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The 0.01%? Another Wealth Gap Matters More

Noah Smith is a Bloomberg View columnist. He was an assistant professor of finance at Stony Brook University, and he blogs at Noahpinion.
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Everyone knows by now that the U.S. has seen a substantial rise in economic inequality since the 1970s -- an increase that has been mirrored, to a lesser degree, in Europe and Japan. This inequality has manifested itself in both income, which matters for living standards, and wealth, which figures in financial security and political power. What’s less well-known is that this inequality run-up came in two distinct phases. The first, from the late 1970s to the late 1990s, represented the spreading-out of the American middle class. The second, starting in the 2000s, represented a tiny fraction of Americans whose wealth skyrocketed. Let’s call these Phase 1 and Phase 2 of the great inequality increase. 

Here are some numbers. To see Phase 1 in action, check out this Brookings Institution report on the divergence of the American middle class. To show this, the researchers measured the income shares of the top 20 percent, the middle 40 percent and the bottom 40 percent:

As you can see, there was a period from about 1980 through 2000 when the share of the top 20 percent -- the upper-middle class -- rose, and the rest, especially the middle, correspondingly fell. But after 2000, the share of the top fifth stopped rising. Phase 1 was over. 

Why did Phase 1 happen? Several explanations have been offered. Free trade and globalization put the lower-middle class in direct competition with workers from around the world. The decline of unions and manufacturing might chipped away at a mainstay of lower-middle class bargaining power. The development of information technology might have led to a gap between skilled workers and unskilled workers. It isn't obvious yet how powerful each of these factors was. But what is clear is that by 2000, Phase 1 had run its course, while Phase 2 of the age of inequality was just beginning. 

To see Phase 2, we have to look not at the upper-middle class, but at the super-rich. The income of the top 0.1 percent and 0.01 percent of Americans is very difficult to measure, partly because surveys have an upper limit on their income categories. But what we do know indicates that while income for even people at the 99th percentile of the distribution -- the rich-but-not-super-rich -- has flattened out since 2000, the income share of the super-rich at the 99.99th percentile has continued to rise rapidly. 

The evidence is even starker when we look at wealth rather than income. Economists Emmanuel Saez of the University of California-Berkeley and Gabriel Zucman of the London School of Economics have been studying wealth inequality for a long time. Here is their graph of the divergence in wealth between the super-rich and the rest:

While the merely rich haven't seen their share of society’s wealth increase since 2000, the super-rich have seen their slice of the pie soar. That, in a nutshell, is Phase 2. 

What explains the difference between these two phases? The sawtooth pattern of the income of the super-rich gives a hint. For these people, a lot of income comes in the form of capital gains, land rents, dividends and other returns on investments. Money makes money, and the super-rich simply have more money to generate capital income. 

We can see this by looking at capital income as a percentage of the nation’s total income. This was steady for a very long time -- so long that economists began to consider it a constant. Then it suddenly started rising about the year 2000. In other words, since the start of the new millennium, less of the money in the economy has gone to those who work, and more has gone to investors who see their assets appreciate in value and who receive passive income streams from those assets. 

This also helps explain the Phase 2 run-up in the wealth share of the super-rich. Economics predicts that wealthier people will have less risk aversion, meaning that they will tend to invest their wealth in more volatile assets like stocks. Riskier assets go up more, on average, than others. And the 2000s saw a tremendous boom in the value of risky assets -- a boom that has wasn't undone by the financial crisis. 

So there have been two very different phases of inequality, and two very different types of inequality. Many of the policies that have been suggested as remedies -- such as a more progressive tax code or an end to the carried interest loophole for money managers -- focus on the super-rich. That is natural, since Phase 2 is a more recent development than Phase 1. But I wonder if we shouldn’t be focusing on that older type of inequality -- the upper-middle class pulling away from the lower 80 percent. 

Because although Phase 1 is over -- the middle class stopped diverging 15 years ago -- its effects are still with us. The lower-middle class has been suffering not just economic insecurity and decreased social status, but social problems such as isolation, substance abuse and family breakdown. That seems like a more corrosive issue than the increased political power of the super-rich. 

If policy makers want to help boost the lower-middle class, what should they do? One policy is to improve education, both at the high school and junior high level, and in terms of college graduation rates. Efforts to do that, of course, are underway. Another important policy is to let in a lot more high-skilled immigrants, who compete directly with the upper-middle class rather than lower-skilled Americans. Maybe policies such as these could help in stitching the middle class back together.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

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