Last updated: Feb. 6, 2017
What’s the problem?
Since 1980, the share of income and concentration of wealth has heavily favored the richest 10% of Americans. Executive compensation at the largest companies has soared while average worker salaries have stagnated, and those earning the minimum wage have fallen behind. In a consumer economy like ours, circumstances that take spending money out of the hands of the majority of consumers puts the entire system at risk. And in a democracy like ours, a concentration of wealth equals a concentration of political power that threatens the democratic values of the nation. Efforts to shrink the federal government are an indication of the power of money in politics, and a reflection of a shift in power and influence from the elected representatives of the American people to the unelected corporate executives who believe that government regulation is bad for business.
What is being done now?
Much of the most productive activity addressing the related problems of income and wealth inequality have focused on implementing the 2010 Dodd-Frank legislation and raising the minimum wage at the state and local level. The push for a $15 minimum wage, initiated by fast food and other low wage workers in 2012 that’s become known as the Fight for $15 campaign, gained steam during the 2016 presidential campaign as Senator Bernie Sanders made it the central focus of his effort to win the Democratic Party primary. Meanwhile the advocacy group, Business for a Fair Minimum Wage, favors a minimum wage of at least $12 an hour.
Efforts are also aimed at encouraging more companies to adopt employee stock ownership plans or some other means of profit sharing. Both President Obama and House Speaker Paul Ryan advocated to expand the Earned Income Tax Credit. Other proposals take more direct aim at the problem by encouraging an increase in taxes on the rich through one or more mechanisms and by recommending limits on executive compensation. None of these legislative options gained much traction in the last Congress.
What still needs to be done?
Given that the Fight for $15 seems to have gained traction, it is worth analyzing the recent legislative and ballot measures that have produced such a wide range of wage minimums. The disparities might suggest that consideration be given to the value of abandoning the idea of a national minimum wage for a living wage that is determined by the living standards of the local economy.
Each of the solutions put forward has its own strength and addresses a specific aspect of the problem. The business community and local, state, and federal governments will need to determine how best to balance them in order to produce the optimal result.
What’s At Stake
The health of the economy
According to the wealth managers at Morgan Stanley, consumer expenditures are the most significant driver of economic growth. For this reason, higher wages and less debt for workers are “essential steps … to a virtuous cycle of increased profitability, more jobs, higher salaries, more spending, and so on.” Income inequality puts our economy at risk because it takes cash out of the pockets of the majority of consumers. As income and wealth accumulate in the hands of 10% of the population, the 90% of the people whose personal expenditures are vital for sustained economic growth have less and less money to consume.
Equally shared political power
Wealth provides political access to the few individuals who possess it and leaves those who lack financial resources with no independent voice, or a very quiet voice, in the political process. It follows that as wealth shifts to a small percent of the population, so too does political influence. While the US continues to have free elections, in many cases, and especially in state and national elections, the wealthiest individuals contribute vast sums of money to promote the candidates and policies that they prefer.
According to data from the US Bureau of Economic Analysis , the savings rate for Americans between 1959 and 1984 fluctuated between 9% and 13%. A steady decline in the savings rate began in 1985, dropping below 3% for most of 2005 before beginning a slow recovery to slightly better than 5% in the first quarter of 2016. Data on this topic is confusing and less conclusive, though there is some evidence to suggest that as incomes stagnate among lower wage families, their ability to set money aside for retirement and other savings diminishes.
The American Dream
Social mobility has long been considered to be the heart of the American Dream, but since the middle of the last century, access to improving living standards and healthcare have been equally a part of that dream. Some have argued that it has, in fact, replaced social mobility as the dream itself. With stagnating wages, it has become increasingly more difficult for the poor and middle class to realize either. According to research by USA Today, drawing on a range of data, a family of four requires pre-tax income of $130,000 to live the American Dream, and 85% of Americans fall short of this amount.
