States and the United Kingdom. The Reagan-Thatcher supply side revolutions succeeded in making such top tax rate levels unthinkable, yet after decades of increasing income concentration alongside mediocre economic growth since the 1970s followed by the Great Recession, a rethinking of that supply side narrative is now underway.

Zucman and I show in our new working paper that the surge in wealth concentration and the erosion of middle class wealth can be explained by two factors. First, differences in the ability to save by the middle class and the wealthy means that more income inequality will translate into more inequality in savings. Upper earners will naturally save relatively more and accumulate more wealth as income inequality widens.

Second, the saving rate among the middle class has plummeted since the 1980s, in large part due to a surge in debt, in particular mortgage debt and student loans. With such low savings rates, middle class wealth formation is bound to stall. In contrast, the savings rate of the rich has remained substantial.

If such trends of growing income inequality and growing disparity in savings rates between the middle class and rich persist, then U.S. wealth inequality will continue to increase. The rich will be able to leave large estates to their heirs and the United States could find itself becoming a patrimonial society where inheritors dominate the top of the income and wealth distribution as famously pointed out by Piketty in his new book “Capital in the 21st Century.”

What should be done about the rise of income and wealth concentration in the United States? More progressive taxation would help on several fronts. Increasing the tax rate as incomes rise helps curb excessive and wasteful compensation of top income earners. Progressive taxation of capital income also reduces the rate of return on wealth, making it more difficult for large family fortunes to perpetuate themselves over generations. Progressive estate taxation is the most natural tool to prevent self-made wealth from becoming inherited wealth. At the same time, complementary policies are needed to encourage middle class wealth formation. Recent work in behavioral economics by Richard Thaler at the University of Chicago and Cass Sunstein at Harvard University shows that it is possible to encourage savings and wealth formation through well-designed programs that nudge people into savings. –Emmanuel Saez is a professor of economics and Director of the Center for Equitable Growth at the University of California-Berkeley

Addressing Economic Inequality Requires a Broad Set of Policies and Cooperation

by Michael Ettlinger

There are any number of policies suggested by policymakers, academics and commentators for addressing economic inequality. A representative sample would include tax redistribution, improving education, raising the minimum wage, direct government job creation, employer hiring incentives, subsidized child care, better retirement security, a stronger social safety net, direct middle- and low-income subsidies, ending the socialization of environmental degradation, aggressive financial market regulation, stronger trade unions, more investment in public goods (paid for by the better off), socially responsible trade policy, immigration reform, corporate governance changes, and campaign finance reform.

That’s certainly a formidable list, but interestingly most analysts and advocates who care about economic inequality focus on just one or two of these—typically offering a concise, but ultimately unsatisfying recipe. Given the rapidly rising levels of inequality, when one reads the typical, short, policy agenda, it’s hard not to have a feeling of ennui—a sense that the solution offered falls well short of what’s needed to solve the problem or is completely impractical.

It is, for example, hard to believe that better educational opportunities is the complete answer. Improving education has huge virtue in terms of economic advancement at the individual level, creating opportunity, personal fulfillment, and overall economic growth. But, aside from anything else, at the rate we’re going, we’ll have again doubled our level of inequality by the time substantial numbers of people are likely to benefit from improved education. And it’s not like we’ve licked how exactly to improve education or that it’s clear that improved education solves the problem.

After all, if the result of boosting educational attainment is simply more competition for a slowly increasing number of jobs that require further education, then the effect might primarily be that different people are on the winning and losing ends of inequality, not a lessening of inequality itself—at least from a global perspective. And the historical record is not encouraging. So, we should improve education, but we shouldn’t count on it as the silver bullet for addressing inequality.

There are other policies, of course, that are blunter instruments and clearly could fundamentally change the distribution of income and wealth. Taxes are the most clear cut example. If we take a sizable portion of the income of the wealthy and, one-way-or-another, distribute it to everyone else, inequality would, unequivocally, be reduced (call this the Sherwood Forest approach). But redistribution on that scale is unlikely and, at truly the scale that would be needed to reduce the levels inequality to what it was even a few years ago, would probably be damaging to the overall economy. While there is ample evidence that the moderately higher levels of income tax on the well off are not the economic disaster sometimes claimed, addressing extreme economic inequality exclusively through the income tax could get us to the point at which higher taxes do cause harm. As with education, raising income taxes on the wealthy is not, alone, the answer.

