The American Pie: Income Inequality in the United States ... Indicator... · The American Pie: Income Inequality in the United States Scott Wallace Ph.D., Professor of Economics Randy

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Introduction Ina1963speechontheeconomy,PresidentJohnF.Kennedyremarkedthat“arisingtideliftsallboats.”Thisfamousphraseaccuratelycapturedthebroad-based economic prosperity experienced by the United Statesatthattime.EconomistshavecharacterizedthequartercenturyfollowingWorldWarIIasthe“GreatCompression.”From1947to1973,averagehouseholdincome increased an impressive 2.6% annually in inflationadjustedterms.Remarkably,realincomesforhouseholdsinthebottom20percentoftheincome distribution grew 3 percent annually while realincomesforthetopfifthroseby2.5%annually(GoldinandKatz,2009,28).Thiserawitnessedbotharapidly expanding pie and a greater equality among its slices. Thistrajectory,however,hasnotbeensustainedasincomes have become less equal in the U.S. during the last 30 years. Economists and some commentators havelabeledthecurrentperiodofrisingincomeinequality and diminished economic growth as the “GreatDivergence”(Noah,2010).“From1973to2005,thebottom-fifthoffamiliesrealizedalmostnogrowthinrealincome,whereasthetopfifthenjoyedanaverageannualgainof1.6percent”(GoldinandKatz,2009,28).Itisimportanttopointoutthatthe recent increase in income inequality is not a phenomenonfacedsolelybytheUnitedStates;italsohascharacterizedtheexperiencesofotherOECDcountries.Thecommonexperienceofrisinginequalitywithinthesenationsmaylargelyreflectthestructuralevolutionthatalldevelopedeconomiesface. ThispaperanalyzesthisgreatdivergenceineconomicfortunesamongAmericanhouseholds.Itbeginsbyexaminingtheevidenceofincreasingeconomic inequality in the United States over this timeperiod.Fromthere,weconsiderthecomplexfactorsresponsibleforthisrise.Then,weexploreAmericanidealsofequality.Suchanexplorationisimportant in evaluating policy prescriptions that addressinequality.Next,thepaperdescribeschangesin economic mobility during this period. Lastly we brieflyoutlineseveralbroadareasforpotentialpolicyresponsesthatareconsistentwithAmericanvalues.

TheEvidenceofIncreasingEconomicInequality TheGiniIndex(GI)iscommonlyusedtomeasure

thedegreeofincomeequality in a geographic area or a nation. The rangeofGIisfrom0to1.00.Anationorregion is said to have a completely unequal distributionofincomewhentheGIequals1.00(onegroupreceivesalltheincome),andtohave a completely equal distribution when the GIequals0(eachgroup

hasthesameincome).Theevidencefromavarietyofsources suggests that the income distribution in the US has become less equal over past 30 years. The most recent and comprehensive data set comes fromthenonpartisanCongressionalBudgetOffice(CongressionalBudgetOffice,2011,7).Inmeasuringincomeinequality,theCBOusesmarketincomeasreportedonincometaxformsplusemployerpaidhealthcareinsurance(AppendixA).In1980theGIstood at around .48 and by 2008 it reached .59. This represents a 23 percent increase in income inequality in the nation over the past 27 years. The subtraction ofcapitalgainsfrommarketincomedatareducesthedegreeofincomeinequality.However,theGIformarket income excluding capital gains has trended higher as well meaning that capital gains alone do not explain the upward trend in U.S. income inequality. Inmeasuringanation’sincomedistribution,economistsdivideanation’shouseholdsintoquintileswitheachquintileaccountingfor20percentofthepopulation. The CBO study also shows that income has become much more concentrated in the upper quintileofhouseholdswithincomeaccruingtothetop1percentofhouseholdsbeingamajorsourceoftheincreaseinGI,(CongressionalBudgetOffice,2011,xi).Since1979,everyquintileexperiencedadeclineintheshareofmarketincomeexceptforthehighest(or

The American Pie: Income Inequality in the United StatesScott Wallace Ph.D.,

Professor of EconomicsRandy F. Cray Ph.D.,

Professor of Economics and Chief Economist

12 CWERB Economic Indicators Report - Stevens Point

fifth)quintile.Acloserexaminationshowsthatonlythetop1percentofhouseholdsincreaseditsshareofmarket income over the period! Morespecifically,theCBOfoundthat,between

1979and2007,incomegrewby:275percentforthetop1percentofhouseholdsand65percentforthenext19percentofthehighestquintile.Incomeroseapproximately40percentforthenextthreequintilesand18percentforthebottom20percent,(CongressionalBudgetOffice,2011,x).Theevidenceonce again supports the position that income inequalityhasbeengrowingattheverytopoftheincome distribution in the U.S.

Anotherwaytolookatincomeinequalityistoestimatetheincomeshareoffamiliesinthetopdecile(tenpercent)usingincometaxdatathathasbeencollectedsince1913(Saez,2013,8).Thetop1percentoffamilies’shareofincomeintheU.S.hasrisenfromabout8percentin1970to23percentin2007.Meanwhile,thetotalincomeaccruingtotheother9percentoffamiliesremainedrelativelyflatovermostthe past 90 plus years.