Since 1980, the gap in income growth among top executives has far out-paced income growth among the average worker. At the same time, wealth has become more concentrated among the top 1% in the country and is approaching a level not seen since just before the Great Depression.
Earning to Live, Not Able to Save
Income and wealth are tightly intertwined. The relationship may be most simply represented by the equation
income – expenses = saving
where the level of income defines how much you are able to save. Your savings is your wealth. Savings may be kept in bank accounts or invested in real estate, retirement accounts, and other assets that are owned by and accessible to the individual. The more income you have, the more you can save and the more wealth you have. Unfortunately, the opposite is equally true: The less income you have, the less you can save.
An analysis by investor financial solutions firm, The Motley Fool, assumes that the bottom half of income earners are spending their incomes on daily living expenses, education and other loans, and are unable to save. A majority of households – up to 77% of American households – fall into this group. The analysis recognizes that most people in this group work hard just to cover the basic expenses of living, and so it is not “constructive to simply browbeat them and tell them to pull themselves up by the bootstraps.”
Executive Compensation Soars, Worker Pay Stagnates
Since 1980, there has been a significant and widening gap in income as executive compensation among the largest companies has risen much faster than that of the typical worker. To illustrate the severity of this trend, the Economic Policy Institute analyzed data from the top 350 companies ranked by sales. During the 37-year study period from 1978 to 2014, EPI found that the average compensation for non-management employees had increased just $5,000 while annual compensation for CEOs had risen by almost $15 million. That’s an 11% increase for employees and a 997% increase for CEOs.
Looked at another way, the ratio of CEO pay to worker pay has risen dramatically, and been especially volatile, since 1989. In 1965, that ratio was 20:1, meaning that for every $20 given in compensation to the CEO, a typical worker received $1. This ratio remained roughly the same for most of the next 12 years, hovering between 22:1 and 24:1. Then, in 1978, it jumped to almost 30:1 and remained there until 1989 when it almost doubled to a ratio of 58:1 and began a period of frequent and dramatic leaps. After peeking at 383:1 in 2000, it has dropped as of 2013 to 295:1.
Because the largest companies employ so many people and exercise substantial influence on the economy, they are typically used in such analyses as valid indicators of economic trends. CEO-to-worker pay ratios of 383:1 won’t be found among the nation’s small and mid-size businesses, which make up the bulk of the economy. Still, a much broader analysis of household incomes by the Center on Budget and Policy Priorities (CBPP) reveals that incomes rose at a much faster pace among the top 20% of earners than it did for the bottom 80%. The data in the table below shows the percentage change in income by income group before the Great Recession (1979-2007) and how the recession impacted those changes (1979-2013).
Wealth Accumulates at the Top
Since 1980, according to a 2016 report from the Corporation for Enterprise Development and the Institute for Policy Studies, “the wealthiest 20% of Americans have taken 99.4% of all gains in wealth while the bottom 80% have been left to split just 0.6% among themselves.” This should be no surprise, given the significant growth in incomes at the executive level and the much more limited growth among the middle and bottom tiers of the economy.
Citing the work of Emmanuel Saez and Gabriel Zucman, the Center on Budget and Policy Priorities presents a much closer look at wealth accumulation at the very top of the economic ladder since the early 1900s. Since the 1970s, the top 1% have increased their wealth at a steady rate and as of 2012 owned about 43% of the nation’s wealth. The concentration of wealth by the 1% is approaching a level not seen since just before the Great Depression.
The election of Ronald Reagan in 1980 ushered in a new American direction that emphasized tax cuts and reduced government spending, and that glorified the virtues of business and the free market. Intended to re-balance a system that no longer seemed capable of sustaining America’s role in a changing world, the new culture of “trickle-down economics” failed to deliver on its most basic promises.
