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There has been a strong and troubling shift in market rewards for a small minority relative to the rewards available to most citizens. A recent Congressional Budget Office study found that incomes of the top 1 percent of the U.S. population (adjusted for inflation) rose 275 percent from 1979 to 2007, while income for the middle class grew only 40 percent. Even this dismal figure overstates the fortunes of typical Americans. In 1965, only one in 20 men ages 25 to 54 was not working; by the end of this decade, it is likely to be one in six, even if a full cyclical recovery is achieved.
Another calculation suggests that if the income distribution had remained constant from 1979 to 2007, incomes of the top 1 percent would be 59 percent, or $780,000, lower and that incomes among the bottom 80 percent would be 21 percent, or more than $10,000, higher.
Those looking to remain serene in the face of these trends or who favor policies that would disproportionately cut taxes at the high end — and exacerbate inequality — assert that snapshot inequality is all right as long as there is mobility within people’s lifetimes and across generations. In fact, there is too little of both. Inequality in lifetime incomes is only marginally smaller than inequality in a single year. And intergenerational mobility in the United States is now poor by international standards.
Why has the top 1 percent done so well relative to the rest? The answer lies substantially in changes in technology and in globalization. When George Eastman revolutionized photography, he did very well, and because he needed a large number of Americans to carry out his vision, the city of Rochester, N.Y., had a thriving middle class for two generations. When Steve Jobs revolutionized personal computing, he and Apple shareholders did very well, but those shareholders are all over the world, and a much smaller benefit flowed to middle-class American workers, both because production was outsourced and because the production of computers and software was not terribly labor-intensive.
The market system distributes rewards increasingly inequitably. On one side, the debate is framed in zero-sum terms, and the disappointing lack of income growth for middle-class workers is blamed on the success of the wealthy. Those with this view should consider whether it would be better if the United States had more, or fewer, entrepreneurs like those who founded Apple, Google, Microsoft and Facebook. Each did contribute significantly to rising inequality. It is easy to resent the level and extent of the increase in CEO salaries, but firms that have a single owner, such as private equity firms, pay successful chief executives more than public companies do. And for all their problems, American global companies have done very well compared with those headquartered in more egalitarian societies over the past two decades. Where great fortunes are earned by providing great products or services that benefit large numbers of people, they should not be denigrated.
Meanwhile, those who call concerns about rising inequality misplaced or a product of class warfare are even further off base. The extent of the change in the income distribution is such that it is no longer true that the overall growth rate of the economy is the principal determinant of middle-class income growth — how the growth pie is distributed is at least equally important. The observation that most of the increase in inequality reflects gains for those at the very top at the expense of everyone else further belies the idea that simply strengthening the economy will reduce inequality. Focusing on American competitiveness, as many urge, could easily exacerbate inequality while doing little for most Americans if the focus is placed on measures such as corporate tax cuts or the protection of intellectual property for the benefit of companies that are not primarily producing in the United States.
We need more and better responses to rising inequality. Here are three places to start.
First, government must not facilitate increases in inequality by rewarding the wealthy with special concessions. Where governments dispose of assets or allocate licenses, preference should be on the use of auctions to which all have access. Where government provides implicit or explicit insurance, premiums should be based on the market rather than in consultation with the affected industry. Government’s general posture should be standing up for capitalism rather than for well-connected capitalists.
Second, there is scope for pro-fairness, pro-growth tax reform. The moment when more great fortunes are being created and the federal deficit is growing is hardly the time for the estate tax to be eviscerated. And there is no reason tax changes in a period of sharply rising inequality should reinforce the trends in pretax incomes produced by the marketplace.
Third, the public sector must ensure greater equity in areas of the most fundamental importance. It will always be the case in a market economy that some will have mansions, art, etc. More troubling is that middle-class students’ ability to attend college has been seriously compromised by increasing tuitions and sharp cutbacks at public universities, and that, over the past generation, a gap has opened between the life expectancy of the affluent and the ordinary.
Neither the politics of polarization nor those of noblesse oblige on behalf of the fortunate will serve to protect the interests of the middle class in the post-industrial economy.
Lawrence Summers is Charles W. Eliot University Professor of Harvard Kennedy School and faculty director of the Mossavar-Rahmani Center for Business and Government. The views expressed in this article are his own.