The Income Gap Is Suddenly a Hot Issue. Here’s Why.

By Sarah Stodola, The Fiscal Times

December 6, 2011--It may become the defining issue of the 2012 presidential campaign. The growing gap between the very rich and everybody else — the so-called 1 percent and the 99 percent — is the one thing the famously unfocused Occupy Wall Street movement can coalesce around.

The Congressional debate this week about extending the payroll tax cut has revolved around the issue. And it was the subject of an impassioned speech today by President Obama. "Long before the recession hit, hard work stopped paying off for many people," Obama said during an appearance in Osawatomie, Kan. "But this is not just another political debate. This is the defining issue of our time. This is a make-or-break moment for the middle class."

But does the gap really matter?
Is it necessarily a bad thing?

As President Obama noted, the income divide in America isn’t all that new -- it was an issue in Teddy Roosevelt's time, and it has been surging again since the 1970s. The top 1 percent of the population now possesses 40 percent of all wealth in the country -- up from 33 percent 25 years ago.

In 1965, according the Economic Policy Institute, CEOs earned 24 times the average American worker.

In 2010, the institute says, CEOs earned 234 times more than the average working stiff. Among the myriad causes of the income gap, experts say, are advances in globalization and technology, the decline of labor unions, a decrease in jobs for those without a college degree, and perhaps most important, government policy.

The gap between rich and poor in America is now greater than in Russia, Nigeria, Venezuela, and Iran, according to the CIA World Factbook. Between 1980 and 2005, the top 1 percent of earners in the U.S. took home more than 80 percent of income gains.

Between 1993 and 2008, real income for the top 1 percent of families grew an average of 3.94 percent per year, while real income for everyone else grew only 0.75 percent annually.

But that doesn’t mean everyone in the 99 percent is suffering. In fact, some experts believe that the size of the income gap has been exaggerated.

“Oftentimes these inequality numbers fail to take into account a couple of things,” says James Pethokoukis of the American Enterprise Institute (AEI). “One is household size … and two is differing levels of inflation.”

Pethokoukis says that households at the upper end of the income scale tend to be bigger, meaning that income has to be dispersed among more people than at the bottom, and that high-income households also contend with a higher level of inflation for the goods they consume. Both of these factors, he says, somewhat equalize the income gap.

But even if they don’t, and even if there is a significant income gap in America -- so what?

Income inequality can provide clear benefits, breeding competition and innovation critical to economic growth. “If there's no inequality, then people tend not to work,” says Jacob Hacker, a professor of political science at Yale and co-author of Winner-Take-All Politics: How Washington Made the Rich Richer -- And Turned Its Back on the Middle Class. But he adds that when income inequality reaches an extreme level, “there are rapidly diminishing returns.”

This can have huge economic and political consequences. In a society with extreme inequality, citizens “will have little incentive to support society,” says Glenn Firebaugh, a professor of sociology and demography at Pennsylvania State University. “It isn't good for a society to have too many people who feel alienated.”

In addition to breeding resentment, extreme income gaps can affect political power, education, crime rates, and health care.

Last year, 27 percent of those making less than $25,000 per year went without health insurance (although 14.6 percent of those were children), while among those making over $75,000, only 8 percent had no health coverage, according to a recent report from the U.S. Census Bureau.

That’s up from 10 years ago when the numbers were 23 percent (with 21.8 percent under the age of 18) and 7 percent, respectively. And a 2008 government report found that the growing disparities in life expectancy between rich and poor in this country mirror the expansion of the income gap.

In the early 1980s, the most affluent Americans could expect to live 2.8 years longer than the least affluent. By 2000 that number had grown to 4.5 years and continues to rise, according to an article in the International Journal of Epidemiology that was based on research from the Department of Health and Human Services.

And many experts believe that as the very rich pull away from everyone else, they are taking political power with them, undermining the democratic process. “The crucial aspect of democracy is that you're not supposed to be able to translate financial resources into political power,” says Hacker.

Says Gary Burtless, an economist at the Brookings Institution who specializes in income distribution: “in a democracy like ours, money helps, number one, helps determine who gets elected, and number two, influences the behavior of people once they are elected.

The wider inequality has become, the more I am concerned that the government [has] become captive to the views of the people who have the most money.”

Once the very richest wield inordinate power in government, they tend to preserve their own interests, creating a vicious cycle. “Wealth begets power, which begets more wealth,” economist and Nobel Prize winner Joseph Stiglitz wrote in a May 2011 article for Vanity Fair. Financial deregulation, tax cuts for the wealthy, the revolving door between government jobs and high-paying private-sector positions, and increased corporate financing of political campaigns all reflect this phenomenon.

“Inequality exacerbates educational disparities because we fund so much of education through local property taxes … But in areas with greater inequality, you also see more resistance to education funding,” says Hacker. “Really rich people have a lot less interest in public institutions. The public library or public school is less important to people who can buy themselves out of these shared institutions.”

While the rate of property crime -- the kind motivated by the prospect of financial gain -- has dropped over the past 15 years, the rate would have fallen far more without a rising income gap, says Antonio Merlo, an economist at the University of Pennsylvania who has done research on the economics of crime.

“There exists a … positive association between income inequality and property crime,” he says. “So as the income inequality in a society increases, property crime increases. Crime, like all other activities, is a place where people are going to compare marginal costs and marginal benefits.”

In a highly unequal society, Merlo points out, the benefit of committing a crime for financial gain often seems greater than the cost of breaking the law, especially when the legal alternatives are bleak.

Still, thinkers such as Pethokoukis of the AEI don’t believe that the current income gap and its ramifications demand radical new policies.

“Frankly, whether income inequality is better or worse,” Pethokoukis says, “I would still be prescribing the same policies, which are tax reform, spending reform, education.”