In the late 1970s, the Carter administration began a steady stream of tax cutting that accelerated under the supply-side economic policies of the Reagan presidency. These cuts most benefited the wealthiest individuals and families, who tend to save or invest their “extra” money in order to grow their wealth. As the chart from the Center on Budget and Policy Priorities shows, the first hint of an income gap is detectable as early as 1980, and then steadily grows wider over the next three-and-a-half decades as supply-side economics, often referred to as Reaganomics or “trickle-down economics”, came to dominate policymaking with substantial cuts to income tax and corporate tax rates.
Deregulation and de-unionization
Deregulation was also central to supply side theory and also played an important role throughout the Reagan years and beyond. Loosening of regulations, particularly in the financial markets, combined with a weakening of labor unions favored corporations and their executives with greater income and diminished the bargaining power of low income workers to support wage increases.
Merriam-Webster defines greed as “a selfish desire to have more of something (especially money)”. While we don’t believe that desiring more of something is a bad thing nor a selfish characteristic, the desire for substantially more at the expense of others is, in our view, a clear sign of greed.
It’s difficult to prove that greed is a factor in the creation of the income gap, especially when it seems to be culturally embedded in the risk-reward system. Still, as executive compensation has soared over the last 30 years while worker compensation has not, this definition suggests that greed is involved. Consider that CEOs have often been rewarded for cutting jobs in order to “improve performance” – that is, increase the company’s profits and/or stock price:
- BP’s CEO received a 20% raise after laying off 5,000 people in 2015.
- JPMorgan cut more than 6,700 jobs in 2015 and rewarded its CEO with a 35% raise.
- A report by BioSpace, a leading site for news for life science professionals, found that, in 2013, five companies rewarded their CEOs after implementing large layoffs.
In addition, according to the National Priorities Project, due to tax breaks and other loopholes, “In some cases, billionaires can pay lower [income tax] rates than middle-class workers. And some corporations, like Bank of America and Citigroup, have gotten away with paying zero federal income taxes, even when they make billions in profit.”
We Should Not Be Concerned by Income Inequality
Starting with the perspective that economic policies should not focus on “whether some people earn more than others”, venture capitalist Kip Hagopian and Hoover Institute senior fellow Lee Ohanian argue that income inequality has little impact on the economy, and that middle class incomes grew and did not stagnate between 1979 and 2007. In a paper published by The Hoover Institute in 2012 , the authors make this latter point to directly refute the conclusion of a study by the Congressional Budget Office that income of high-income earners grew more quickly than did the income of low-income earners.
Income inequality is inherent in a market-based economy, and as The Economist has reminded us, the opportunity for great rewards beyond the norm is an important driver of innovation and entrepreneurship. The key point made by The Economist and other sources consulted by The American Leader is that extreme inequality has negative impacts on the economy and can also undermine the democratic system of government.
Supply Side Policies Produced Growth
In a defense of supply side economics, The Laffer Center identifies a tripling of wealth in US households and businesses in the period from 1983-2010, calling it the longest boom in US economic history despite the stock market crash and Great Recession of 2008-2009. More wealth was created from 1981 – 2007, according to the Center, than in the previous 200 years. What the analysis fails to do, however, is address how that wealth was distributed. The wealth of the nation may have tripled prior to the Great Recession, as stated, but as we’ve seen in the research from the Economic Policy Institute, most of the wealth generated during this time was accumulated by the top 5% of income earners. During this same period, EPI research indicates that the bottom 60% of income earners actually lost wealth.
Poor, Middle Class Still Benefit
Writing in The Federalist, Scott Winship, Walter B. Wriston Fellow at the Manhattan Institute, wrote that income inequality is occurring because the size of the economic pie is growing. In his view, even though more of the growth is accruing to the wealthiest, there’s still enough left over for the poor and middle class – what he called a “comparatively skinnier” slice of the pie. It is this perspective that gave supply side economics one of its earliest nicknames – “trickle down economics”. As the data on wealth and income demonstrate, however, such trickle down has not occurred. And what trickle down theory ignores is that a true democracy cannot withstand such economic disparity.