“Wealth” or “capital” taxes on the assets of the better off, another favored approach, face a number of practical limitations. One problem in the United States is that a federal wealth tax would almost certainly require an amendment to the constitution. But even aside from that “technicality,” there is a limit to what one could reasonably expect to accomplish with a wealth tax.

One of the virtues of an income tax is that it taxes money going between two parties who both are typically required to inform the tax authorities of the transaction—so to outright cheat on taxes requires the complicity of at least two people. It happens, but the requirement of trust limits it. Wealth, in contrast, can be held without active engagement of another party.

Another virtue of an income tax is that if the transaction is honest then the dollar amount involved is usually clear-cut. That is less true for a tax on wealth. Assets held in publicly traded corporations or real estate in areas where there are frequent land deals are relatively easy. But the valuation of closely held corporations, let alone art and obscure intellectual property rights, can be extremely difficult—and one can count on more wealth ending up in those forms if a substantial wealth tax were put in place. A very small wealth tax would not necessarily spark this sort of tax avoidance. A substantial one would.

I can make similar arguments for almost the entire list I started with. Even if one believes that the minimum wage is too low, most everyone would agree that it can be too high. Even if one believes that our trade regimes are a factor in increasing inequality and that reforms are needed, overly restrictive policies would be counterproductive. Even if you believe that the outsized incomes from Wall Street are a consequence of power and influence—not genuine contributions to our overall prosperity—the national economy would surely be hurt if we tried to address economic inequality purely through restraints on the financial sector.

If you didn’t have ennui when you started reading this you probably do now. But the point isn’t that it’s impossible to address income inequality. The point is that it’s going to take a range of approaches. And, arguably, a range of approaches is easier to accomplish than trying to put all of one’s eggs in a single basket. If the whole solution doesn’t depend on a confiscatory tax on the wealthy, or vastly increasing educational attainment, or world-wide consensus on a socially responsible, equitable, trade agreement—but instead on incremental change in range of areas—that is a much less daunting task.

There are agreements to be had in many of these areas. None of those individual policies will be at the scale needed to address inequality in a meaningful way, but together they can add up to make a difference.

There are reasons to do this. Extreme inequality leaves many people having harder lives than is necessary while, at the other end of the spectrum, personal wealth can reach a point where its growth does little to improve the lives of its beneficiaries—with the overall result being a net reduction in the aggregate quality of life. And there are real dangers to our society of such severe stratification. It’s an issue that is going to require a broad range of effort and cooperation around the world to address. But it’s achievable if we don’t try to accomplish it with just one or two highly contested policies. — Michael Ettlinger is the founding director of the Carsey School of Public Policy at the University of new Hampshire

What the Wealthy Know and Believe About Economic Inequality

by Fiona Chin

The wealthiest one percent among us in the United States are pulling away from everyone else, a trend documented by numerous economists and highlighted often by the media. Despite all this attention on inequality, there is a dearth of empirical research on what the wealthy know and believe to be true about this trend.

Recent research on social stratification and mobility in our country examines the beliefs of ordinary Americans about the growing wealth and income gaps, but few academics are talking directly to the wealthiest Americans about their own perceptions. It is notoriously difficult to interview wealthy subjects. It is hard to find them, given their scarcity in the population. Once you identify possible subjects, it is hard to gain their cooperation, particularly when discussing topics they find uncomfortable, such as income and wealth inequality.

How the very affluent view economic inequality is important because what they know and think influences how they interact with our political leaders responsible for translating these views into public policies. If policymakers respond disproportionately to the affluent and the majority of the wealthy do not favor government programs to ameliorate inequality then it is especially important for scholars and policy experts to learn what ideas and preferences the wealthy embrace. In contrast, if the majority of the very affluent favor steps to rectify the wealth and income gaps, then policymakers can consider enacting programs that are favored more by the general public.

I study wealthy Americans to find out what they believe about income and wealth inequality.1 My data come from two sources. The first is the Survey of Economically Successful Americans and the Common Good, or SESA, which was pioneered by Northwestern University political science professor Benjamin Page and Vanderbilt University political science professor Larry Bartels and funded by the Russell Sage Foundation.2 NORC at the University of Chicago conducted the survey in 2011. Respondents had an average of $14 million in household wealth (median of $7.5 million), making the sample representative of the wealthiest one-to-two percent of Chicago-area residents.

