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Upwardly Mobile America?

From the Magazine: Monday, September 22, 2008

Are we in a new ‘gilded age’ where the rich are doing well and the poor and middle class are treading water?

With the U.S. economy in a fragile state, politicians are again debating the age-old question: Should America’s economic policies be geared to increasing the rate of economic growth or to promoting economic fairness through income redistribution? During this election year, some have argued that the last quarter-century has given rise to a new “gilded age” in which the privileged have done supremely well but the lower income earners have made no progress. A different view sees an upwardly mobile society in which those who get ahead fastest do so through their hard work, risk-taking, and grit. Let’s find out what’s actually happened.

Q. Has the gap between the rich and the poor been getting larger?
A. The answer to this question is that it depends on how you measure things. If we concentrate on the share of wealth that is earned by the richest 1, 5, or 10 percent, then yes, over time, the rich have corralled a larger share of the wealth. For example, in 1980 the wealthiest 1 percent and 5 percent of Americans earned 8 percent and 19 percent of the nation’s total income respectively. But by 2006 those percentages had jumped to 22 percent and 36 percent. The richest Americans now earn a larger share of income than at any time since the Roaring ’20s. It is also true that over the past quarter-century the share of income that has gone to the lowest income group (the bottom 20 percent) has fallen from 15 percent to 12 percent. So on this basis it would appear that “economic fairness” has declined in America.

Change in Income.jpgQ. Have the income gains by the rich come at the expense of the middle class and the poor?
A. Since 1983, every income group has seen an advance in after-tax income (see graph 1). Yes, the gains of the very rich have increased the fastest. But that is in part because of a statistical illusion. When poor people earn more over time, they move into the middle class or the upper class and are no longer  classified as poor. Consider someone who was earning $20,000 a year and saw her income move to, say, $50,000 as she moved up the career ladder. That 150 percent gain in income isn’t apparent, because we no longer categorize her as poor. But every penny of income gain by a rich person is counted, because there is no higher income class she can move into.

Another problem with comparing the distribution of income from one point in time with another is that up to 1.5 million new immigrants enter the United States every year. A fairly high percentage of these immigrants start at the bottom of the income ladder, replenishing the people who are at the bottom rungs. This creates the impression that poor people do not make significant progress in the American labor force.

Q. Is there really a ‘war against the middle class’ in America as claimed by people such as CNN’s Lou Dobbs?
A. Well, if the middle class is fighting a war, they’ve been winning. Graph 2 shows the income range needed to be considered in the middle class in the United States (between the 40th and 60th percentiles in income for families). In 1967 the average middle-class pre-tax income was about $40,000; in 2005 it was about $60,000. And this does not include the increased generosity of non-wage and non-salary benefits such as healthcare, pensions, flexible workweeks, and more family leave, vacation, and holidays.

Most economists agree that when these income numbers are adjusted by a more accurate inflation measure—one that takes full account of the improved quality of the products we now have access to, such as cell phones, laptop computers, and new medical technologies, for example—the purchasing power of the American middle-class family is about one-third higher today than in the 1970s.

The Census Bureau family income data indicate that in 1967 one in 20 families had an income of $100,000 or more (in today’s dollars). In 2005 one in six families did. There are three times as many families earning more than $75,000 a year today than there were in 1967.

Income Range of Middle Class.jpgQ. Is there much income mobility in America?
A. Yes. Income mobility studies track what happens to the economic fortunes of real people and families over time. It turns out the middle class and the poor have experienced much bigger gains over the last several decades than originally thought. What’s more, their gains have been even larger than those of the rich.

A 2007 study by the Treasury Department tapped into IRS data to observe family incomes over two periods, 1987 to 1996 and 1996 to 2005. During both periods, the poorer a household was at the start, the more rapid that family’s subsequent income gain. Average income for the poorest households more than doubled from 1996 to 2005. Perhaps even more stunning is that all income groups gained over the period, except for the super-rich, or the top 1 percent. That’s because people who make a very high income in a few years don’t always maintain that high income. Think of the many stories of NFL football stars who make millions of dollars before the age of 30 but then retire after an injury and see their earnings go way down.

The Federal Reserve Bank of Dallas looked at the same income mobility data over the time period 1975 to 1991. It found that 95 percent of poor households in 1975 were not poor by 1991. Three out of four of the “near poor” (the bottom 20 to 40 percent in family income) climbed into the middle class or higher over this period.

