The Rich Are Richer And America May Be The Poorer

In recessions, certain things are predictable: Incomes stagnate or fall, and the poverty rate climbs.

This recession is no different. Median household income fell 1.7% in 1990, and the poverty rate jumped to 13.5%. The numbers for 1991, which will be released just before the Presidential election in 1992, could look even worse. But the cyclical deterioration in incomes shouldn't be regarded as merely a passing phenomenon. Indeed, the most troubling thing about the latest numbers is that for the majority of the U. S. population, they cap more than a decade of income stagnation or worse. At the same time, a small minority has enjoyed rapid gains in income. This is already shaping up as a juicy morsel for politicians -- the "fairness issue" is on more and more vote-seekers' lips these days.

But what has happened to incomes in America over the past 15 years or so is troubling on economic as well as moral grounds. Simply put, growing income inequality and stubbornly high poverty rates threaten the country's long-term growth prospects. That's because inequality of income distribution and persistent poverty can put a damper on productivity growth, while stagnating incomes crimp consumer purchasing power.

What's more, there don't seem to have been any economic benefits derived from the rich having gotten richer, as some economists argued in the early 1980s, when the Reagan Administration first slashed taxes. The nation's savings rate was supposed to rise, but it didn't. And the swelling tide of income for a few was supposed to lift all boats, but it didn't. "I don't know what you can say that's good about what's happened to incomes," says Lawrence Chimerine, senior adviser to DRI/McGraw-Hill.

FAT SLICE. Most of the 3.3 million families whose income topped $102,000 last year -- the richest 5% of the population -- would probably disagree with Chimerine and give three cheers for their good fortune. By next year, that group will have seen its aftertax income, after inflation, grow nearly 60% over a 15-year period, according to calculations by the Congressional Budget Office based on Census Bureau data (chart). And the richest 1% of the population will have enjoyed even sharper gains in real income, both pretax and especially aftertax, over the same period. Indeed, it's only those in the top quintile, or top 20%, who show a respectable gain in real incomes over the 15-year span.

The "next richest" quintile experienced only a modest gain in real incomes, while the bottom three quintiles saw family incomes shrink in real terms over the period. Meanwhile, 1990's poverty rate jumped 0.7 of a percentage point. While it isn't surprising that poverty rose, it is troubling that the increase occurred on top of an already-high 12.8%.

Typically, sustained economic growth lifts people out of poverty and drives the rate down. If the long expansion of the 1960s is any guide, poverty should have been 3.5 percentage points lower than it was in 1989, the last full year of the 1980s' expansion, according to calculations by economist Rebecca M. Blank at Northwestern University. Key macroeconomic indicators, such as how much output grew, were remarkably similar for the periods 1963-69 and 1983-89 for which Blank made comparisons, yet the results were very different. "The whole relationship between economic growth and poverty has changed," she concludes.

Indeed, it's clear that the link between economic growth and income growth has weakened -- the pie has kept growing, but the slices of that pie are being unevenly distributed. What accounts for that weakening link? Interestingly, most economists now agree that tax and transfer policy in the 1980s played a role, but not the chief one. At the uppermost end of the income scale, tax cuts made aftertax income surge even higher than pretax income. And at the low end of the distribution scale, cuts in income transfers hurt the poor. But it's clear that incomes have grown unequally on both a pretax as well as an aftertax basis (chart), so the overall impact of policy changes has not been that great. "I would estimate that something like 15% to 20% of the change in the distribution is due to changes in taxes and transfers," says Isabel V. Sawhill, an economist at the Urban Institute in Washington, D. C.

Today, economists agree that the widespread competitive and technological changes that occurred during the 1980s induced a sharp increase in the rewards for skill and education, thereby widening the gap in incomes. From 1980 to 1990, men with four years of high school saw their median incomes fall 15.5% in real terms. During the same period, men with four years of college experienced a gain in median income, after inflation, of 1.6%.

The changes in the supply and demand for low-skilled labor may explain why some incomes lagged behind even the mediocre performance of the middle-income group. But they fail to explain why incomes of the richest segment surged. "It's impossible to attribute the sharp increase in income at the top of the scale to a drastic increase in the relative value of the services provided by people at that level," says Henry J. Aaron of the Brookings Institution. "What we're observing is some successful rent-seeking activity," whereby lawyers, investment bankers, and other professionals extract extra income for seemingly unique abilities. And because such endeavors earn high rewards, says Aaron, talent may be diverted from more productive but lower-paying endeavors, such as engineering.

FEWER BUYERS. What are the economic consequences of the stark divisions that have developed? Big earners may be big spenders, but their outlays may not offset cutbacks in the rest of the economy. It's possible, ventures DRI's Chimerine, that with wages squeezed, tax burdens up, and the majority of the population "standing still or worse in terms of purchasing power," the U. S. could end up with "a demand-short economy." He argues that if one person gets a $20,000 raise while another person loses a $20,000 job, the first person's additional consumption is unlikely to make up for the loss of the newly unemployed person's consumption.

For most economists, this is a difficult argument to make for the overall economy. While people with low incomes have a high propensity to consume -- that is, they are more likely to spend a large portion of an extra dollar earned -- it's also true that high-income people spend a sizable share of their dollars. So on an aggregate basis, consumption in the economy shouldn't contract or be anything but marginally affected by shifts in income distribution. Nevertheless, there are differences in spending patterns that may be important. "The rich simply demand different types of goods," says James K. Galbraith, an economist at the University of Texas at Austin. Both Galbraith and Chimerine worry that income trends could dampen demand in the mass market for goods. And it's that market that just may happen to have more domestic than foreign producers.

Inequality and stagnating incomes may also constrain growth in other ways. "We have to ask ourselves whether the macroeconomy is becoming permanently hostile to less-skilled workers," says Northwestern's Blank. If so, there will be considerable costs. First, there are the costs of having to support a population that is barely making it economically. Next, there's the potential cost of possible social disruption resulting from worsening income inequality and a population of persistently poor individuals. Finally, there's the cost of consigning people to low-productivity jobs when they and society could do better.

Poverty is always a burden, of course -- both to those who must endure it and to the society that must cope with it. But by far the greatest burden -- and the greatest potential loss to the economy -- stems from the extraordinarily high level of child poverty in America today. One in five children under the age of 15 lives in poverty, and a staggering 50% of all black children under the age of six live in poverty. Poor children don't eat as well or learn as much as their better-off peers, which means they won't do as well when they become adults. "We are disadvantaging the next generation," says Timothy M. Smeeding, an economist at Syracuse University.

The consequences of high poverty among children and widening inequality throughout the income spectrum can't be readily quantified. And as the economy starts to recover and incomes start to rebound, worries about fairness may recede. But the underlying shifts in income over the past 15 years have been seismic, and they may well make it harder for the economy to get up a full head of steam.

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