Most national surveys with representative samples capture very few respondents from the top of the wealth distribution. While it targets the Chicago metropolitan area, SESA is among the very few data sets on the wealthy and includes questions on a variety of topics, from economic mobility to taxes, retirement, philanthropic and charitable volunteering and giving, and other areas. As a survey, however, SESA was limited in the depth to which respondents could answer any particular question.

Upon reviewing the original survey sheets with interviewer notations in the margins, I found that the wealthy were eager to express more nuance than closed-ended survey responses provided. To complement the survey data with more detail, I am compiling a second source of information by conducting in-depth interviews with economically successful Americans from across the country. These interviews focus much more specifically on subjects’ beliefs about economic inequality and mobility, politics, and public policy.

As of August 2014, I have conducted 89 interviews ranging from 45 minutes to three hours in length. I spoke with top income earners and top wealth holders, who I recruited based on the chain-referral method. Although my sample is not statistically representative, this methodology has allowed me to collect data on the beliefs of wealthy Americans from different geographic regions and backgrounds. Interview respondents had an average of $8.2 million in household wealth (median of $4.7 million). The interview sample was not as wealthy as the SESA sample overall, but more than half of my interviewees were within the top one percent of the income or wealth distributions. Interview subjects were from 18 different metropolitan areas across 15 states and the District of Columbia and worked in a variety of occupations and industries.

Despite the methodological differences, the interview questions that duplicated SESA questions yielded very similar patterns of answers. My research is on-going, but I have some preliminary results to share, with the important caveat that I am continuing to analyze my data and hope to conduct approximately ten more interviews.

The wealthy are aware of economic inequality and recognize that it has grown in recent decades. In the SESA data and my own in-depth interviews, the vast majority of respondents knew that income inequality is larger today than it was 20 years ago. They also tended to express a desire for a lower level of income inequality. Approximately two-thirds of respondents believed that income differences in our society are too large.

The wealthy also recognize that the distribution of wealth across society is very skewed. In fact, they tend to overestimate the proportion of wealth held by the top one percent. Based on the SESA data and my preliminary interviews, the median perception of the respondents so far was that the top one percent hold approximately half of all U.S. wealth. (According to New York University economist Edward Wolff, the wealthiest one percent held a 35 percent share of the country’s household net worth, as of 2007.3) In my interviews, I also probe subjects about how large a share the wealthiest one percent “ought” to hold. Only about two-fifths of interview respondents believed that the wealthiest one percent ought to hold less.

In short, both survey and interview respondents tended to agree that income inequality is too high. But my interview data show that the wealthy did not necessarily believe that there should be less wealth inequality.

As much as the wealthy appear to be aware of growing economic inequality, they did not necessarily favor any kind of public intervention to remedy or ameliorate the trend. In fact, the wealthiest SESA respondents favored cutting back federal government programs such as Social Security, job programs, health care, and food stamps. Only 17 percent of SESA respondents thought that the government should “redistribute wealth by heavy taxes on the rich.”

Among my interviewees, very few were in favor of raising taxes to redress economic disparities, although a minority supported public intervention in the form of job training and other programs aimed at increasing economic opportunity. In general, many interview subjects were very pessimistic about the future of inequality trends and did not foresee any slow down in the growing bifurcation between the wealthy and the rest of society.

As a group, then, the wealthy are well informed about current events and public affairs, according to my preliminary interviews and the SESA data. They pay attention to the news and are very politically active, so understanding and considering their preferences are important. My preliminary findings indicate two emerging patterns: The wealthy know that economic inequality is rising, but they do not agree that anything should or can be done to reverse the trend. My analysis is at an early stage, and much more research must be done in this arena in order to inform a productive dialogue between scholars and policymakers. –Fiona Chin is Ph.D. candidate in sociology at Northwestern University and a graduate research assistant at the Institute for Policy Research

How are economic inequality and growth connected?

Posted on October 8, 2014May 14, 2019 by Ed Paisley

In the mid-20th century, economists began witnessing inequality’s decline in the developed world. Prior to the two World Wars and Great Depression, rising inequality was characteristic of most of the developed world, but in the aftermath of the upheavals, the trend reversed. At the time, many reasoned that declining inequality was a natural outgrowth of the development process: As countries become more economically mature, inequality would fall. This trend led Nobel Laureate economist Simon Kuznets to write:

“One might thus assume a long swing in the inequality characterizing the secular income structure: widening in the early phases of economic growth when the transition from the pre-industrial to the industrial civilization was most rapid; becoming stabilized for a while; and then narrowing in the later phases.”