Q. Does age have much to do with income status?
A. Yes. For example, an analysis by the Minneapolis Federal Reserve found that the average age of the heads of households in the bottom quintile is 66. A lot of people who are labeled as “poor” are senior citizens, who are retired and have little income but many assets.

Q. How likely are people to break out of poverty from one generation to the next?
A. A recent study on income mobility, funded by the Pew Charitable Trusts, compares the economic status of parents in the late 1960s and early 1970s with the income level of their children in recent years.
The study confirms that kids from wealthy families have a head start in life, but not an insurmountable lead. Of those children who grow up in poor households, more than half are not poor as adults.

The latest Forbes list of the 400 richest people confirms that America remains an opportunity society and that it’s not easy to stay perched atop the wealth ladder for long. While some are on the list due to dynastic wealth, 270 of the 400—almost 70 percent—amassed fortunes by giving the rest of us products we want.

In 1967 one in 20 families had an income of $100,000 or more in today's dollars. In 2005, one in six families did.

Q. Don’t the rich engage in conspicuous consumption and spend much more than the middle class and poor?
A. Some people who are fabulously rich do buy Ferraris and yachts and dine on lobster and champagne every night. But they are the exceptions. Overall consumption is the great equalizer in America. Sam Walton, the founder of Wal-Mart, was one of the richest men in history and he drove around in a pickup truck most of his life. According to calculations by former Labor Department economist Diana Furchtgott-Roth, who has analyzed Bureau of Labor Statistics data on household spending patterns, the wealthiest fifth of Americans now consume $28,272 a year per person compared to $15,843 for the middle class and $11,247 for the poor. It’s a sign of the growing affluence of the poor that the single largest increase in expenditures for low-income households over the past 20 years was for audio and visual entertainment systems, which were up 119 percent.

Q. Are there other ways that the income data distort our perception of the gap between rich and poor?
A. Yes. One reason that high income families have higher earnings than low income families is that high income families have more workers. For example, the average household in the lowest income quintile has only, on average, about half a person working (meaning many of the households in that quintile have no one working at all). But the average high income family has two people working, usually a husband and a wife. It is also true that many forms of income that flow to the poor, such as government benefits, are not included in official calculations. When all sources of income are included, households in the lowest 20 percent of the income scale saw a 12 percent rise in their incomes from 1983 to 1993 and then another 9 percent rise from 1993 to 2005. But even this undercounts the actual gains, because the number of people living in low income households has been shrinking as a result of the breakdown of the family, people having fewer children, and more people living alone.

Real Income Gains.jpgQ. Is this a ‘winner-take-all’ society?
A. Not winner-take-all, but there is no question that in America today those who have superior talents and are the best or near-best at what they do—surgeons, lawyers, athletes, entertainers, and so forth—earn a big premium above those who are only average or even above average in these professions. While the first pick in the NFL draft might sign a $60 million contract, the 40th pick in the draft may not even make the team. 

This is a consequence of an information age and a global economy where talent and celebrity pay very large dividends. And, admittedly, it doesn’t always seem fair.

Q. Are the income gaps between races and between sexes increasing or decreasing?
A. Here we have very positive news. Since 1980, women have seen much faster income gains than men, and blacks have made faster gains than whites (see graph 3). White males still earn the most, but the gap is narrowing significantly. What this means is that the “gaps” in pay today are more likely to be a result of one’s skills and productivity, not so much the color of one’s skin or one’s gender.

Since 1980, the median income for black households has risen by 28 percent; Hispanic households by 17 percent; and white households by 16 percent.

Q. Are high tax rates on the rich a good way to redistribute income?
A. No. History teaches us that high tax rates are the worst way to redistribute income to the poor and the middle class. I recently reviewed IRS tax return data by income group going back to 1972. The results are jaw-dropping. In 1972, when the highest tax rate on the rich was 70 percent and the top capital gains tax rate was 35 percent, the richest 1 percent of Americans paid 17 percent of the income tax burden. Today, with a top income tax rate of 35 percent and capital gains at 15 percent, they pay 39 percent. With higher income tax rates the rich shelter more of their income through tax carve-outs, they invest less in the United States and more abroad, and they work less. The Robin Hood strategy has almost always failed because it means less income, not more, to take from the rich and give to the poor.

Stephen Moore is the The Wall Street Journal editorial board’s senior economics writer. He last wrote for THE AMERICAN about who pays taxes in the United States. He is the coauthor with Arthur Laffer and Peter Tanous of “The End of Prosperity” (Simon and Schuster), which will be out this fall. 

Image by Altrendo Images/Getty Images.

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