Anumberofanalystscontendthatthesemeasuresoverstatetheriseofinequalityoverthistimeperiod.One argument claims that changes in the tax code havecausedanunderreportingofincomeforthelowerquintilesbyignoringothersourcesofincome such as employer paid health insurance. In addition,thereductionincapitalgainstaxrateshaveencouragedthewealthytorealizetheircapitalgains,thusinflatingincomesintheupperendoftheincomedistribution. While there is some validity to these criticisms,theirimpactontheanalysisismarginalatbest.

NationalandLocalAreaIncomeInequality Anotherdimensionisthespatialdistributionofincomeinequality.Incomeinequalityisnotuniformthroughout the United States. The U.S. Census Bureau mapoftheUnitedStatesshowstheGIatthecountylevelfrom2006to2010.Incomeinequalitytendsbeconcentrated in metropolitan areas and in the South. However,asthemapillustrates,therearepocketsofhighincomeinequalityelsewhereinthenation(UnitedStatesCensusBureau,2012,2).


International Comparisons: Within Nations and AcrossNations Data on income equality within nations and across nations over time supports the assertion that the U.S.hasahigherconcentrationofincomeinequalitythananyotherdevelopedcountry(EconomicPolicyInstitute,2013,84).Moreover,therateofincreasein income share by the top 1% is higher in the U.S. thanin15otherdevelopedcountries.Ifwelookfromanalternativeperspective,weseeeconomicinequalityacrossnations(ratherthanwithin)hasdeclined.“Globalinequalityhasbeguntofallaspoorercountriescatchupwithrichercountries”(TheEconomist,2013,4).Thissurelyisgoodnewsasglobaleconomicgrowthhassignificantlyreducedpovertyinemergingeconomies.Thefocus,here,however is on rising inequality within the United States.

CausesofRisingIncomeInequality InthissectionofthepaperweexploresomepossiblecausesfortheriseinincomeinequalityintheU.S.Researchershavehadadifficulttimeascribingblametojustonefactor(EconomicReportofthePresident,February,1997).WebelieveitistheconfluenceofanumberoffactorsthatbestexplainstherisingincomeinequalityintheU.S.Thesefactorsincludeskill-biasedtechnologicalchange,globalization,institutional&organizationalchange,theriseofwinner-take-allmarkets,taxationpolicy,andimmigration. Skill-biased Technological Change This idea here is that technological innovation hasfavoredknowledge-basedoccupations.Theimplicationisthatautomationandnewinformationtechnologieshavegreatlyreducedthenumberofhighpayinglowskilledjobs.Atthesametimeindividualswith the requisite technological skills are relatively scarceandinhighdemand.Theautomobileindustry,

forexample,hasseenalargereductionininhighpayinglowskilljobslargelycausedbythewideadoptionoflabor-savingautomation.Atthesametimetheautomobileindustryandothermanufactureshavehaddifficultyfindingskilledworkerstodomorecomplex tasks. Thislineofreasoningsuggeststhatdigitalandelectronic innovations have simultaneously driven downthewagesofalargenumberoflowskilledworkersnumberswhileincreasingthewagesofamuchsmallergroupofhighlytrainedandskilledworkers. Even though innovation has contributed to economicinequality,itdoesnotexplaineverything.Mostofthegainsinincomehavegonetothetop1percentoftheincomedistribution.Whileitistruethat education and training are highly correlated withearnings,individualsinthetop1percentarenotnecessarily any better educated or trained than people furtherdowntheincomedistributionwhohavenotexperiencedextraordinarygainsintheirincome(U.S.CensusBureau,(2006). Globalization Thisargumentcontendsthattheglobalizationoftheworld’seconomyhasexposedAmericanworkersto greater competition. More than at any time in history,lessskilledinexpensiveforeignlaborisindirect competition with U.S. workers. Improvements intransportation,communicationandtherelaxationoftraderestrictionshavemadeforeignmadegoodsmoreaccessibletoU.S.consumers.Thus,U.S.workershave become more susceptible to being displaced byinexpensiveforeigncompetition,withlow-skilledU.S.workersfacingthefiercestcompetition.Converselythegreatertheskilllevelofworkers,thelesslikelytheyaretolosetheirjobstounskilledforeignworkers.Thissituationhasexacerbatedincome inequality in this country. Whileglobalizationhassomeexplanatorypower,theriseinincomeinequalitywastakingplacebeforelongbeforetheglobaltradepactsandtheimprovementsintransportationwereinplace(TimothyNoah,2010).Thus,globalizationwhilepartofthestorycannotaccountforthelongtermtrendinU.S.incomedistributionorbethesoleexplanationofwhythetop1percenthasseenalargeincreaseinitsshareofincome. Winner-take-all-markets(WTAM) TheWTAMhypothesistakesthepositionthatsocietyhas been paying larger premiums to the very best in a profession.Whetherinacademics,athletics,business,


entertainment,medicine,law,orotherprofessions,thetop people are commanding ever higher premiums abovetheaverageincomelevelintheirprofession.AgoodexampleofaWTAMisthemarketfortournamentgolfers.“WhenhewasatthetopofhisgameTigerWoodswasmaking$12millioninwinningsand$100millioninendorsementswhereasthesecondbestgolfer,PhilMickelson,wasmaking$4millioninwinningsand$47millioninendorsementsand the third best was making less than 15 million combined”(Zingales,2012,23).

