Economic inequality has been growing rapidly in the United States,
and Congress is about to take steps that will increase it further. How did we
get here - and are we wise to continue on this path?
At the end of World War II, income inequality was lower in the United States
than at any time since the 1920s. During the ensuing three decades, incomes
grew briskly and at about the same rate - almost 3 percent per year - for households
up and down the income ladder.
That pattern began to change in the 1970s. Since 1979, for example, the incomes
of families in the bottom 80 percent of the income distribution have grown by
less than 1 percent each year, and only households in the top 20 percent have
enjoyed income growth comparable to that in the earlier period. For a small
group at the very top of the economic ladder, however, incomes have been growing
For more than 25 years, Business Week has conducted an annual survey of the
earnings of chief executive officers of the largest U.S. corporations. In 1980,
those executives earned 42 times as much as the average American worker, a ratio
larger than the corresponding ratios for such countries as Japan and Germany
even today. By 2000, however, American CEOs were earning 531 times the average
worker's salary. The gains have been even larger for those above CEOs on the
With corporate malfeasance much in the news, we know that at least some of
the spectacular corporate pay packages were not won on merit. Most of them,
however, are a simple consequence of market forces. As local markets have given
way to regional, then national, and now global markets, even a few slightly
improved executive decisions can now add hundreds of millions of dollars to
the bottom line.
More generally, rapid pay growth at the top owes much to the spread of reward
structures once confined largely to markets for sports and entertainment. In
these "winner-take-all markets," small differences in performance
often translate into enormous differences in economic reward. Now that we listen
mostly to recorded music, the world's best musicians can literally be everywhere
at once. The electronic news wire has allowed a small number of syndicated columnists
to displace a host of local journalists. And the proliferation of personal computers
has enabled a handful of software developers to replace thousands of local tax
accountants. Each change has benefited consumers but has also led to greater
Around the globe, income inequality has been growing for essentially similar
reasons. In most countries, public policy has attempted to counter this trend.
Not in the United States. With the market's push toward greater inequality already
apparent, for example, Congress reduced the top marginal income tax rate from
50 percent to 28 percent during the 1980s.
These tax cuts have increased inequality not only through their direct effects
on after-tax incomes, but also through indirect effects on federal spending
policies. Although supply-side economists predicted that the cuts would increase
tax revenues by stimulating more than enough income growth to offset the lower
rates, this did not happen, and hence the large budget deficits of the 1980s.
Those deficits were eliminated during the Clinton years but have reappeared,
larger than ever, under President Bush, who has reduced tax rates on earnings,
dividends and large inheritances. Once the enabling legislation is fully phased
in, more than half of the resulting cuts - 52.5 percent, according to one recent
estimate - will go to the top 5 percent of earners. The nonpartisan Congressional
Budget Office now forecasts deficits larger than $300 billion for each of the
next six years.
Many proponents of smaller government applaud these deficits, arguing that
they will force legislators to cut wasteful spending. As always, however, budget
cuts focus not on wasteful programs but on those whose beneficiaries are least
able to resist them. Recent proposals by House Republicans would eliminate free
school lunches for 40,000 children and food stamps for 225,000 people in working
households with children. House Republicans also propose $12 billion in cuts
for Medicaid, a program on which 25 percent of American children now rely heavily
for access to medical care.
The combined effects of market forces and changes in public policy have clearly
made life more difficult for middle- and low-income people. They are working
longer hours, saving less, borrowing more, commuting longer distances, and doing
without things once considered essential. Personal bankruptcy filings have set
new records in each of the last several years. The personal savings rate, always
low by international standards, has fallen sharply since the 1980s. It has hovered
close to zero since the late 1990s, and in recent months has actually been negative.
About 45 million Americans now have no health insurance, 5 million more than
in the early 1990s.
Although income inequality has increased sharply in recent decades, it has
always been greater here than in other industrial democracies. Can a case be
made for it? Many have described inequality as the price we must pay to achieve
high rates of economic growth.
The evidence, however, suggests otherwise. As economists Alberto Alesina and
Dani Rodrik have found, for example, growth rates across countries are negatively
related to the share of national income going to top earners.
Others have portrayed inequality as a necessary condition for socioeconomic
mobility, arguing that people who are willing to work hard and play by the rules
face a better chance of making it to the top here than in any other country.
But here, too, the evidence suggests otherwise. Even as economic inequality
has been rising, social mobility has been declining. According to sociologist
David Wright, the probability that a child born to parents in the third quartile
of the income distribution would move up into the top quartile was only half
as large in 1998 as in 1973. Economist Thomas Hertz has found that children
whose parents are in the bottom fifth of the income distribution have only a
7.3 percent chance of making it into the top fifth. In contrast, children born
in the top fifth have a 42.3 percent chance of remaining there. Contrary to
popular impressions, socioeconomic mobility is now lower in the United Stated
than in most other industrialized countries.
Although the market forces that have been producing higher inequality show
no signs of abating, Republicans in Congress are now calling for an additional
$70 billion in tax cuts aimed largely at high-income families, arguing that
because the most prosperous Americans have worked hard, they are entitled to
keep a greater portion of their pretax incomes. But tens of millions of less
prosperous Americans have worked hard, too. And in winner-take-all markets,
examples abound in which some earn thousands of times more than others just
as talented and hardworking.
The economist Herbert Stein once said, if something cannot go on forever, it
won't. History has repeatedly demonstrated that societies can tolerate income
inequality only up to a point, beyond which they rapidly disintegrate. Numerous
governments in Latin America have been overthrown largely because of social
unrest rooted in income inequality. And in a survey of more than a quarter of
a million randomly selected individuals worldwide, economist Robert MacCulloch
found that people in countries with high income inequality were much more likely
to voice support for violent revolution.
Major social upheavals are sometimes preceded by years or even decades of rising
levels of social unrest. If such unrest is currently building in the United
States, it remains well-hidden. But as recent experience has made clear, social
upheavals often occur with virtually no warning. Almost no one predicted the
fall of the Eastern European governments in 1989. Because revolutions almost
always entail important elements of social contagion, even small changes can
launch political prairie fires once a tipping point is reached.
As Plutarch wrote almost 2000 years ago, "An imbalance between rich and
poor is the oldest and most fatal ailment of all republics." Before the
United States succumbs to that ailment, we might want to reconsider the wisdom
of policies that widen that already large gap.
Robert H. Frank (email@example.com)
is an economist at the Johnson School of Management at Cornell University
and the coauthor, with Philip J. Cook, of "The Winner-Take-All Society."