Solving the Problem
A number of ideas have been proposed to solve the problem of inequality in America. Each is briefly described below with more detail available by clicking on the “more” button. We invite you to review the details and rank the solutions as you prefer, or suggest another solution that we have not yet covered.
Raise the minimum wage
An increase in the minimum wage may not reduce income inequality as much as hoped, but it will improve the living standards for the majority of workers who earn it. The proposed $15 minimum wage would raise millions families out of poverty and reduce their dependence on other taxpayer-funded assistance programs that serve as subsidies to those companies that do not pay a living wage. Raising the minimum wage would also be an important means of communicating that a system that has allowed for exorbitant wage increases at the top of the pay scale has not forgotten those at the bottom. On the other hand, legislators would be wise to consider the risks of creating a national minimum wage that exceeds the capacity of some local and regional economies to pay it. More >>>
Limit executive compensation
Given that soaring executive pay is the primary contributor to a widening income gap (stagnating wages for low income workers being another, lesser contributor), limiting executive compensation is a clear and direct step towards re-balancing the income scales and closing the wealth gap. The impact of any such efforts, however, may require new federal legislation backed up by more political will for real change than elected officials have been able to deliver to date. More >>>
Increase Taxes on the Wealthy
Since the widening of the wealth gap occurred around the same time that substantial cuts were made in the income taxes of the wealthiest Americans, increasing those taxes would be a direct mechanism for closing the gap. Despite substantial political opposition, it may be the most efficient means for closing the gap and more fairly balancing economic and political power. More >>>
Expand the Earned Income Tax Credit (EITC)
Studies have shown that the EITC has a positive impact on incomes for a specific segment of those who are eligible to take advantage of the tax credit. In particular, study results indicate that a $1,000 increase in the EITC can increase employment, and therefore, incomes, by more than 7%. More >>>
Expand Adoption of Employee Stock Ownership Plans (ESOPs)
Almost 7,000 companies are owned by their employees. Research has shown that employees at these companies have larger retirement accounts and earn 5% – 12% more income than their peers at companies that are not employee owned. More >>>
Morgan Stanley Research, “The Economic Cost of Inequality”, January 23, 2015, http://www.morganstanley.com/ideas/the-economic-cost-of-inequality. Accessed February 23, 2016.
Matthew Kerkhoff, “Breaking Down the US Economy”, Financial Sense, February 17, 2016, http://www.financialsense.com/contributors/matthew-kerkhoff/breaking-down-us-economy. Accessed March 9, 2016.
Center on Budget and Policy Priorities, “Income Gains Widely Shared in Early Postwar Decades – But Not Since Then” (based on US CensusBureau data), http://www.cbpp.org/income-gains-widely-shared-in-early-postwar-decades-but-not-since-then-0. Accessed April 1, 2016.
Landy, Benjamin, “A Tale of Two Recoveries: Wealth Inequality After the Great Recession”, The Century Foundation, August 28, 2013, http://tcf.org/content/commentary/a-tale-of-two-recoveries-wealth-inequality-after-the-great-recession/. Accessed March 10, 2016.
Trading Economics, “United States Personal Savings Rate 1959-2016” (based on data from the US Bureau of Economic Analysis), http://www.tradingeconomics.com/united-states/personal-savings. Accessed March 10, 2016.
Stone, Chad, Trisi, Danilo, Sherman, Arloc, and DeBot, Brandon, A Guide to Statistics on Historical Trends in Income Inequality, Center on Budget and Policy Priorities, updated Oct. 26, 2015, http://www.cbpp.org/research/poverty-and-inequality/a-guide-to-statistics-on-historical-trends-in-income-inequality. Accessed April 1, 2016.
Top CEOs Make 300 Times More than Typical Workers, Table 1: CEO compensation, CEO-to-worker compensation ratio, and stock prices, 1965–2014 (2014 dollars), http://www.epi.org/publication/top-ceos-make-300-times-more-than-workers-pay-growth-surpasses-market-gains-and-the-rest-of-the-0-1-percent/. Accessed March 21, 2016.
