October 20, 2002
By PAUL KRUGMAN
I. The Disappearing Middle
When I was a teenager growing up on Long Island, one of my
favorite excursions was a trip to see the great Gilded Age
mansions of the North Shore. Those mansions weren't just
pieces of architectural history. They were monuments to a
bygone social era, one in which the rich could afford the
armies of servants needed to maintain a house the size of a
European palace. By the time I saw them, of course, that
era was long past. Almost none of the Long Island mansions
were still private residences. Those that hadn't been
turned into museums were occupied by nursing homes or
private schools.
For the America I grew up in -- the America of the 1950's
and 1960's -- was a middle-class society, both in reality
and in feel. The vast income and wealth inequalities of the
Gilded Age had disappeared. Yes, of course, there was the
poverty of the underclass -- but the conventional wisdom of
the time viewed that as a social rather than an economic
problem. Yes, of course, some wealthy businessmen and heirs
to large fortunes lived far better than the average
American. But they weren't rich the way the robber barons
who built the mansions had been rich, and there weren't
that many of them. The days when plutocrats were a force to
be reckoned with in American society, economically or
politically, seemed long past.
Daily experience confirmed the sense of a fairly equal
society. The economic disparities you were conscious of
were quite muted. Highly educated professionals -- middle
managers, college teachers, even lawyers -- often claimed
that they earned less than unionized blue-collar workers.
Those considered very well off lived in split-levels, had a
housecleaner come in once a week and took summer vacations
in Europe. But they sent their kids to public schools and
drove themselves to work, just like everyone else.
But that was long ago. The middle-class America of my youth
was another country.
We are now living in a new Gilded Age, as extravagant as
the original. Mansions have made a comeback. Back in 1999
this magazine profiled Thierry Despont, the ''eminence of
excess,'' an architect who specializes in designing houses
for the superrich. His creations typically range from
20,000 to 60,000 square feet; houses at the upper end of
his range are not much smaller than the White House.
Needless to say, the armies of servants are back, too. So
are the yachts. Still, even J.P. Morgan didn't have a
Gulfstream.
As the story about Despont suggests, it's not fair to say
that the fact of widening inequality in America has gone
unreported. Yet glimpses of the lifestyles of the rich and
tasteless don't necessarily add up in people's minds to a
clear picture of the tectonic shifts that have taken place
in the distribution of income and wealth in this country.
My sense is that few people are aware of just how much the
gap between the very rich and the rest has widened over a
relatively short period of time. In fact, even bringing up
the subject exposes you to charges of ''class warfare,''
the ''politics of envy'' and so on. And very few people
indeed are willing to talk about the profound effects --
economic, social and political -- of that widening gap.
Yet you can't understand what's happening in America today
without understanding the extent, causes and consequences
of the vast increase in inequality that has taken place
over the last three decades, and in particular the
astonishing concentration of income and wealth in just a
few hands. To make sense of the current wave of corporate
scandal, you need to understand how the man in the gray
flannel suit has been replaced by the imperial C.E.O. The
concentration of income at the top is a key reason that the
United States, for all its economic achievements, has more
poverty and lower life expectancy than any other major
advanced nation. Above all, the growing concentration of
wealth has reshaped our political system: it is at the root
both of a general shift to the right and of an extreme
polarization of our politics.
But before we get to all that, let's take a look at who
gets what.
II. The New Gilded Age
The Securities and Exchange Commission hath no fury like a
woman scorned. The messy divorce proceedings of Jack Welch,
the legendary former C.E.O. of General Electric, have had
one unintended benefit: they have given us a peek at the
perks of the corporate elite, which are normally hidden
from public view. For it turns out that when Welch retired,
he was granted for life the use of a Manhattan apartment
(including food, wine and laundry), access to corporate
jets and a variety of other in-kind benefits, worth at
least $2 million a year. The perks were revealing: they
illustrated the extent to which corporate leaders now
expect to be treated like ancien regime royalty. In
monetary terms, however, the perks must have meant little
to Welch. In 2000, his last full year running G.E., Welch
was paid $123 million, mainly in stock and stock options.
Is it news that C.E.O.'s of large American corporations
make a lot of money? Actually, it is. They were always well
paid compared with the average worker, but there is simply
no comparison between what executives got a generation ago
and what they are paid today.
Over the past 30 years most people have seen only modest
salary increases: the average annual salary in America,
expressed in 1998 dollars (that is, adjusted for
inflation), rose from $32,522 in 1970 to $35,864 in 1999.
