America is becoming more unequal economically, and most people find that disturbing. Indeed, the trend toward greater inequality has been one of the consistent themes of the election campaign. Some believe that inequality is necessary to reward hard work, achievement and entrepreneurship but think that the current level is too extreme. Others blame unfair tax policies and see the extent of today’s inequality as a sign that the government has abandoned the goal of equal opportunity.
In fact, whenever inequality increases in a society, there are both good reasons for the trend — that is, reasons we should not discourage — as well as bad ones. To best address the genuine problems caused by inequality today, it’s essential to identify the bad reasons and focus on reducing those.
First, though, let’s be clear: there’s no doubt that the very richest in the U.S. have been getting richer. One of the often quoted indicators, albeit a simplistic one, is the share of pretax income going to the top 1% of the population. These data suggest that the U.S. was most equal right before the oil crisis hit in the early 1970s, and that it has since returned to levels of inequality not seen since the Great Depression.
More sophisticated indicators, like the Gini coefficient, also show the U.S. becoming notably more unequal. As a generality, countries such as Brazil and South Africa rate high on this scale, while most European countries have lower levels of inequality. The U.S. is in between – at almost the same level as China. Prior to 1980, the U.S. was much closer to the European level, and some countries — such as France and Italy — actually had higher levels of inequality at that time.
Let’s also dispose of a red herring in the inequality debate: taxes. Contrary to popular belief, the data clearly show that growing inequality is being driven by changes in income, not by changes in tax rates. In fact, four separate studies have concluded that since 1969, the federal income tax has become slightly but steadily more progressive overall. The explanation: various credits, deductions and exemptions have reduced the effective tax rate on the lower half of the population — and especially the bottom fifth – more than tax-rate cuts have benefited the upper half. In any event, the effect of tax-rate changes can’t possibly compare with the fourfold increase in top executive compensation since 1989.
As a result, we have to look at the causes of greater divergence in pretax income — and distinguish between the good ones and the bad ones. The good ones are those that clearly contribute to the overall well-being of society: rewards for hard work, achievement, artistic talent and entrepreneurship, all of which encourage activities that benefit the common good.