The Economist, “Too Thin a Cushion”, Apr 2, 2013, http://www.economist.com/blogs/freeexchange/2013/04/saving. Accessed May 11, 2016.
Hagopian, Kip and Ohanian, Lee, “The Mismeasure of Inequality”, The Hoover Institute, August 1, 2012. http://www.hoover.org/research/mismeasure-inequality. Accessed April 26, 2016.
The Economist, “The Economist explains: How inequality affects growth”, June 15, 2015, http://www.economist.com/blogs/economist-explains/2015/06/economist-explains-11. Accessed July 19, 2106.
The Laffer Center, “Supply Side Economics”, http://www.laffercenter.com/supply-side-economics/. Accessed April 5, 2016.
Winship, Scott, “Income Inequality is Good For the Poor”, The Federalist, November 5, 2014, http://thefederalist.com/2014/11/05/income-inequality-is-good-for-the-poor/. Accessed March 25, 2016.
Garon, Sheldon, Beyond Our Means: Why America Spends While the World Saves, Princeton University Press, 2012, Kindle edition.
U.S. Census Bureau, Income and Poverty in the United States: 2014, September 2015, http://www.census.gov/library/publications/2015/demo/p60-252.html. Accessed August 28, 2016.
Center on Budget and Policy Priorities, “Chart Book: The Earned Income Tax Credit and Child Tax Credit”, updated May 24, 2016, http://www.cbpp.org/research/federal-tax/chart-book-the-earned-income-tax-credit-and-child-tax-credit. Accessed August 22, 2016.
Williams, Erica, “States Can Adopt or Expand Earned Income Tax Credits to Build a Stronger Future Economy”, Center on Budget and Policy Priorities, January 19, 2016, http://www.cbpp.org/research/state-budget-and-tax/states-can-adopt-or-expand-earned-income-tax-credits-to-build-a. Accessed August 25, 2016.
Frentz, Nathaniel, “A State-by-State Look at the EITC and Child Tax Credit”, Center on Budget and Policy Priorities, March 5, 2014, http://www.cbpp.org/blog/a-state-by-state-look-at-the-eitc-and-child-tax-credit. Accessed August 23, 2016.
Buffett, Warren, “Better Than Raising the Minimum Wage”, Wall Street Journal, May 21, 2015, http://www.wsj.com/articles/better-than-raising-the-minimum-wage-1432249927. Accessed
Cooper, David, “The Minimum Wage Used To Be Enough To Keep Workers Out Of Poverty—It’s Not Anymore”, Economic Policy Institute, December 4, 2013, http://www.epi.org/publication/minimum-wage-workers-poverty-anymore-raising/. Accessed September 3, 2016.
Covert, Bryce, “Wealth Inequality Is Now As Bad As It Was During The 1920s”, Think Progress, March 31, 2014, http://thinkprogress.org/economy/2014/03/31/3420998/wealth-inequality/. Accessed August 5, 2016.
Buffett, Warren, “Stop Coddling the Super-Rich”, New York Times, August 14, 2011, http://www.nytimes.com/2011/08/15/opinion/stop-coddling-the-super-rich.html. Accessed August 24, 2016.
Blodget, Henry, “THE TRUTH ABOUT TAXES: Here’s How High Today’s Rates Really Are”, Business Insider, July 12, 2011, http://www.businessinsider.com/history-of-tax-rates#. Accessed August 5, 2016.
Dorn, James A., “Ending Tax Socialism”, The Cato Institute, September 13, 1996. http://www.cato.org/publications/commentary/ending-tax-socialism. Accessed April 28, 2016.
Aaron, Henry J., “Can taxing the rich reduce inequality? You bet it can!”, Brookings Institution, October 2015. https://www.brookings.edu/wp-content/uploads/2016/06/taxing-the-rich-you-bet-aaron.pdf. Accessed August 5, 2016.