That's about a 10 percent increase over 29 years --
progress, but not much. Over the same period, however,
according to Fortune magazine, the average real annual
compensation of the top 100 C.E.O.'s went from $1.3 million
-- 39 times the pay of an average worker -- to $37.5
million, more than 1,000 times the pay of ordinary workers.
The explosion in C.E.O. pay over the past 30 years is an
amazing story in its own right, and an important one. But
it is only the most spectacular indicator of a broader
story, the reconcentration of income and wealth in the U.S.
The rich have always been different from you and me, but
they are far more different now than they were not long ago
-- indeed, they are as different now as they were when F.
Scott Fitzgerald made his famous remark.
That's a controversial statement, though it shouldn't be.
For at least the past 15 years it has been hard to deny the
evidence for growing inequality in the United States.
Census data clearly show a rising share of income going to
the top 20 percent of families, and within that top 20
percent to the top 5 percent, with a declining share going
to families in the middle. Nonetheless, denial of that
evidence is a sizable, well-financed industry. Conservative
think tanks have produced scores of studies that try to
discredit the data, the methodology and, not least, the
motives of those who report the obvious. Studies that
appear to refute claims of increasing inequality receive
prominent endorsements on editorial pages and are eagerly
cited by right-leaning government officials. Four years ago
Alan Greenspan (why did anyone ever think that he was
nonpartisan?) gave a keynote speech at the Federal
Reserve's annual Jackson Hole conference that amounted to
an attempt to deny that there has been any real increase in
inequality in America.
The concerted effort to deny that inequality is increasing
is itself a symptom of the growing influence of our
emerging plutocracy (more on this later). So is the fierce
defense of the backup position, that inequality doesn't
matter -- or maybe even that, to use Martha Stewart's
signature phrase, it's a good thing. Meanwhile, politically
motivated smoke screens aside, the reality of increasing
inequality is not in doubt. In fact, the census data
understate the case, because for technical reasons those
data tend to undercount very high incomes -- for example,
it's unlikely that they reflect the explosion in C.E.O.
compensation. And other evidence makes it clear not only
that inequality is increasing but that the action gets
bigger the closer you get to the top. That is, it's not
simply that the top 20 percent of families have had bigger
percentage gains than families near the middle: the top 5
percent have done better than the next 15, the top 1
percent better than the next 4, and so on up to Bill Gates.
Studies that try to do a better job of tracking high
incomes have found startling results. For example, a recent
study by the nonpartisan Congressional Budget Office used
income tax data and other sources to improve on the census
estimates. The C.B.O. study found that between 1979 and
1997, the after-tax incomes of the top 1 percent of
families rose 157 percent, compared with only a 10 percent
gain for families near the middle of the income
distribution. Even more startling results come from a new
study by Thomas Piketty, at the French research institute
Cepremap, and Emmanuel Saez, who is now at the University
of California at Berkeley. Using income tax data, Piketty
and Saez have produced estimates of the incomes of the
well-to-do, the rich and the very rich back to 1913.
The first point you learn from these new estimates is that
the middle-class America of my youth is best thought of not
as the normal state of our society, but as an interregnum
between Gilded Ages. America before 1930 was a society in
which a small number of very rich people controlled a large
share of the nation's wealth. We became a middle-class
society only after the concentration of income at the top
dropped sharply during the New Deal, and especially during
World War II. The economic historians Claudia Goldin and
Robert Margo have dubbed the narrowing of income gaps
during those years the Great Compression. Incomes then
stayed fairly equally distributed until the 1970's: the
rapid rise in incomes during the first postwar generation
was very evenly spread across the population.
Since the 1970's, however, income gaps have been rapidly
widening. Piketty and Saez confirm what I suspected: by
most measures we are, in fact, back to the days of ''The
Great Gatsby.'' After 30 years in which the income shares
of the top 10 percent of taxpayers, the top 1 percent and
so on were far below their levels in the 1920's, all are
very nearly back where they were.
And the big winners are the very, very rich. One ploy often
used to play down growing inequality is to rely on rather
coarse statistical breakdowns -- dividing the population
into five ''quintiles,'' each containing 20 percent of
families, or at most 10 ''deciles.'' Indeed, Greenspan's
speech at Jackson Hole relied mainly on decile data. From
there it's a short step to denying that we're really
talking about the rich at all. For example, a conservative
commentator might concede, grudgingly, that there has been
some increase in the share of national income going to the
top 10 percent of taxpayers, but then point out that anyone
with an income over $81,000 is in that top 10 percent. So
we're just talking about shifts within the middle class,
right?