Thereasonsforthisaremany,butattheheartofthe story is that new communication technologies haveloweredthecostofreachingvastmarkets.Thiscreatesthepotentialforhugeprofitsforthosepeopleorfirmswhoaremarginallybetterattheiractivitythanthecompetition.Simplystated,newtechnologies now give markets the choice between selectingapersonorafirmwhoisverygoodatwhattheydoandchoosingaperformerwhoistheverybestintheirfield.InaWTAMworldapersonorfirmthat has a slight edge over the competition will have greatpotentialtocommandanincreasingshareoftheincomepie(FrankandCook,1996).Itisimportanttorecognizethattheincreaseinincomeinequalitywasunderwaybeforetheemergenceofthesetechnologicalinnovations.Therefore,WTAMcanexplainsome,butnotallofthegrowingincomedisparityinthiscountry. Institutional&OrganizationalChange:CEOpayandthedeclineinunionization This explanation says that the dramatic rise in CEO payhascontributedtoofrisingincomeinequalityintheU.S.Thechartbelowshowshowtheratioofaverage CEO to average compensation to average production worker compensation has changed

over the past 40 years. In 2011 the average CEO compensationwasapproximately209timesthatoftheaveragepersoninthatorganization(EconomicPolicyInstitute,2013,C.4118).Anecdotalevidencesuggests that the number has risen since 2011. Sowhatarethereasonsforthistrend?MuchoftheincreaseinCEOpaystemsfromchangesincorporategovernance practices that were widely implemented in the late 1980s and early 1990s. Changes in executive compensationthroughtheincreaseintheuseofstockoptionsandotherpayforperformanceschemeswere designed to align managerial and shareholder interests(HolmstromandKaplan,2001).Insteadofreplacingtraditionalformsofcompensationlikesalary,thesenewschemesoftenwereaddedontothese existing methods. Evidence suggests that the stronginfluenceofCEOsonthemembershipofBoardsofDirectorsinfluencedtheadoptionofthesehighlyfavorablepaymentarrangements(BebchukandFried,2003).

In1973,26.7percentofallwageandsalaryworkerswereunionmembers.By2011,unionparticipationhadfallento13.1percentofthelaborforce.CriticssaythedeclineinunionizationhasallowedCEOstocaptureagreaterpercentageofafirm’sproductivity


gains,a.k.a.profits(EconomicPolicyInstitute,2013,C.4269).Thechartbelowshowsaclosecorrelationbetween productivity gains and real medium householdincomeuntilabout1979.Afterthat,gainsinworkerproductivityhavehadmuchlessinfluenceonrealmediumfamilyincome(EconomicPolicyInstitute:EconomicIndicators,2013). Taxation policyTaxation policy and the role that it may have played in accelerating income inequality has been a hot button issue in the U.S. The argument is well known andstraightforward.Taxcuttingpolicieshavehad the largest impact on households earning at or above the 95 percentile. The chart below shows the federaltaxratesforvariouspercentilesoftaxpayingunitsin1960andafterthelastmajorroundoftaxratereductions.Thedataindicatesthatournation’sfederaltaxsystemhasbecomemuchlessprogressive.In1960thetop0.01percentofhouseholdsfacedacombinedrateofabout70percent;in2004thecombinedratefelltorateofabout30percent(PikettyandSaez,2007).

Thechartbelowshowsaftertaxincomeshareforvariouspercentilesfrom1979-2007.Theonly group to experience an increase was the top1percentofhouseholds.However,someresearchers believe that tax rate reductions account forjustasmallportionofthegreatdivergences

(Noah,2010,1).Theypointoutthattaxratereductions had little impact on changing income distribution in this country as shown in the CBO chart (CongressionalBudgetOffice,2011). ImmigrationTheimmigrationoflowerskilledworkersintotheU.S.it’sarguedhaspusheddownwagesratesfortheunskilled workers. The Immigration and Nationality Actof1965whichliberalizedimmigrationrestrictionsledtosignificantincreasesinimmigrationratesintotheUnitedStates.“Since1970,theforeign-bornshareoftheU.S.population(legalandillegal)hasrisenfrom4.8percentto11percent.MorethanhalfofU.S.immigrantsnowcomefromMexico,CentralandSouthAmerica,andtheCaribbean.Althoughasubstantialminorityofimmigrantsarehighlyskilled,formostimmigrantsincomesandeducationalattainmentaresignificantlylowerthanforthenative-born”(Noah,2010,5). The rise in immigration has had the greatest negative impactontheincomesonlow-skilled,low-incomeworkers.Studiesshowthat,from1980to2000,Mexicanimmigrantsalonereducedtheincomesofnative-born high school dropouts by over 8 percent (Noah,2010,5).Whileimmigrationhashadsomeimpactinincreasingeconomicinequality,itseffectis much smaller than the other causes that we have presented.Higherratesofimmigration,forexample,dolittletoexplaintherapidriseinthetop1percent’sincome level. Whilewehavediscussedanumberofcausesofrisinginequality,itisimpossibletoisolateonefromanother.Skill-biasedtechnologicalchange,globalization,andwinner-take-allmarkets,forexample,aredeeplyinterrelatedintheireffectsoninequality.Competitivepressuresfromincreasingglobalizationincentivizefirmstoadoptnewtechnologiesthatharmlow-skilled workers but reward highly skilled workers. These new technologies also act to expand global markets by reducing communication and search costsforcustomersandbyfacilitatingcoordinationamong businesses and their suppliers on a greater geographicalscale.Thephenomenonofwinner-take-all markets similarly depends upon both access to globalmarketsandtheutilizationofnewinformationand communication technologies to reach these global markets.