Given the narrowing of inequality in the more economically developed nations, Kuznets’ analysis suggested that the inequality in poorer countries was a transitional phase that would reverse itself once these nations became more economically developed. Thus, similar to how the level of inequality was decreasing in wealthy nations, inequality would eventually decline in poorer countries as they became richer. In fact, some economists theorized that inequality in the less developed world was actually good for growth because it meant that the economy was generating select individuals wealthy enough to provide the savings necessary for investment-led growth.

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Today, the world looks very different than it did in 1955 when Kuznets made his famous assertion. In the past several decades, economic inequality in the United States and other wealthy nations has risen sharply, spurring renewed interest in the question of whether and how changes in income distributions affect economic wellbeing. Over the same time period, economic inequality has persisted and even grown in many poorer economies.

These trends have sparked economists to conduct empirical studies, analyzing data across states and countries, to see if there is a direct relationship between economic inequality, and economic growth and stability. Early empirical work on this question generally found inequality is harmful for economic growth. Improved data and techniques added to this body of research, but the newer literature was generally inconclusive, with some finding a negative relationship between economic growth and inequality while others finding the opposite.

The latest research, however, provides nuance that can explain many of the conflicting trends within the earlier body of research. There is growing evidence that inequality is bad for growth in the long run. Specifically, a number of studies show that higher inequality is associated with slower income gains among those not at the top of the income and wealth spectrum.

Economists and policymakers today should not be surprised that empirical studies were inconclusive given the broad theoretical (and sometimes contradictory) reasons that hypothesized inequality would both promote growth and inhibit growth. On the one hand, hundreds of years of economic theory has been built on the hypothesis that inequality in outcomes creates incentives for individuals to work hard or be more productive than others in order to receive greater incomes—activity that spurs growth. In addition, many theorized that inequality would help individuals become rich enough to save some of their earnings and fund investments necessary to produce economic growth.

On the other hand, economic theory also suggests the opposite—that inequality may inhibit the ability of some talented but less fortunate individuals to access opportunities or credit, dampen demand, create instabilities, and undermine incentives to work hard, all of which may reduce economic growth. Growing inequality could also generate a relatively larger group of low-income individuals who are less able to invest in their health, education, and training, thereby retarding economic growth.

In this paper, we review the recent empirical economic literature that specifically examines the effect inequality has on economic growth, wellbeing, or stability. This newly available research looks across developing and advanced countries and within the United States. Most research shows that, in the long term, inequality is negatively related to economic growth and that countries with less disparity and a larger middle class boast stronger and more stable growth. Some studies do suggest that in the short run, inequality may spur growth before hindering it over the longer term, but overall there is growing evidence that, in the long run, more equitable societies are associated with higher rates of growth.

In looking at studies that directly estimate the effect of inequality on growth, there are concerns about data quality and statistical methodology. The purpose of these studies is to establish whether economic inequality has some effect on economic growth or stability. For researchers, there are important two questions: is there a causal relationship between inequality and growth? If so, can researchers actually identify this factor, or are they actually measuring the effect of some other factor. Establishing causality is exceptionally difficult in the social sciences and the standard approach employed for studying relationships between inequality and growth has been to look at the level of inequality preceding the growth period being measured. This does not firmly establish causality but can be indicative of it. On the other hand, the approaches for detecting the relationship vary widely by the statistical design, the data, controls included. Given enough time and flexibility in their specifications, economists have demonstrated an ability to draw a variety of conclusions. The best practices in this area are evolving and so it is important to look at the breadth of the literature, rather than focus on a single paper or approach.

Important as well for the purposes of this paper is this—the latest economic research we reviewed only examines the outcome of whether there are results for regressions that demonstrate positive or negative relationships between inequality and economic growth and stability. This means the paper cannot provide clear guidance for policymakers on exactly how to address inequality or mitigate its effects on growth. In other words, the research examined in this paper generally does not identify the channels or mechanisms by which inequality affects growth.