Wrong: the top 10 percent contains a lot of people whom we
would still consider middle class, but they weren't the big
winners. Most of the gains in the share of the top 10
percent of taxpayers over the past 30 years were actually
gains to the top 1 percent, rather than the next 9 percent.
In 1998 the top 1 percent started at $230,000. In turn, 60
percent of the gains of that top 1 percent went to the top
0.1 percent, those with incomes of more than $790,000. And
almost half of those gains went to a mere 13,000 taxpayers,
the top 0.01 percent, who had an income of at least $3.6
million and an average income of $17 million.
A stickler for detail might point out that the Piketty-Saez
estimates end in 1998 and that the C.B.O. numbers end a
year earlier. Have the trends shown in the data reversed?
Almost surely not. In fact, all indications are that the
explosion of incomes at the top continued through 2000.
Since then the plunge in stock prices must have put some
crimp in high incomes -- but census data show inequality
continuing to increase in 2001, mainly because of the
severe effects of the recession on the working poor and
near poor. When the recession ends, we can be sure that we
will find ourselves a society in which income inequality is
even higher than it was in the late 90's.
So claims that we've entered a second Gilded Age aren't
exaggerated. In America's middle-class era, the
mansion-building, yacht-owning classes had pretty much
disappeared. According to Piketty and Saez, in 1970 the top
0.01 percent of taxpayers had 0.7 percent of total income
-- that is, they earned ''only'' 70 times as much as the
average, not enough to buy or maintain a mega-residence.
But in 1998 the top 0.01 percent received more than 3
percent of all income. That meant that the 13,000 richest
families in America had almost as much income as the 20
million poorest households; those 13,000 families had
incomes 300 times that of average families.
And let me repeat: this transformation has happened very
quickly, and it is still going on. You might think that
1987, the year Tom Wolfe published his novel ''The Bonfire
of the Vanities'' and Oliver Stone released his movie
''Wall Street,'' marked the high tide of America's new
money culture. But in 1987 the top 0.01 percent earned only
about 40 percent of what they do today, and top executives
less than a fifth as much. The America of ''Wall Street''
and ''The Bonfire of the Vanities'' was positively
egalitarian compared with the country we live in today.
III. Undoing the New Deal
In the middle of the 1980's, as
economists became aware that something important was
happening to the distribution of income in America, they
formulated three main hypotheses about its causes.
The ''globalization'' hypothesis tied America's changing
income distribution to the growth of world trade, and
especially the growing imports of manufactured goods from
the third world. Its basic message was that blue-collar
workers -- the sort of people who in my youth often made as
much money as college-educated middle managers -- were
losing ground in the face of competition from low-wage
workers in Asia. A result was stagnation or decline in the
wages of ordinary people, with a growing share of national
income going to the highly educated.
A second hypothesis, ''skill-biased technological change,''
situated the cause of growing inequality not in foreign
trade but in domestic innovation. The torrid pace of
progress in information technology, so the story went, had
increased the demand for the highly skilled and educated.
And so the income distribution increasingly favored brains
rather than brawn.
Finally, the ''superstar'' hypothesis -- named by the
Chicago economist Sherwin Rosen -- offered a variant on the
technological story. It argued that modern technologies of
communication often turn competition into a tournament in
which the winner is richly rewarded, while the runners-up
get far less. The classic example -- which gives the theory
its name -- is the entertainment business. As Rosen pointed
out, in bygone days there were hundreds of comedians making
a modest living at live shows in the borscht belt and other
places. Now they are mostly gone; what is left is a handful
of superstar TV comedians.
The debates among these hypotheses -- particularly the
debate between those who attributed growing inequality to
globalization and those who attributed it to technology --
were many and bitter. I was a participant in those debates
myself. But I won't dwell on them, because in the last few
years there has been a growing sense among economists that
none of these hypotheses work.
I don't mean to say that there was nothing to these
stories. Yet as more evidence has accumulated, each of the
hypotheses has seemed increasingly inadequate.
Globalization can explain part of the relative decline in
blue-collar wages, but it can't explain the 2,500 percent
rise in C.E.O. incomes. Technology may explain why the
salary premium associated with a college education has
risen, but it's hard to match up with the huge increase in
inequality among the college-educated, with little progress
for many but gigantic gains at the top. The superstar
theory works for Jay Leno, but not for the thousands of
people who have become awesomely rich without going on TV.