EqualityandAmericanValuesDoes the dramatic increase in economic inequality overthelast30yearsrepresentamajorproblem?WhetherinequalityislikelytobeamajorconcerntocitizensdependsuponhowAmericansviewinequality.Thepoliticalfeasibilityofanypolicyresponse to inequality needs to be consistent with Americanvalues.Thoughequalityishighlyvaluedideal,Americanshavearatheruniqueconceptionofequalitycomparedwithpeoplesfromothercountriesand cultures.

PerhapsnopassagebettercapturestheAmericannotionofequalitythanthiscelebratedphrasefromtheDeclarationofIndependence:“Weholdthesetruthstobeself-evident,thatallmenarecreatedequal,that they are endowed by their Creator with certain unalienableRightsthatamongtheseareLife,Liberty,andthepursuitofHappiness.”Here,theemphasisisontheequalityofrightsamongcitizensratherthanonequalityofoutcomesorresults.Consistentwiththisrights-basedconceptionofequalityaretheAmericanidealsofsocialequality,equalitybeforethelaw,andequalityofopportunity.Asideals,Americansrecognizethateachhasn’tbeenfullyrealizedbutremain important goals that society should always strive to achieve. Theidealofsocialequalityrejectsdistinctionsbasedon“rankanddeferenceinsocialrelations”(Ladd,1994,9).Ingeneral,Americansabhortheideaofprivilegeassociatedwithclass,birthright,religion,race,orethnicity.“’I’masgoodasyouare’–that’stheidealofsocialequality”(Ladd,1994,10).Individualsshouldbejudgedonthebasisoftheircharacter,capabilities,andaccomplishments,notoncriteriadivorcedfromtheirownefforts.Equalitybeforethelawasaprinciplereferstoallindividualsreceivingequal treatment and due process under the law. The right to legal representation and the public support oflegalservicesforthepoorreflectsocietaleffortstoensuregreaterequalitybeforethelaw. Therearetwofacetsthatconstituteequalityofopportunityasanideal.Formalequalityofopportunityrepresentsa“standardofdecision-making,stipulatingthatallpeoplebetreatedthesame,exceptwhendistinctionscanbeexplicitlyjustified.Thisstandardhasbeenusedtodefinefairnessinlending,housing,hiring,wageandsalarylevels,jobpromotion,votingrights,andotherconcerns.Artificialbarriers,prejudices,andpersonalpreferencesshouldneitherrestrictnorenhanceopportunitiesforanyone”(DeVries,2005).Thefocus

on“equaltreatment”andtheoppositionto“artificialbarriers”isconsistentwiththeidealsofsocialequalityandequalitybeforethelaw. Thesecondfacetisknownassubstantiveequalityofopportunity. In addition to ensuring that individuals arejudgedfairlyontheirmerits,substantiveequalityofopportunitycallsuponsocietyto“providegoodenoughopportunitiesforallitsmemberstodeveloptheirnativetalentssoastobecomequalifiedforcompetitive positions. The idea here would be thatthereissomethresholdlevelofopportunitytodevelopone’snativetalentsintoskillstowhichallareentitled”(Arneson,2002).Americanshavestronglysupportedpubliceffortsaimedatgivingallitscitizensopportunitiestocultivateandexpandtheircapabilities. Laws requiring that all children receive a basic education extend back to the colonial period ofAmericanhistory.“Thewholethrustinmakingagoodeducationbroadlyavailableisbringing,astheideal,allsegmentsofthepublictothestartingline with more or less an equal chance to succeed. Extendingeducationenlargesopportunity,but,atthesametime,doesn’tguaranteesuccess”(Ladd,1994,41). Whiletheseidealshaveinformedpoliticaldebateandthesubstanceofpolicy,Americansgenerallyhavenotsupportedgovernmentaleffortstoensuregreaterequalityofresults.Thoughalltaxationand expenditure policies unavoidably result in a redistributionofincome,Americanshavenotviewedthereductionofincomeinequalityasalegitimategoalofgovernmentalpolicy.Argumentssupportingprogressive taxation traditionally have been based on attaininga“fair”distributionofthetaxburdenratherthanasameansofredistributingincomefromtherichtothepoor.Thegoalofanti-povertyprogramslikewelfareistoprovidesomeminimaleconomicsupporttothoseunabletofendforthemselvesbutdonotrepresentalegitimatemeansofnarrowingincomeinequality(Plattner,1979). MostAmericansstronglybelievethatthosewhoworkhardfullydeservetherewardstheyreceivefortheirefforts.OpinionpollstakenduringdifferenttimeperiodsinAmericanhistoryhaveshownaremarkableconsistencyinAmericanattitudestowardsgovernmentaleffortsthatredistributeincometoremedyeconomicinequality.In1938,aRoperOrganizationpollaskedrespondentswhethera top limit should be placed on income with any excess income coming to the government as tax revenue.DespitetheeconomichardshipsoftheGreat


Depression,onlyone-thirdofrespondentssupportedsuchalimit(Ladd,1994,41). Inequality and Economic Mobility Not only are policies that reduce income inequality through income redistribution inconsistent with Americanvalues,mosteconomistsbelievethatsuchattemptswouldbeharmfultoeconomicgrowth.InEqualityandEfficiency:TheBigTradeoff,economistArthurOkundescribedtheproblemwitheffortstoachieveincomeequality.“Inpursuingsuchagoal,societywouldforegoanyopportunitytousematerialrewardsasincentivestoproduction.Andthatwouldleadtoinefficienciesthatwouldbeharmfultothewelfareofthemajority.Andanyinsistenceoncarvingthepieintoequalsliceswouldshrinkthesizeofthepie”(Okun,1975,48).