Frank, Robert H., “Why Not Shift the Burden to Big Spenders?”, NY Times, October 7, 2007, http://www.nytimes.com/2007/10/07/business/07view.html. Accessed April 27, 2016.
Cebon, Peter and Hermalin, Benjamin E., When Less is More: The Benefits of Limits on Executive Pay, Rev. Financ. Stud. (2015) 28 (6): 1667-1700 first published online December 17, 2014, http://rfs.oxfordjournals.org/content/early/2015/01/31/rfs.hhu140.abstrac%20t. Accessed August 16, 2016.
Seyfarth Shaw LLP, “Dodd-Frank and Executive Compensation: Where Are We Now?”, August 28, 2015, http://www.seyfarth.com/publications/MA082815-CORP. Accessed August 17, 2016.
Mishel, Lawrence and Davis, Alyssa, “CEO Pay Has Grown 90 Times Faster than Typical Worker Pay Since 1978”, Economic Policy Institute, July 1, 2015, http://www.epi.org/publication/ceo-pay-has-grown-90-times-faster-than-typical-worker-pay-since-1978/. Accessed August 15, 2016.
Wilmers, Robert, “Why Excessive CEO Pay Is Bad for the Economy”, American Banker, March 14, 2014 (excerpted from Wilmers’ 2014 letter to shareholders), http://www.americanbanker.com/bankthink/why-excessive-ceo-pay-is-bad-for-the-economy-1066239-1.html. Accessed August 15, 2016.
Woocher, Jacob, “It’s Still Tough To Curb CEO Pay After Five Years Of Dodd-Frank”, Campaign for America’s Future, July 15, 2015, https://ourfuture.org/20150721/its-still-tough-to-curb-ceo-pay-after-five-years-of-dodd-frank. Accessed August 16, 2016.
Francis, Theo, “Best-Paid CEOs Run Some of Worst-Performing Companies”, The Wall Street Journal, July 25, 2016, http://www.wsj.com/articles/best-paid-ceos-run-some-of-worst-performing-companies-1469419262. Accessed August 16, 2016.
US Department of Labor, Minimum Wage Chart1, https://www.dol.gov/featured/minimum-wage/chart1. Accessed August 19, 2016.
Autor, David H., Alan Manning and Christopher L. Smith. 2016. “The Contribution of the Minimum Wage to US Wage Inequality over Three Decades: A Reassessment”. American Economic Journal: Applied Economics, 8(1):58-99, https://www.aeaweb.org/articles?id=10.1257/app.20140073. Accessed July 18, 2016.
Schmitt, John, “Why Does the Minimum Wage Have No Discernible Effect on Employment?”, Center for Economic and Policy Research, February, 2013, http://cepr.net/documents/publications/min-wage-2013-02.pdf. Accessed July 20, 2016.
Massachusetts Institute of Technology, Living Wage Calculator, http://livingwage.mit.edu. Accessed August 22, 2016.
Cooper, David, Schmitt, John, Mishel, Lawrence, “We Can Afford a $12.00 Federal Minimum Wage in 2020”, Economic Policy Institute, April 30, 2015, http://www.epi.org/publication/we-can-afford-a-12-00-federal-minimum-wage-in-2020/. Accessed July 13, 2016.
Kimball, Will, “14 states raised their minimum wage at the beginning of 2016, lifting the wages of more than 4.6 million working people”, Economic Policy Institute, January 21, 2016, http://www.epi.org/blog/14-states-raised-their-minimum-wage-at-the-beginning-of-2016-lifting-the-wages-of-more-than-4-6-million-working-people/. Accessed July 13, 2016.
Dimon, Jamie, “Why We’re Giving Our Employees a Raise”, NY Times, July 12, 2016, http://www.nytimes.com/2016/07/12/opinion/jamie-dimon-why-were-giving-our-employees-a-raise.html. Accessed July 14, 2016.