The Great Compression -- the substantial reduction in
inequality during the New Deal and the Second World War --
also seems hard to understand in terms of the usual
theories. During World War II Franklin Roosevelt used
government control over wages to compress wage gaps. But if
the middle-class society that emerged from the war was an
artificial creation, why did it persist for another 30
years?
Some -- by no means all -- economists trying to understand
growing inequality have begun to take seriously a
hypothesis that would have been considered irredeemably
fuzzy-minded not long ago. This view stresses the role of
social norms in setting limits to inequality. According to
this view, the New Deal had a more profound impact on
American society than even its most ardent admirers have
suggested: it imposed norms of relative equality in pay
that persisted for more than 30 years, creating the broadly
middle-class society we came to take for granted. But those
norms began to unravel in the 1970's and have done so at an
accelerating pace.
Exhibit A for this view is the story of executive
compensation. In the 1960's, America's great corporations
behaved more like socialist republics than like cutthroat
capitalist enterprises, and top executives behaved more
like public-spirited bureaucrats than like captains of
industry. I'm not exaggerating. Consider the description of
executive behavior offered by John Kenneth Galbraith in his
1967 book, ''The New Industrial State'': ''Management does
not go out ruthlessly to reward itself -- a sound
management is expected to exercise restraint.'' Managerial
self-dealing was a thing of the past: ''With the power of
decision goes opportunity for making money. . . . Were
everyone to seek to do so . . . the corporation would be a
chaos of competitive avarice. But these are not the sort of
thing that a good company man does; a remarkably effective
code bans such behavior. Group decision-making insures,
moreover, that almost everyone's actions and even thoughts
are known to others. This acts to enforce the code and,
more than incidentally, a high standard of personal honesty
as well.''
Thirty-five years on, a cover article in Fortune is titled
''You Bought. They Sold.'' ''All over corporate America,''
reads the blurb, ''top execs were cashing in stocks even as
their companies were tanking. Who was left holding the bag?
You.'' As I said, we've become a different country.
Let's leave actual malfeasance on one side for a moment,
and ask how the relatively modest salaries of top
executives 30 years ago became the gigantic pay packages of
today. There are two main stories, both of which emphasize
changing norms rather than pure economics. The more
optimistic story draws an analogy between the explosion of
C.E.O. pay and the explosion of baseball salaries with the
introduction of free agency. According to this story,
highly paid C.E.O.'s really are worth it, because having
the right man in that job makes a huge difference. The more
pessimistic view -- which I find more plausible -- is that
competition for talent is a minor factor. Yes, a great
executive can make a big difference -- but those huge pay
packages have been going as often as not to executives
whose performance is mediocre at best. The key reason
executives are paid so much now is that they appoint the
members of the corporate board that determines their
compensation and control many of the perks that board
members count on. So it's not the invisible hand of the
market that leads to those monumental executive incomes;
it's the invisible handshake in the boardroom.
But then why weren't executives paid lavishly 30 years ago?
Again, it's a matter of corporate culture. For a generation
after World War II, fear of outrage kept executive salaries
in check. Now the outrage is gone. That is, the explosion
of executive pay represents a social change rather than the
purely economic forces of supply and demand. We should
think of it not as a market trend like the rising value of
waterfront property, but as something more like the sexual
revolution of the 1960's -- a relaxation of old strictures,
a new permissiveness, but in this case the permissiveness
is financial rather than sexual. Sure enough, John Kenneth
Galbraith described the honest executive of 1967 as being
one who ''eschews the lovely, available and even naked
woman by whom he is intimately surrounded.'' By the end of
the 1990's, the executive motto might as well have been
''If it feels good, do it.''
How did this change in corporate culture happen? Economists
and management theorists are only beginning to explore that
question, but it's easy to suggest a few factors. One was
the changing structure of financial markets. In his new
book, ''Searching for a Corporate Savior,'' Rakesh Khurana
of Harvard Business School suggests that during the 1980's
and 1990's, ''managerial capitalism'' -- the world of the
man in the gray flannel suit -- was replaced by ''investor
capitalism.'' Institutional investors weren't willing to
let a C.E.O. choose his own successor from inside the
corporation; they wanted heroic leaders, often outsiders,
and were willing to pay immense sums to get them. The
subtitle of Khurana's book, by the way, is ''The Irrational
Quest for Charismatic C.E.O.'s.''
But fashionable management theorists didn't think it was
irrational. Since the 1980's there has been ever more
emphasis on the importance of ''leadership'' -- meaning
personal, charismatic leadership. When Lee Iacocca of
Chrysler became a business celebrity in the early 1980's,
he was practically alone: Khurana reports that in 1980 only
one issue of Business Week featured a C.E.O. on its cover.