Unequal incomes represent the carrots and sticks that ensure that resources are employed in their most productive uses. Because the rich save and invest moreoftheirincome,incomeinequalityalsosupportsawealthaccumulationprocessthatfuelseconomicexpansionandjobcreation.Somedegreeofincomeinequalityisthereforeanecessarycomponentofarapidly growing economy which can improve the standardoflivingforallincomegroupsbecauseitexpandstheeconomicpie.Thougharisingtideliftsallboats,itisreasonabletoexpectthattheyachtsascendfurtherthanthedinghiesiftheactionsofyachtownerslargelyareresponsiblefortherisingtide. Despitetherecognitionoftheeconomicimportanceofincomeinequality,anumberofrecentstudiessuggestthat its sharp rise over the last 30 years has not enhancedincentivesforproductiveeffortandmayreflectgrowinginefficienciesintheeconomy.Suchan increase in inequality would be less problematic ifaccompaniedbyhighratesofeconomicmobilitysothatasignificantproportionofpeoplewhostartoffearninglowincomesmoveintohigherincomecategoriesovertime.Thesestudies,unfortunately,paintapictureofaneconomycharacterizedbyboth increasing income equality and declining income mobility during this period. The decline in income mobility is particularly troubling because itmayindicateadeclineinsubstantiveequalityofopportunity during this period. Onewayofmeasuringeconomicmobilityis by examining intragenerational mobility. Intragenerational mobility measures the “likelihood thatapersonwillmovefromonesegmentoftheincomedistributiontoanother”(Zingales,2012,26).

Some studies show a decline in intragenerational mobilitysincethe1970s.“Inthe1990s,…36percentofthosewhostartedinthesecondpoorestquintileoftheincomedistributionstayedthere,versus32percentinthe1980sand28percentinthe1970s”(Zingales,2012,26). Moststudiesanalyzingincomemobilityfocusonintergenerational mobility which measures the correlationofparents’incomeswiththeirchildren’searnings. The idea here is to determine whether aparent’sincomeisagoodpredictoroftheirchildren’sincome.“Inasocietywithbroadequalityofopportunity,theparents’positionontheincomeladdershouldhavelittleimpactonthatoftheirchildren.”(TheEconomist,2012,10). Awell-acceptedstatisticforintergenerationalmobilityisintergenerationalelasticityinearnings(IGE).TheIGEis“thepercentagedifferenceinearningsinthechild’sgenerationassociatewiththepercentagedifferenceintheparentalgeneration.Forexample,an[IGE]of.6tellsusthatifonefathermakes100%morethananotherthenthesonofthehighincomefatherwill,asanadult,earn60%morethanthesonoftherelativelylowerincomefather.Anelasticityof0.2saysthis100%differencebetweenfatherswouldonlyleadtoa20%differencebetweenthesons.Alowerelasticitymeansasocietywithmoremobility”(Corak,2011,2). EconomistsDanielAaronsonandBhashkarMazumdercalculatedUSIGEestimatesforeachdecadefrom1940to2000.ThefiguresbelowshowthatIGEdeclinedfrom1940to1980butincreaseddramatically in the 1990s and 2000s. These results implythateconomicmobilityincreasedforthefirstfourdecadesoftheirsurveyanddramaticallyfellduringthelasttwodecades(AaronsonandMazumder,2007).

Elasticitiesbetweenparentalincomeandsons’earnings,1950–2000


Note:Thehighertheintergenerationalelasticity(IGE),thelowertheextentofmobility.TheIGEsshownarefor40-to44-year-oldsons. Source:Authors’analysisofAaronsonandMazumder(2007,Table1) Inadifferentstudy,economistMilesCorakcalculatedestimatesofintergenerationalelasticitybetweenfatherandsonearningsfor22countries,includingthe United States. Cross-country comparisons show thattheUnitedStatesdoesnotcomparefavorablywithmostdevelopedcountries.OftheOECDnations,onlyGreatBritainandItalyscorelowerthantheUnited States with regard to economic mobility. ThesignificantdifferenceinIGEscoresbetweentheUnitedStates(0.47)andCanada(0.19)isparticularlystriking,giventherelativeculturalsimilaritiesbetweenthetwonations(Corak,2011).TherelativelypoorperformanceoftheUnitedStatesseemstocontradictAmericannotionsthatseetheUnitedStatesasalmostuniquelythelandofopportunity. IntergenerationalcorrelationsbetweentheearningsoffathersandsonsinOECDcountries

Note:Thehighertheintergenerationalelasticity,the lowertheextentofmobility. Source:AdaptedfromCorak(2011,Figure1) PerhapsCorak’smostinterestingresultsaregiveninthenextfigure.Here,Corak“plotstheintergenerationalearningselasticities[of22countries]againstacross-sectionalmeasureofinequality(theGiniCoefficient)”(Corak,2011,5).Thefigureclearly indicates that countries with high degrees ofincomeinequalityalsosufferfromlowratesofintergenerational mobility.

