April 26 (Bloomberg) -- The themes of inequality and the 1 percent dominate the news. Critics deplore that the share of pretax income accruing to those at the top has increased markedly over the past 30 years and is now greater than it has been since the 1920s.
It is suggested, too, that growth in income inequality has been a significant contributor to the current financial crisis and the slow recovery. President Barack Obama recently took this position, arguing that this is dragging down the economy. The Occupy Wall Street movement has been motivated by outrage over the gains of the top 1 percent and the nefarious consequences of this imbalance.
If those concerns are valid, it would be reasonable to expect that increased inequality at the top should be associated with a decline in household well-being. That isn’t the case. In fact, household well-being is much more closely related to unemployment than it is to the increase in pretax-income inequality. This implies that policies that focus on reducing inequality at the top, but don’t reduce unemployment, aren’t likely to improve well-being.
Every two years since the early 1970s, the General Social Survey has solicited the views of 1,000 to 2,000 Americans on a large number of questions, including happiness and financial well-being. To gauge happiness, the GSS asks respondents whether they are very, pretty, or not too happy. On financial well-being, it asks respondents whether they are pretty well satisfied, more or less satisfied, or not at all satisfied. The Nobel prize-winning economists Joseph Stiglitz and Amartya Sen, among others, have championed the use of such well-being measures.
I used the GSS to calculate two measures of net well-being. The first subtracts the percentage of people saying they are not too happy, from the percentage saying they are very happy. The second subtracts the percentage of people saying they are not at all satisfied financially from the percentage who say they are pretty well satisfied. Both measures should increase when Americans as a group are better off, and decline when they are worse off.
The attached graph plots these two measures of well-being against inequality (the pretax-income share of the top 1 percent) and the unemployment rate from 1980 to 2010. Over that period, the share of pretax income held by the top 1 percent first increased markedly from 10 percent in 1980 to a peak of 23.5 percent in 2007 and then declined to about 20 percent in 2010.
The results are clear. Perceived well-being doesn’t decline as inequality increases. In fact, well-being has tended to increase with inequality at the top. At the same time, well-being, particularly financial satisfaction, declines when unemployment is high and it improves when unemployment is low.
During the 1980s, income inequality increased markedly. Happiness and financial satisfaction also rose. Income inequality gained markedly from 1994 to 2000, as did happiness and financial satisfaction. And from 2006 to 2010, inequality declined markedly and well-being fell, too.
These patterns are decidedly inconsistent with the idea that income inequality damages Americans’ well-being. Instead, over the last 30 years, perceived well-being has been positively correlated with inequality at the top.
That’s not to say all is rosy in these periods. Happiness and financial satisfaction tend to be negatively related to unemployment. Well-being increases when unemployment is low and tends to decrease when unemployment is high. Note the large increases in happiness and financial satisfaction from 1994 to 2000, a period in which unemployment decreased, but income inequality increased. Also note the large declines in happiness and financial satisfaction from 2006 to 2010, a period in which unemployment increased, but income inequality fell.
This suggests that boosting employment and the economy will do the most to increase perceived well-being. The data also suggest that well-being will improve with higher employment even if inequality also increases; similarly, well-being can decline even when inequality decreases if the economy doesn’t perform well.
Put another way, policies that reduce inequality, but at the same time hurt economic growth aren’t likely to improve well-being, especially during a recession or weak recovery, when growth is more likely to boost employment.
These patterns also raise the question of why increases in pretax-income inequality at the top aren’t associated with decreases in perceived well-being. One possible answer, as my University of Chicago colleague Bruce Meyer has pointed out, is that income inequality isn’t the same as consumption inequality. Meyer found that consumption inequality -- at least when comparing the 90th percentile with the 10th percentile -- is roughly at the same point it was in the early 1980s.
In other words, income taxes are still progressive and transfers do provide a safety net for those with lower incomes. Furthermore, when taxes, transfers and inflation are taken into consideration, after-tax incomes and consumption for the median family have increased on the order of 50 percent since 1980.
Other researchers have reached similar conclusions. Another related, but less sanguine answer, attributed to Raghuram Rajan, also of the University of Chicago, is that the politically driven availability of credit allowed the less well-off to maintain their consumption. This may provide part of the explanation for the patterns in the 2000s, but it seems less likely to explain those in the 1980s and 1990s.
The conclusion, then, isn’t that inequality is good, but rather, that income inequality hasn’t been related to perceived well-being. Income inequality at the top (along with consumption inequality) doesn’t appear to be all that different from the levels reached in the late 1990s, when there was far less criticism. Unemployment, of course, was quite a bit lower then.
Since the financial crisis, the income share of the top 1 percent has decreased at the same time that perceived well-being has declined substantially. If this history is a guide, then any new policies that focus on reducing income inequality without increasing employment and growth aren’t likely to improve well-being. In contrast, policies that increase growth and employment, even if they maintain, or even increase, pretax-income inequality, seem more likely to be well received by the public.
(Steven N. Kaplan, a professor of entrepreneurship and finance at the University of Chicago Booth School of Business, is a contributor to Business Class. The opinions expressed are his own.)
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