November 19, 2012

How the gap between rich, poor affects us all

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By Sarah Shemkus / Salary.com

The typical American household had less income last year than the year before, and the gap between the richest and the poorest is growing, according to the U.S. Census Bureau.

Adjusted for inflation, median household income in 2011 was $50,054, down 1.5 percent from the 2010 midpoint.

Meanwhile, the gulf between the poor and the wealthy has been growing wider over the past two decades. In 1991, those households in the bottom fifth of income took in a median of $11,638 per year (adjusted for inflation), while those in the top fifth had a median annual income of $141,923.

Last year, the bottom fifth had a median income of $11,239. The yearly earnings of the top fifth, however, were up to $178,020 in 2011, an increase of 25 percent over the past 20 years.

The numbers suggest the real income of the poor is holding steady; it is the soaring income of those at the top that is widening the gap.

According to several analyses, income inequality can cause problems for everyone.

It’s bad for demand. When poor households get an extra dollar, they are likely to spend that money. Rich households, however, are more likely to lock up the money in investments.

Therefore, as more wealth is concentrated among that already-rich, relatively less money is poured into consumer spending, says Robert Reich, former U.S. labor secretary and current professor of public policy at the University of California at Berkeley.

"As the middle class's share of total income continues to drop, it cannot spend as much as before," Reich wrote in August. "Nor can most Americans borrow as they did before the crash of 2008 -- borrowing that temporarily masked their declining purchasing power."

It’s bad for economic growth. Research by Andrew Berg and Jonathan Ostry of the International Monetary Fund suggests that countries with high income inequality have a harder time sustaining long-term economic growth than those with smaller income gaps.
Income inequality may make financial crises more likely or increase political instability, discouraging investment, Berg and Ostry say.

Furthermore, "inequality may make it harder for governments to make difficult but necessary choices in the face of shocks, such as raising taxes or cutting public spending to avoid a debt crisis," they write. "Or inequality may reflect poor people’s lack of access to financial services, which gives them fewer opportunities to invest in education and entrepreneurial activity."

It’s harder to get ahead. Income inequality may also make it more difficult for those from low-earning backgrounds to move up into a higher income range, according to labor economist Alan Krueger, chair of the White House Council of Economic Advisors. In a January presentation to the Center for American Progress, Krueger cited several studies that found a correlation between income inequality and lack of mobility between income levels.

“Children of wealthy parents already have much more access to opportunities to succeed than children of poor families,” Krueger says. “This is likely to be increasingly the case in the future unless we take steps to ensure that all children have access to quality education, health care, a safe environment and other opportunities that are necessary to have a fair shot at economic success.”

It causes social problems. Though intuition might suggest that rich countries would have fewer social problems than poor ones, work by public-health researcher Richard Wilkinson indicates that nations with higher economic inequality face more social challenges.

In a recent TED talk, Wilkinson presented analysis that showed countries with higher levels of income inequality had lower levels of child well-being, higher levels of mental illness, lower levels of trust among their citizens and higher levels of social and health problems such as obesity, teenage pregnancy, alcohol and drug addiction and infant mortality.

"The more unequal countries are doing worse on all these kinds of social problems," Wilkinson concludes.

An opposing view. On the other hand, some say the growing income gap may be overstated.

Michael Tanner, a fellow at the conservative Cato Institute, argues in a recent commentary that low-income earners today are compensated with non-taxable benefits such as health insurance, and the numbers that show stagnant wages among the lowest earners fail to capture the value of these benefits.

Furthermore, he writes, changes in the tax code may be making it seem as if top-tier incomes are rising faster than they actually are.

To the extent that income inequality exists, it should be seen as a good thing, motivating and rewarding those who work hard to improve their economic standing, he says.

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