Middle Class Stagnation

It is no surprise that the high unemployment rate, the horrific rate of home foreclosures, the escalating cost of health insurance, and an increasing number of baby boomers facing retirement with little financial security have left Americans feeling angrier and more anxious than usual. It is also no surprise that under these circumstances the idea of raising taxes on the rich has gained favor. If income inequality has increased because the rich have gotten richer, and this inequality provides unfair advantages to the rich that in turn reduce economic opportunity and security for everyone else, then further taxing them makes sense. This argument is partly correct.

Increasing taxes and redistributing the proceeds can reduce economic inequality. Analyses of Gini coefficients, which measure the degree of inequality in a society, show as much. In 2000, the latest year for which comparisons are available, the Gini coefficient of market income (earned income and other cash income from private sources) was about the same in the United States (.48) and Sweden (.45). This means that, before each state becomes involved in redistribution, Sweden and the United States have about the same degree of income inequality. However, after adding income from government transfers and deducting taxes and social security contributions, the Gini coefficient in Sweden (.25) is much smaller than the Gini coefficient in the United States (.37), meaning that Sweden is more equal. Most countries reduce inequality mainly through taxes and transfers.

It would be wrong, though, to assume that tax rates are a major factor in the increase in income inequality in the United States. Effective federal tax rates have declined more for households at the lower end of the income distribution than for households at the top. If anything, tax policy has moderated the increase in inequality since 1979.

Even if more progressive taxes can reduce inequality we must ask, as Grusky does, whether there are better ways to do the job. Most countries use taxes and transfers to narrow the income distribution because changing the pre-tax and pre-transfer income distribution is difficult in open economies.

For example, many people believe that equalizing schooling will lead to a more equal income distribution. And, to some extent, this is true—my research suggests that if everyone had the same amount of schooling and the same test scores, inequality in earnings would decline by around 20 percent. The problem is that we do not know much about how to equalize educational outcomes, and what we do know suggests that it would be costly.

We could equalize school inputs such as per-pupil expenditures, teacher credentials, class sizes, and so on, but most research suggests that this would do little to equalize either educational attainment or test scores. Even expensive and intensive programs for disadvantaged young children increase test scores by only a few points—nowhere near enough to close the gap with their more advantaged peers.

If equalizing years of schooling and test scores does little to reduce inequality, reducing the bottlenecks in higher education is likely to do even less. Unequal opportunity is not the main reason for unequal adult earnings, and equalizing opportunity, which is important for many reasons, will not do much to reduce inequality.

Finally, and most importantly, the problems facing middle-income Americans are not the result of the rich getting richer. Over the 30 years that income inequality has grown, it has been largely ignored by politicians and voters because as inequality grew so did income in the middle of the distribution. Between 1970 and 1990 real median family income increased by around 7 percent per decade. It then increased by more than 12 percent between 1990 and 2000. But median income stagnated between 2000 and 2007 and declined once the recession hit. This lost economic decade has much to do with the increasing concern about inequality, but reducing inequality by cutting the income of the rich will not necessarily raise the income of middle-class Americans, just as rising inequality did not reduce middle-class income. If the income of the middle class does not resume growing, the urge to punish the rich will remain.