How Economic Growth (and the 1%) Left the Middle Class Behind

By Matthew O'Brien

Being rich used to be boring. Well, maybe not quite so much boring as stable. Incomes at the top used to move more or less with the size of the economy -- like everybody else's. These were the halcyon days of broad-based prosperity. Then the 1980s happened.

The brave, unequal world we've lived in for the past 30 years is shaped more like a barbell. As former Office of Management and Budget chief Peter Orszag recently pointed out, the incomes of the rich and poor both are especially sensitive to the business cycle nowadays. The middle class much less so. The result is a society where inequality races ahead during the booms and falls during the busts -- before racing ahead again. 

The below chart compares how incomes for the top 1 percent (red), median households (green) and real GDP per capita* (blue) have grown since 1976. (Note: All income figures are inflation-adjusted. The data on the top 1 percent comes from Picketty and Saez and includes income from capital gains. The data on median household incomes comes from the Census Bureau. Real GDP, 1 percent and median income are all indexed to 100 beginning in 1976).


Occupy Wall Street was on to something. The American economy really has become bifurcated. There's the top 1 percent, and then there's everybody else. Actually, the reality is even starker. It's more like the top 0.5 or 0.1 percent and everybody else. Look at how the 1 percent stacks up against the 0.1 percent.


The super-rich make the merely stinking rich look almost middle class. Well, not really. The 1 percent have still seen substantial gains the past few decades. The middle class has not. It's debatable how small their gains have been -- the picture changes if you include taxes, transfers, benefits and adjustments for household size -- but the story isn't much changed compared to what's happened at the top. 

Bu remember: This is new. According to a recent Brookings paper by Jonathan Parker and Annette Vissing-Jorgensen, incomes at the top used to be less cyclical than average prior to the early 1980s. In other words, the fortunes of the rich depended less on the overall economy than others did. But since then, the incomes of the rich have increasingly risen and fallen with the economy. It looks like a ball bouncing up. With each boom, the rich have gotten richer than before, and with each bust, they've lost a large portion of those gains. It's not entirely clear what's caused this shift, but the ever growing financialization of the economy is a likely culprit.

For Orszag, our lopsided income distribution immediately raises at least two big policy questions. First, if the incomes of the rich are so closely tied to the overall economy, why isn't there more support for stimulus among them? And second, should we tax the uber-wealthy differently? Let's consider these in turn.

There's admittedly not much hard data on how the rich feel about stimulus. But considering that the uber-wealthy trend Republican and Republicans don't look too kindly on stimulus, it seems fair to assume that they're mostly opposed. Why are they seemingly not acting in their own self-interest? The answer: uncertainty and loss aversion. Many don't think stimulus would help now, and even the ones who do aren't sure how much good it would do. But they are worried about the costs -- to them. Specifically, they're worried that more spending will mean future tax hikes and that more inflation will erode their wealth -- which has already begun to recover from the Great Recession, unlike for most everyone else.

Taxes are more straightforward. We need more brackets at the top! Just as the top 1 percent live in a different world compared to the middle class, so too do the top 0.1 percent live in a different world compared to the 1 percent. And yet we tax them at the same rate. Less, even. The richer you are, the more income you typically get from capital gains. It's tricky to say exactly how much we tax capital gains -- corporate income taxes figure in too -- but it's certainly nowhere near being progressive. Fixing that should be the lowest of low-hanging fruit when it comes to tax reform.

Inequality is too multi-faceted a story to even begin addressing here. But a bad economy is certainly part of it -- at least in the short-term. Workers have little leverage when unemployment is high. Wages stall. And corporate profits surge to record highs. The 0.1 percent recover, and nobody else does. And that creates a pragmatic case for taxing the superrich more, beyond fairness. Use tax policy to reduce inequality just might reduce political opposition to stimulus, which could reduce inequality even more.  

That's the key: The politics and economics of inequality are self-reinforcing. If we take the first step, we might end up going much further than we expect.

*The original version of this post used real GDP instead of real GDP per capita. 

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