WhileCorak’sanalysisdoesnotexplainthereasonsforthisnegativecorrelationbetweenincomeinequalityandeconomicmobility,itdoessuggestthateconomicinequalitymaybeself-perpetuating.“Fromviolinlessonstotutorsfortests,richerparentscaninvestmoreintheirchildren,improvingtheirchancesofgettingintothebestuniversities”(TheEconomist,2012,22).ThedecentralizedfundingofpubliceducationintheUnitedStatestranslatesintosignificantqualitydifferencesbetweenwealthyand poor districts. “Richer neighborhoods can affordbetterschools,whichreinforcesthegrowinggeographicalgapbetweendifferentsocialgroups”(TheEconomist,2012,12).

These gaps between social groups have been accentuated by a rise in residential segregation by incomeoverthelast30years.APewResearchCenterstudy“findsthat28%oflower-incomehouseholdsin2010werelocatedinamajoritylower-incomecensustract,upfrom23%in1980,andthat18%ofupper-incomehouseholdswerelocatedinamajorityupper-incomecensustract,upfrom9%in1980”(FryandTaylor,2012).Suchchangesarefurtherreinforcedbyothersocialtrends.“In1960Americancoupleswithtwocollege-educatedpartnersaccountedforonly3%ofthetotal.Todaythatfigureis25%andinthetop5%oftheincomedistributionitis75%(TheEconomist,2012,14).

Policy ResponsesInthissection,webrieflyconsideranumberofbroadpolicyresponsestothetwinproblemsofeconomicinequality and declining economic mobility. The data presented in the previous section strongly suggests that increases in economic inequality are linkedtogreaterinequalityofopportunityamongitscitizens.Policyresponsesdesignedtoexpandoverall


opportunityareconsistentwithAmericanvaluesand simultaneously help grow the economic pie by encouragingamoreefficientuseofresources.Here,we show how government can improve outcomes by doing more in some arenas while doing less in others. Giventhebreadthandcomplexityoftheseissues,weonlyprovideabriefsketchofseveralareaswherepolicy changes may have a positive impact.

Human CapitalEarlierinthepaper,wedescribedhowskill-biasedtechnological change increased income inequality byincreasingthedemandforhighlyskilledandeducatedworkerswhilereducingthedemandforlessskilledworkers.Therisingwagepremiumforcollegeeducatedworkersisstrongevidenceforthisphenomenon.“Employersarepayingthetypicalfour-yearcollegegraduate[withoutgraduateschool]75%morethantheypayhighschoolgrads.Twenty-fiveyearsago,theywerepaying40%more”(Wessel,2007,A2).

Askepticofthislineofreasoningcouldcorrectlypointoutthatotherperiodsoftechnologicalchangesimilarlyincreasedthedemandforskilledworkersyet did not lead to greater income inequality. The problemwiththestorywehavetoldsofaristhatitfocusessolelyondemandwithoutconsideringsupply.Atthestartofthe20thcentury,forexample,advancesinelectricity,communications,andcontinuousprocessmachinerycreatedademandformanagers,clericalworkers,andhighlyskilledbluecollarworkers(BrynjolfssonandMcAfee,2011).“[O]fficeworkers had to know how to operate typewriters and addingmachines.Theyhadtomasterbookkeeping,billingprocedures,andstenography”(Noah,2010).The education system in the United States during thiserasuccessfullyaccommodatedthisincreaseindemandforhigherskilledworkers.Workerswitha high school level education had learned the skills neededtomeetthisnewdemand.“AverageyearsofschoolingincreasedrapidlyforAmericansbornfrom1875to1950(andeducatedintheUnitedStates).

TheincreaseinsupplyofhigherskilledworkersreflectsAmericans’strongcommitmenttoeducation.“Indeed,Americaledtheworldinuniversaleducationinthefirsthalfofthe20thcentury,beginning with the movement in 1910 to 1940 to expandfreecompulsoryeducationtohighschoolyears and continuing with the post war transition tomasscollegeattendance”(GoldinandKatz,2009,30).Thisincreaseinthesupplyofeducatedworkerseffectivelyreducedthewagepremiumforeducated

workers,therebysupportingtheincreasingincomeequalityexperiencedduringtheGreatCompression.

Thewaveofnewcomputerandinformationtechnologies over the last three decades has once againincreasedthedemandforamorehighlyeducatedworkforce.EconomistsErikBrynjolfssonandAndrewMcAfeedescribethesechanges.“Whilecomputerswinatroutineprocessing,repetitivearithmetic,anderror-freeconsistencyandarequicklygetting better at complex communication and pattern matching,theylackintuitionandcreativityandare lost when asked to work even a little outside a predefineddomain”(BrynjolfssonandMcAfee,2011,55).Peoplewhopossesshigherorder,criticalthinkingskills are in greater demand while moderately skilled workers are increasingly be replaced by thesenewtechnologies.“Inparticular,softerskillslikeleadership,teambuilding,andcreativitywillbe most important. They are the areas least likely to beautomatedandmostindemandinadynamic,entrepreneurialeconomy”(BrynjolfssonandMcAfee,2011,63).Thegreaterneedforthesekindsofskillshasincreasedthedemandforworkerswithcollege-leveland graduate degrees.

