Why the Rich Got Richer

Most of the widening of the income gap occurred during the 1980s, not the 1990s or later.

The Democratic sweep of Congress in last November's election is widely seen as a rejection of Bush's Iraq policy. But it appears that many Democrats believe that the election handed them a much wider mandate. They interpret the election as reflecting a growing dissatisfaction with the economy and the widening gap in income distribution.

Jim Webb, the newly elected Democratic senator from Virginia, stated in his rebuttal to President Bush's State of the Union address that "these benefits of a rising economy are not being fairly shared." The word fair implies either that the rich do not deserve the income that they have earned or wealth they have accumulated, or, if they do, that policies should be put in place to reverse the trends in income distribution. Often Bush's tax cuts and globalization are named as factors that have widened income inequality.

But recent research disputes many of these claims. Changes in the distribution of income have come about for many reasons unrelated to economic policy. Furthermore, there is no evidence that the distribution of economic welfare, as opposed to income, is becoming more inequitable.

Subscribe to Kiplinger’s Personal Finance

Be a smarter, better informed investor.

Save up to 74%

Sign up for Kiplinger’s Free E-Newsletters

Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.

Profit and prosper with the best of expert advice - straight to your e-mail.

Sign up

I do not deny disparities in the rate of income growth in recent decades. Federal Reserve chairman Ben Bernanke reported last February that over the past 27 years the income of the top 10% of earners rose 34%, while the income of those in the bottom 10% improved only 4%. But after closely examining the issue -- there were 48 references in his paper!-- Bernanke attributed the cause to differences in workers' educational attainment, not to tax policy or globalization. Plus, most of the widening of the income gap occurred during the 1980s, not the 1990s or later.

One reason the income-distribution gap widened in the 1980s was the reversal of post-World War II economic trends. In the '50s and '60s, producers of heavy goods faced no competition abroad, so they did little to resist unionized workers' wage-and-benefit demands. At that time, many auto and steel workers were paid more than college-educated professionals. That situation could not last.

Demographic forces have also helped to widen the income gap. Thomas Lemieux, of the University of British Columbia, ties most of the rise in income inequality to an aging population. Wages among young workers tend to be more uniform because differences in skills, motivation and chance have yet to have an impact. As workers age, these differences are more apparent and cause an increase in income inequality.

Income distribution may not even be the best way to describe inequality. Economists say it is consumption, not income, that benefits individuals. Recent research by professor Tyler Cowen, of George Mason University, indicates that the consumption distribution, unlike income distribution, has not widened in recent decades.

The impact of charity

One reason is that the rich save more, and much of that saving goes for philanthropy. This is especially true in the very top income brackets. Warren Buffett has a huge income (if you measure his share of the earnings of Berkshire Hathaway), but his consumption is very modest, and he has recently given tens of billions to the Bill and Melinda Gates Foundation. Gates, the richest man in the world, consumes more than Buffett but also has given the lion's share of his wealth to charity.

But even the distribution of consumption overstates the true differences of economic well-being. Leisure is an important component of consumer welfare, and there is good evidence that less-well-educated and lower-income individuals do not work as many hours as better-educated, high-income consumers. Some workers want to have more leisure time, even if it means earning a lower income.

Finally, the pundits have always said "Money doesn't buy happiness," and recent research shows that to be true. Erasmus University in Rotterdam, The Netherlands, publishes the Journal of Happiness Studies, which has conducted scientific research comparing levels of satisfaction among nations. One study, entitled "How Well Nations Combine a High Level of Happiness With an Equitable Distribution," found that the U.S. was one of the few countries that had experienced a "significant increase" in self-reported well-being across income levels between 1973 and 2004, despite a widening income-distribution gap.

What does all this mean? It does not mean we should abandon those who find themselves unable to meet their own basic needs. Our nation can afford a safety net for those who, through no fault of their own, fall through the cracks. But we should be wary of concluding that income distribution is the best way to measure well-being. And we certainly should not jump to the conclusion, as Senator Webb did, that flattening the distribution of income will result in a "fairer" economy.

Columnist Jeremy J. Siegel is a professor at the University of Pennsylvania's Wharton School and author of Stocks for the Long Run and The Future for Investors.

Jeremy J. Siegel
Contributing Columnist, Kiplinger's Personal Finance
Siegel is a professor at the University of Pennsylvania's Wharton School and the author of "Stocks For The Long Run" and "The Future For Investors."