An additional issue (above and beyond the challenges of how to specify a model) is the paucity of data to evaluate questions about inequality and growth. Ideally, economists would want a variety of measures for inequality, including earnings, income, and wealth, that can be compared across a large number of countries over a long period of time. Sadly, such a perfect data set does not exist. Therefore, econ- omists are left to do the best estimates with the data at hand. Over time, though, the data sets that have been used to perform these analyses have been improving.

Other scholars who have examined this literature have also come to the conclu- sion that to inform policymaking, we need to do more than search for a mechanis- tic relationship between inequality and growth. Dani Rodrik, the former Harvard University professor now at the Institute of Advanced Studies, underscores the limitations of this kind of research, arguing that methods for analyzing data that span across places and time are ill-suited to address the fundamental questions about the relationship of government policy and inequality with growth outcomes. This conclusion is echoed by University of Melbourne economist Sarah Voitchovsky in her recent review of the literature in the “Oxford Handbook on Economic Inequality,” where she says:

“While data constraints continue to limit the type of empirical analyses that can be undertaken, investigations that focus on specific channels generally provide more robust conclusions than evidence from reduced form analyses.”

This paper does not contain policy advice. Instead, it contains analysis that largely demonstrates there are direct, and possibly causal, relationships between economic inequality and growth—places that begin with a lower level of inequality subsequently tend to grow faster and have longer periods of growth than those with a higher level of inequality. In future research, we will focus on the channels through which inequality could or does affect economic growth.

All American youth need opportunities to grow our economy

Posted on October 3, 2014April 18, 2018 by Ed Paisley

Fast forward to 2030, when the last baby boomers are moving into retirement, the millennials are middle aged, and within 10 years about 50 percent of the U.S. population will be people of color. This demographic destiny—coming our way amid rising economic inequality and inadequate investments for growth—will define our nation’s economic strength in the 21^st century. In 15 years, the needs of an aging population and the earnings power and capacity of our workforce to drive growth and support a thriving U.S. economy will simply not match up.

Unless we do something about it now.

Economic research on the overall earnings of young people entering the workforce in the teeth of the recessions indicates their future earnings power will be stunted by their poor job prospects and low starting wages. These adverse economic conditions further constrict the already limited employment prospects for 16-to-24 year olds—disproportionately individuals of color—who are neither in school nor in the workforce.

There are at least 6.7 million Opportunity Youth nationwide, or about one-sixth of the U.S. youth population. These youth do not have the skills and education they need to productively contribute in our society. Their disconnection—often precipitated or exacerbated by the failure of critical education, training, and social service systems—places an enormous and unnecessary economic burden on our nation. The direct service costs and the losses that will accrue in the form of forgone earnings and taxes over their lifetime are estimated at $4.75 trillion.

Yet this same segment of the population is expected to help generate wealth to maintain the intergenerational social contract encapsulated in Social Security, Medicare and Medicaid. To ensure a productive workforce that can also shoulder the costs associated with an aging population, we need to invest in our talent pipeline. And because people of color will account for all of net workforce growth in the United States by 2030, our economic vitality demands that the education and workforce systems meet their needs—not just the “talented tenth,” but all American youth.

Improving life outcomes for future generations of children is a moral imperative and an economic necessity. We need to ensure opportunity youth become productive, active members of society— and in doing so, eliminate the inevitable societal loss if we continue down our current path. These youth are a vital but as yet untapped source of intellectual energy, cultural vitality, and innovation. But for their talents to achieve escape velocity, we must work with them to overcome significant barriers.

We should start by making sure our education system meets their needs. Innovative models that bridge high school and postsecondary education have demonstrated success at increasing completion rates of students from backgrounds underrepresented in higher education. Early college high schools, for example, provide opportunities for students to earn an Associate’s degree or significant college credits while still in high school. There is variation—some early college high schools are located on a college campus while others bring college faculty to high schools—but the main idea is the same: exposing students to a college environment early and providing support while setting high expectations.

These programs are based on the need for every student to continue their education after high school and a belief that students’ past failures do not define their educational potential. This design has produced dramatic outcomes for students including our opportunity youth. One in three early college students complete an Associate’s degree or other credential prior to graduating high school, whereas nationally only 10 percent of students earn any college credit in high school. Early college high school students are also more likely to graduate from high school, enroll in college, and persist for a second year.