Thedifferenceduringthisperiodisthatsupplyhasnotkeptupwithdemand.“Asharpslowdownintheincreaseofeducationalattainmentandhighschoolgraduationratesoccurredforthosebornafter1950.College graduation rates began to slow and high schoolgraduationreachedaplateau”(GoldinandKatz,2010,31).Thisdeclineintherateofgrowthineducationalattainmentisstriking.AtypicalAmericanbornin1945receivedtwomoreyearsofschoolingthantheirparentswhileeducationalattainmentofatypicalAmericanbornin1975exceededtheirparents’byonly6months(Noah,2010).Theinabilityoftheeducation system to adequately increase the supply ofeducatedworkershasdramaticallyincreasedtherelativewagesofthosewithcollegedegrees.

Inthemeantime,muchofthedevelopedworldhascaught up and surpassed the United States. “The UnitedStates,oncetheworldleaderintheproportionofpeoplefinishinghighschoolhasfallentonearthebottomofthe(richandrelativelyrich)nationsthatbelongtotheOrganizationofEconomicCooperationandDevelopment”(GoldinandKatz,2010,31).Though the United States leads the world in the numberofstudentswhogotocollege,it“hasfallenfromfirsttotenthintheshareofcitizenswhoarecollegegraduates”(BrynjolfssonandMcAfee,2011,61).


Debatesoverhowtoreformtheeducationalsystemat all levels are widespread and are well beyond thescopeofthisreport.We,therefore,wouldliketobrieflymentionacoupleofotherwaystoimproveeducationaloutcomes.First,theabilityofworkerstoupdatetheirskillsthroughouttheirworkinglifetimesis increasingly important in a dynamic and innovative global economy. The United States badly trails other developedeconomiesinprovidingopportunitiesforjobretraining.TheUnitedStatesgovernment“spendsbarelymorethan0.1%ofGDPof‘activelabormarketpolicies’togetthelessskilledbacktowork,one-fifthoftheOECDaverage”(TheEconomist,2012,24).

Notallofthenewjobsthatareingreatdemandrequireacollegedegreefromafouryearinstitution.Greatersupportfortechnicalandcommunitycollegesthatpossessspecializedknowledgeoftheneedsoflocal businesses can help provide workers with the appropriateskillstofillthisdemand.Inaddition,UniversityofChicagoeconomistsRaghuramRajanandLuigiZingalesbelieve“theremaybereasontorethinktheentirestructureofhighereducation,asystem designed at a time when students typically lefttheuniversityforacareerwithoneemployer.Weneedmoremodulardegreesandlifelongadmissiontoauniversity(atleastforthegeneralprograms)–sothat the student can pick and choose what she wants andwhensheneedsit”(RajanandZingales,2003,304).

Second,scientistsincreasinglyhaverecognizedthecriticalimportanceofearlychildhoodexperiencesinimpactingthedevelopmentofnon-cognitiveabilitieslikeperseverance,motivation,andattentiveness.TheyarefindingthattheseskillsarejustasimportantindeterminingfuturesuccessascognitiveskillsasmeasuredbytraditionalIQtests.Childrengrowingupindisadvantagedfamilies,however,arelesslikelyto develop these non-cognitive skills in their home environments.Byincreasingnon-cognitiveabilities,earlyinterventionthroughtheprovisionofpre-schoolopportunitieslikeHeadStartforthesechildrenhasshownpositive,long-termimpactsonperformanceinlaterlife.Thedevelopmentofstrongnon-cognitiveabilities becomes increasingly important in world that highlyvaluessofterskills.Programsthatfostertheseskillsincreaseequalityofopportunitybyensuringthataccidentsofbirtharenotthedeterminingfactorofone’sfuturesuccess(Heckman,2012).

InvestmentsinInfrastructureandResearch&DevelopmentPublicinvestmentsininfrastructurecanplaya

critical role in expanding economic opportunities. “Inthelongrun,investmentininfrastructureboostsproductivity by enabling people and goods to get to placesfaster,communicatemoreeasily,spendlesstime and money on repairs and so on. One recent studyfoundthattheconstructionofaroadtypicallyled to an increase in economic activity between three and eight times bigger than the initial outlay within eightyearsafteritscompletion”(TheEconomists,2013,13).TheAmericanSocietyofCivilEngineers(ASCE)recentlygavetheUnitedStatesagradeofDontheoverallstateofitsinfrastructure(BrynjolfssonandMcAfee,2011,67).TheASCEalsofoundthatin2009trafficdelayscostAmericansover$78billioninwastedtimeandgasolinewithanadditional$67billion going to car repair attributable to poor road conditions(TheEconomist,2013,13).

Therecentfiscalcrisesatboththefederalandstatelevelshaveconstrainedthegovernment’sabilitytotaptraditionalsourcesinfundinginfrastructureprojects.Statesandmunicipalities,however,arecreativelyusing“public-privatepartnerships”(PPP)topayforsuchprojects.PPPs“helppairinvestorswithprojectsthatwillgeneratearevenuestreamtobehypothecatedtocoverthecostoftheoriginalinvestment,plusareturn”(TheEconomist,2012,14).Byeliminatingimpedimentstoeconomicexpansion,improvements in transportation and communication infrastructurespromisetoexpandopportunities.

