The Economic Case for Reducing Income Inequality

The trend in declining wages and increased income inequality has been well documented, most recently in a July 18 North Star article. Concern over these trends goes beyond the gut level response to the impropriety of concentrating a larger and larger share of societal wealth within a smaller and smaller slice of the population. There are hard-nosed economic reasons for seeking to reduce the level of income and wealth inequality.

Let’s start with the basics. An economy is driven by people buying and selling “stuff”—everything from groceries to electronics to automobiles to houses. When people can no longer afford to buy stuff, everybody loses—both the buyers who can no longer acquire the goods and services they need or desire, as well as the producers and sellers who no longer have a market for the stuff they are producing or selling. The producers and sellers consequently lay people off, thereby further reducing the purchasing power of working households. A vicious cycle ensues.

As a practical matter, an increase in the purchasing power of extremely high-income households cannot offset the effects of an equivalent decline in the purchasing power of low- and moderate-income households. This is because low- and moderate-income households tend to spend a much larger percentage of each dollar of disposable income on stuff. High-income households, on the other hand, tend to spend a small percentage of disposable income on stuff; instead, their disposable income goes disproportionately into savings. Billionaire venture capitalist Nick Hanauer describes the situation well:

The annual earnings of people like me are hundreds, if not thousands, of times greater than those of the average American, but we don’t buy hundreds or thousands of times more stuff. My family owns three cars, not 3,000. I buy a few pairs of pants and a few shirts a year, just like most American men. Like everyone else, I go out to eat with friends and family only occasionally… I can’t buy enough of anything to make up for the fact that millions of unemployed and underemployed Americans can’t buy any new clothes or enjoy any meals out. Or to make up for the decreasing consumption of the tens of millions of middle-class families that are barely squeaking by, buried by spiraling costs and trapped by stagnant or declining wages.

The bottom line is this: if, on the one hand, $1 million is distributed among 99 low- and moderate-income families, a large percentage of that $1 million will be spent on stuff. If, on the other hand, that $1 million goes entirely to one very high-income household, a much smaller percentage of the $1 million will be spent on stuff. Consequently, much more economic stimulus will result if the $1 million goes into the pockets of the 99 low- and moderate-income households.

The rebuttal to this argument among some conservatives is that high-income households will invest their surplus wealth in new production that will result in job creation. However, high-income households will not invest in new production if the bulk of consumers cannot afford to purchase the stuff they are producing. Hence, the surest path to economic growth and job creation is to increase in the purchasing of the lower- and middle-income families who comprise the vast majority of the consumer base. As Hanauer puts it:

…rich people don’t create jobs, nor do businesses, large or small. What does lead to more employment is the feedback loop between customers and businesses. And only consumers can set in motion a virtuous cycle that allows companies to survive and thrive and business owners to hire. An ordinary middle-class consumer is far more of a job creator than I ever have been or ever will be.

The principal economic problem of our time is the gradual erosion of consumer purchasing power—the ability of ordinary households to buy stuff. This outcome is a natural consequence of increased concentration of wealth and income among a tiny percentage of the population. Thus, policies that purport to “turn around the economy” should be evaluated based on their ability to return a fair portion of wealth and income to the lower- and middle-income families that are the backbone of the U.S. economy. After all, as Paul Wellstone said, “We all to better when we all do better.”