The Trouble with U.S. Income Inequality

June 1, 2015

In a thought experiment, imagine two scenarios each with a U.S. population of 100 people and a rise in real GDP of $1,000.  In the first case, everyone’s income rises by $10, but in the second, the entire incremental GDP of $1,000 is reaped by a single individual, and the other 99 residents experience no rise in income.  Most earned income gets spent, becoming somebody else’s purchasing power after some lag of time.  However, the percentage of income that is retained as savings climbs as the amount of consumption rises and the needs to be met become less urgent.  In economist jargon, one’s marginal propensity to consume diminishes at higher and higher levels of spending.  If only one of 100 people in the population gets all the incremental growth in income, a smaller percentage of that $1,000 will in turn get spent than in the case where everybody’s income has grown but by only a small $10 amount.  The underlying potential for future spending and income growth is considerably less dynamic with extreme income inequality.

Among the bedrock principles upon which America was founded is the rule of law and codes that promote opportunity for all to secure happiness.  This American Dream is that no matter the circumstances into which one is born, a better life, though not guaranteed, is not unduly prohibited by barriers.  Influence over law-making is costly, nonetheless, so the more unequal living standards become, the greater becomes the ability of the richest class to shape the law in such a way as to perpetuate its advantage from generation to generation.  In public education, for instance, costs are covered mostly by property taxes, creating a self-selecting process of tying access to the best human and capital resources of instruction with the same families that are already most endowed to afford such exposure.  That’s a first step of many that stratifies future opportunity from parent to child.

In a well-working social contract that mutually supports the individual and all society, that is the state, people need to believe that what’s good for the state will generally benefit the self.   Such an ideal will never be perfectly in place, but for the good of a country, people need to buy into the belief that the system is working and capable of becoming less imperfect.  Extreme income inequality, and the absence of reasonable expectation of a reversal of that situation, points in the direction of a less cohesive society and a diminishing commitment to community.  Bury the American dream, and what’s left will be neither exceptional nor even average.

Copyright 2015, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.


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