Thecreationofnewknowledgefrompublicinvestment in basic research and development has beenanimportantdriverofeconomicgrowthinthepast.Privateinvestmentinbasicresearchisofteninadequatebecauseoftheenormouscostsinvolvedforanyonefirmandbecausethebenefitsareoftensubjecttospillovereffects.

Forexample,thegovernmentfundedHumanGenomeProjectwhichmappedthehumangenomecosttaxpayersover$3.8billionover15years.Anindustrystudyclaimsthattheproject“helpeddrive$796billionineconomicactivityandraised$244billioninpersonalincome;itsupported310,000jobsin2010.Thesenumbersmaybeexaggerated,butthescaleoftheimpactisclearacrosssuchvastfieldsasagriculture and medicine and new areas such as gene therapy”(Zakaria,2012).Despitethesuccessofsuchinvestments,federalfundingofbasicresearchasapercentageofGDPhasbeendecliningfordecades.“Inaknowledgeeconomy,Americanjobswilldependmoreonscientificresearchthantheydidinthe1950s,yetwespendmuchlessasashareofGDP”(Zakaria,2012).


Reducing Regulatory Barriers to EntrySometimes the best thing that government can do toexpandopportunitiesistogetoutoftheway.Theeliminationorreductionofregulatorybarrierstoentrycancreatenewopportunitiestofosternewbusinesscreation.“Intoomanyindustries,elaborateregulatoryapprovalsareneededfrommultipleagenciesatmultiplelevelsofgovernment.Thesetoooftenhavetheimplicitgoalofpreservingrents[profits]ofexistingbusinessownersattheexpenseofnewbusinessesandtheiremployees”(BrynjolfssonandMcAfee,2011,67).

TheUnitedStates’intellectualpropertyregimesarebadlyinneedofreform.Thelargeincreaseinthenumberofpatentsgrantedoverthelastseveraldecadeshashadadampeningeffectoninnovation.Theproblemofoverlappingpatentrightshascreateda“patentthicket”thatnewinnovatorshavetoconfrontincommercializingnewproductsandprocesses.Thesystemalsoencouragestheformationof“patenttrolls.”Patenttrollsarefirmsthatbuyuppatents,notformanufacturingpurposesbutsolely to engage in litigation. These developments underminetherationaleforhavingapatentsystem.Theexpansioninthelengthoftermundercopyrightcoverage under the Sonny Bono Copyright Extension Acthasservedtheinterestsofexistingcopyrightholdersratherthanencouragethecreationofnewcontent(BrynjolfssonandMcAfee,2011,69).

Conclusion Inaddressingthechallengesofeconomicinequality,policyproposalsshouldfocusonadvancingsubstantiveequalityofopportunity.Bygivingcitizensopportunitiestodeveloptheirownskillsandcapabilities,theseeffortshavetheeffectofincreasingsocialmobilityasindividual’sabilitiestocompeteforhigherlevelpositionsinsocietyimprove.Thesepolicies thus can decrease economic inequality while expandingtheeconomicpieasthepotentialofscarcehumanresourcesismorefullyrealized. Anotherwaytodealwithincomeinequalityisthroughtheredistributionofincome.Redistributivepolicies,however,faceanumberofproblems.First,suchpoliciesareoftenpoliticallyinfeasiblebecausetheyconflictwithAmericanvalues.Second,theredistributionofincomecandampeneconomicgrowth by distorting economic incentives. Perhaps themostimportantrationaleforavoidingincomeredistributionisbestdescribedbytheNobel-Prizewinningeconomist,JamesHeckman.“Therearemany calls to redistribute income to address poverty

andpromotesocialmobility….[W]hileredistributionsurelyreducessocialinequalityatapointintime,itdoesnot,byitself,improvelong-termsocialmobilityorinclusion”(Heckman,2012,14).Thusgovernmental policies need to provide people a “leg up”ratherthana“handout.”

Appendix:A

Measuring IncomeCBOconstructeddefinitionsforMarketincome,Transfersincome,andFederaltaxes,(CongressionalBudgetOffice,2011,37)• Marketincome—includesallcashincome(bothtaxableandtax-exempt),taxespaidbybusinesses(whichareimputedtohouseholdsasdescribedbelow),andthevalueofincomereceivedin-kindfromsourcessuchasemployer-paidhealthinsurancepremiums. The taxes paid by businesses are the imputedvalueofcorporateincometaxes(whichareconsideredtobepartofcapitalincome)andtheemployer’sshareofpayrolltaxes(whichareconsideredtobepartoflaborincome).Theyareincluded in the measure under the assumption that household income would have been higher by a correspondingamountintheabsenceofthosetaxes.• Transfersincome—addscashtransferpayments(suchasSocialSecurity,unemploymentinsurance,andwelfarebenefits)tomarketincome,alongwithestimatesofthevalueofin-kindbenefits(fromMedicare,Medicaid,theChildren’sHealthInsuranceProgram(CHIP),theSupplementalNutritionAssistanceProgram(formerlyknownastheFoodStampprogram),andotherprograms).• Federalindividualandcorporateincometaxes,socialinsurance(payroll)taxes,andexcisetaxes.Inthisanalysis,CBOdidnotsubtractotherfederaltaxes(suchasestateandgifttaxes)orstateandlocaltaxesinconstructingafter-taxincome.


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