Despite impressive results, the availability of these types of programs remains limited. According to analysis by Jobs for the Future, there are 280 early college high schools in 32 states, with an additional 56 new schools under development. In order to ensure that our opportunity youth have a chance to participate in high-growth occupational sectors and realize their full potential, we must move beyond our current status, which is best described as “program rich but system poor.” Instead, we must retool our education systems at the local, state, and federal level to help scale successful models of early college high schools.

We have examples of young people beating the odds, but that’s not enough. To continue to drive growth in the economy, we need to change the odds so that we capture the overlooked and underutilized talent of a significant portion of those 6.7 million opportunity youth. Smart education and workforce training policies, enacted now, can change the earning power and career trajectories for millions of these youth. That’s the America we must create in order to secure our economic future in 2030 and beyond.

Melody Barnes is the former Domestic Policy Advisor to President Obama and now Vice Provost for Global Student Leadership Initiatives at New York University, Chair of the Aspen Institute Forum for Community Solutions, a member of the Year Up national board of directors, and a steering committee member of the Washington Center for Equitable Growth, a new grantmaking and research institution.

U.S. Census highlights rising economic inequality

Posted on September 25, 2014April 18, 2018 by Ed Paisley

The U.S. Census Bureau’s latest set of annual reports on income, poverty, and health insurance coverage in the United States demonstrates that economists and policy makers alike need to come to grips with the short- and long-term affects of economic inequality on economic growth and prosperity. The two reports present data for 2013, four and half years after the official start of the economic recovery from the Great Recession that began in December 2007 and ended in June 2009. Although there are a few bright spots, most of the data reported are dismal and the implications for income inequality are disturbing.

Most tellingly, the long-term trend lines in rising income inequality are essentially unchanged over more than four decades—across several business cycles—which means we need to understand the short- and long-term factors that result in stagnant incomes for all but the most wealthy. So let’s parse the numbers.

The first report deals with income and poverty while the second report describes health insurance coverage. The first report found that real median household income (the income of the household in the middle of the income distribution) in 2013 was stagnant for the second year in a row after having fallen for the four consecutive years after 2007. At $51,900, median household income was still 8 percent, or nearly $4,500, below its level in 2007, roughly equal to what it was nearly 20 years ago in 1995, and less than what it was in 1989. The only racial or ethnic group to experience a statistically significant increase in annual income last year was members of Hispanic households, who earned 3.5 percent more in 2013 than in 2012.

The median earnings of full-time, year-round workers did not improve, though the number of such workers increased by 2.8 million, which reflects the growth in jobs in 2013 and the gradual shift from part-time to full-time work that has been ongoing since 2010. The gap between the median earnings of men and women who worked full time, year round, was slightly reduced, but the gap was not statistically different from what it was in 2012—meaning that the data are not precise enough for the Census Bureau to state unequivocally that the earnings gap had narrowed.

Moreover, the reported improvement in the female-to-male earnings ratio, from 77 cents on the dollar in 2012 to 78 cents last year, was not just a function of an increase in the earnings of women, something we could all celebrate, but also a function of the long-term continuing stagnation in the earnings of full-time, year-round, male workers. This is a worrisome phenomenon. In fact, the median earnings of full-time, year-round male workers were no higher in 2013 than they were more than 40 years ago in 1972.

One positive finding in this year’s poverty-and-income report is that the overall poverty rate declined from 15 percent in 2012 to 14.5 percent in 2013. As the report notes, this was the first decrease in the poverty rate since 2006. However, the report cannot tell us how much of the reduction in poverty was due to an improvement in the economy and in earnings versus an increase in government transfer payments to low income households or other factors.

Almost the entire decline in poverty is attributable to a reduction in the poverty of children under the age of 18 alongside a reduction in the poverty rate of Hispanics. The poverty rate for children fell from 21.8 percent to 19.9 percent, and an estimated 1.4 million fewer children lived in poverty. The poverty rate among Hispanics dropped from 25.6 percent to 23.5 percent, indicating that nearly 900,000 Hispanics (almost 600,000 of whom were children under age18) were no longer living in poverty.

Still, some 45.3 million people were living in poverty in 2013, including 14.7 million children. And, as was true in prior years, those with the highest poverty rates include women, children, people of color, and the disabled.

