The Lagging Income of the Middle Class

The Economic Policy Institute and the Center on Budget and Policy Priorities issued a joint study today called “Pulling Apart” that shows, on a state-by-state and national basis, that income inequality in the United States has continued to worsen in the past decade, building on a trend that began in the late 1970s. Although the report focuses attention on the huge gap between the top fifth of income-earning families and the bottom fifth, a gap worthy of Brazil, the more striking numbers delineate the widening gap between the top fifth of income earners (and, within that group, the top 5 percent in particular) and everyone else.

Between the late 1970s and the late 1990s, for example, the top fifth saw its average real income rise by about 35 percent, while the fourth fifth (closest to the top) saw real income rise 13 percent, and the middle fifth saw real income rise just 7 percent. As a result, the top fifth now averages about twice as much as the second fifth, and three times as much as the middle fifth.

Now, you might say to this, so what? In the first place, these groups are not static. Not everyone in the top fifth in 1998 (the last year of the study) was there in 1988, nor will everyone there in 1998 be there in 2008. (Though a much higher percentage will be than won’t.) In addition, inequality itself is a tricky problem. If remedying inequality comes at the expense of overall growth, then it’s possible that the poor and middle class will end up worse in absolute terms even if their relative position improves.

In general, after all, the best remedy for poverty, and the best way to lift people into the middle class, is not income redistribution but rather economic growth. Although many critiques of globalization and free trade depend, at least implicitly, on Marx’s immiseration thesis, which held that growth in a capitalist economy inevitably impoverished most while enriching a few, the experience of most capitalist economies, and especially those in the Third World, has demonstrated exactly the opposite. A 1996 World Bank study of more than 30 fast-growing economies showed that in nearly all of them, growth did not meaningfully change income distribution, and that even the poorest fifth of income-earners reaped absolute benefits from economic growth. (The study did show that in countries that adopted land reform growth was more equitable.)

Unfortunately, the United States does not fit well into that study. On the contrary, the remarkable thing is how narrow the benefits, even in absolute terms, of the boom of the last 15 years have been. Remember, the middle fifth of income-earning families saw its real income rise just 7 percent in 20 years, and just 2 percent in the last decade. The second fifth saw its real income actually drop since the late 1980s, while the poorest fifth saw its income stay relatively steady.

These statistics are, of course, subject to question. If the Consumer Price Index really overstates inflation, then those real income numbers should be higher. After-tax numbers, because the federal income tax is progressive, would not be as striking. And the past couple of years have seen real–although still small–wage increases for most workers, increases they did not enjoy for most of the 1990s.

Still, the economic inequality we now have in the United States is of a magnitude we have not witnessed since before the New Deal. And what’s remarkable is that it’s happening at a time when unemployment is at historic lows and when economic growth is much faster than most economists thought possible. Stephen Moore of the Cato Institute, pooh-poohing the new study, said that the best solution to the problems it raises–assuming they are problems–would be to cut the capital-gains tax, spurring greater investment. But it seems implausible that putting more money in the stock market or in venture capital funds will affect income inequality at all. More to the point, if the economy grows any faster than it is now, Fed Chairman Alan Greenspan will just slam on the brakes. In terms of growth and employment, this is probably as good as it gets. And as good as it gets is actually making income gaps wider, rather than narrowing them.

Whether economic inequality of the magnitude the United States now has should matter to a society is, of course, a matter of principle, and not logic. (Paul Krugman made a good case for its importance.) And we should not let concern over inequality obscure the lessons of the last 20 years: the virtues of deregulation, competition, entrepreneurship, and, above all, the allocation of capital by markets, not planners. But as Congress heads into its latest round of budget planning, and as Dubya tries to offer up his latest “middle-class” tax cut, it’s probably worth remembering who’s actually in the middle class, and whether those who are a long way out of it really need yet another break.