The Census bureau report measures income inequality in a wide variety of ways. They include:

Six different income ratios such as the 90^th/10^th ratio, which is the income of the household that is earning more than 90 percent of other households (i.e. the household at the 90^th percentile) divided by the income of the household earning less than 90 percent of households (i.e. the household at the 10^th percentile).
The Gini coefficient, which summarizes the income dispersion in a number that varies from 0 to 1 and indicates greater inequality as it approaches 1.
The Mean logarithmic deviation of income, which is a measure of the gap between the median and average income.
The Theil index, which summarizes the dispersion of income in a number that varies from 0 to 1 with higher numbers indicating more inequality.
The Atkinson measure, which suggests the end of the income distribution that contributed most to inequality.

None of the measures in the report indicates any reduction in income inequality in 2013 relative to 2012. By every measure, income inequality in 2013 was higher than in previous years or equally as high as has ever been reported by the Census bureau since it started collecting these data in 1967.

Here are just two cases in point. The household income at the high earning 90^th percentile was 12.1 times greater than the income of the household at the low earning 10^th percentile—the widest gap ever reported by the Census Bureau. Similarly, the Gini index of income inequality, one of the most commonly used measures of income inequality, was 0.476 and indistinguishable from the record high of 0.477 reported in 2012 and 2011.

It should be noted, too, that the income data reported by the Census Bureau understate the degree of income inequality. The reason: research shows that the data, derived from a survey of people, tends to overstate the incomes of low earners and understate the incomes of high earners. Thus, the true distribution of income is more uneven than indicated by the reported data.

The bottom line is that after nearly five years of economic recovery and growth in national income most Americans have not experienced an increase in their earnings while the earnings of those at the top have largely returned to their pre-recession level. The wages of men in particular have stagnated while women, children, and people of color have suffered in disproportionate numbers from the ravages of poverty. By every measure, income inequality is at a record high or on par with the record highs reported by Census in 2012 and 2011.

The second report, which deals with health insurance coverage, provides additional data that confirm the high degree of inequality revealed in the first report. Unfortunately, because of a redesign in the questions asked of respondents, it is not possible to compare results from this year’s report to prior years. Thus, the second report does not provide a perspective on whether or not inequality in health insurance coverage is growing. A different Census Bureau study, the American Community Survey, provides annual estimates of health insurance coverage that have closely followed trends in the Current Population Survey Annual Social and Economic Supplement, also commonly known as the March CPS. The American Community Survey data suggest that there have been recent improvements in health insurance: the percent of the population without health insurance fell from 15.5 percent in 2010 to 14.5 percent in 2013.

The most recent Census Bureau survey found that nearly 42 million residents, or 13.4 percent of the population, did not have health insurance coverage for the entire 2013 calendar year. The lower a household’s income, the more likely they were to lack health insurance. For example, 24.9 percent of households living in poverty had no health insurance during the year while only 5.3 percent of households earning more than $150,000 lacked insurance in 2013. Those most eligible for government provided health insurance typically had the highest insurance coverage. For instance, only 1.6 percent of those over age 65 and 7.6 percent of those under age 19 lacked insurance compared to 18.4 percent of the rest of the population. Race and ethnicity also influence coverage as nearly a quarter of all Hispanics and 1 in 6 blacks lacked health insurance coverage compared to just 1 in 10 non-Hispanic whites.

The quality of health care that people get tends to be a function of both insurance coverage and the quality of health insurance. While these data provide information about coverage, they tell us nothing about the quality of health insurance. But, from other sources we know that lower income households, blacks, and Hispanics tend to have poorer quality insurance even when they are covered which further exacerbates inequality in health care services.

A central concern of the Washington Center on Equitable Growth is that these high and persistent levels of income inequality and other forms of inequality, such as in health care, may have detrimental effects on long-term economic growth and the well-being of most Americans. Though the Census Bureau data provide a useful snapshot at a particular moment in time of the levels of income, poverty, health insurance, and income inequality, they do not tell us what is causing these levels or their economic implications.

To promote rapid and widely shared growth may require attention to both short and long-run demand and supply factors. For instance, we may need to better understand the role that demand plays in promoting business sales, creating jobs, and boosting wages. Likewise, we may need to better comprehend the productivity or long-term supply side effects of investments in the health, education, and training of people. In the coming years, Equitable Growth will analyze the data ourselves and provide annual grants to other academics across an array of social sciences in an attempt to provide answers.

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Category: Economic Stability