By 1999 the number was up to 19. And once it was considered
normal, even necessary, for a C.E.O. to be famous, it also
became easier to make him rich.
Economists also did their bit to legitimize previously
unthinkable levels of executive pay. During the 1980's and
1990's a torrent of academic papers -- popularized in
business magazines and incorporated into consultants'
recommendations -- argued that Gordon Gekko was right:
greed is good; greed works. In order to get the best
performance out of executives, these papers argued, it was
necessary to align their interests with those of
stockholders. And the way to do that was with large grants
of stock or stock options.
It's hard to escape the suspicion that these new
intellectual justifications for soaring executive pay were
as much effect as cause. I'm not suggesting that management
theorists and economists were personally corrupt. It would
have been a subtle, unconscious process: the ideas that
were taken up by business schools, that led to nice
speaking and consulting fees, tended to be the ones that
ratified an existing trend, and thereby gave it legitimacy.
What economists like Piketty and Saez are now suggesting is
that the story of executive compensation is representative
of a broader story. Much more than economists and
free-market advocates like to imagine, wages --
particularly at the top -- are determined by social norms.
What happened during the 1930's and 1940's was that new
norms of equality were established, largely through the
political process. What happened in the 1980's and 1990's
was that those norms unraveled, replaced by an ethos of
''anything goes.'' And a result was an explosion of income
at the top of the scale.
IV. The Price of Inequality
It was one of those revealing moments. Responding to an
e-mail message from a Canadian viewer, Robert Novak of
''Crossfire'' delivered a little speech: ''Marg, like most
Canadians, you're ill informed and wrong. The U.S. has the
longest standard of living -- longest life expectancy of
any country in the world, including Canada. That's the
truth.''
But it was Novak who had his facts wrong. Canadians can
expect to live about two years longer than Americans. In
fact, life expectancy in the U.S. is well below that in
Canada, Japan and every major nation in Western Europe. On
average, we can expect lives a bit shorter than those of
Greeks, a bit longer than those of Portuguese. Male life
expectancy is lower in the U.S. than it is in Costa Rica.
Still, you can understand why Novak assumed that we were
No. 1. After all, we really are the richest major nation,
with real G.D.P. per capita about 20 percent higher than
Canada's. And it has been an article of faith in this
country that a rising tide lifts all boats. Doesn't our
high and rising national wealth translate into a high
standard of living -- including good medical care -- for
all Americans?
Well, no. Although America has higher per capita income
than other advanced countries, it turns out that that's
mainly because our rich are much richer. And here's a
radical thought: if the rich get more, that leaves less for
everyone else.
That statement -- which is simply a matter of arithmetic --
is guaranteed to bring accusations of ''class warfare.'' If
the accuser gets more specific, he'll probably offer two
reasons that it's foolish to make a fuss over the high
incomes of a few people at the top of the income
distribution. First, he'll tell you that what the elite get
may look like a lot of money, but it's still a small share
of the total -- that is, when all is said and done the rich
aren't getting that big a piece of the pie. Second, he'll
tell you that trying to do anything to reduce incomes at
the top will hurt, not help, people further down the
distribution, because attempts to redistribute income
damage incentives.
These arguments for lack of concern are plausible. And they
were entirely correct, once upon a time -- namely, back
when we had a middle-class society. But there's a lot less
truth to them now.
First, the share of the rich in total income is no longer
trivial. These days 1 percent of families receive about 16
percent of total pretax income, and have about 14 percent
of after-tax income. That share has roughly doubled over
the past 30 years, and is now about as large as the share
of the bottom 40 percent of the population. That's a big
shift of income to the top; as a matter of pure arithmetic,
it must mean that the incomes of less well off families
grew considerably more slowly than average income. And they
did. Adjusting for inflation, average family income --
total income divided by the number of families -- grew 28
percent from 1979 to 1997. But median family income -- the
income of a family in the middle of the distribution, a
better indicator of how typical American families are doing
-- grew only 10 percent. And the incomes of the bottom
fifth of families actually fell slightly.
Let me belabor this point for a bit. We pride ourselves,
with considerable justification, on our record of economic
growth. But over the last few decades it's remarkable how
little of that growth has trickled down to ordinary
families. Median family income has risen only about 0.5
percent per year -- and as far as we can tell from somewhat
unreliable data, just about all of that increase was due to
wives working longer hours, with little or no gain in real
wages. Furthermore, numbers about income don't reflect the
growing riskiness of life for ordinary workers. In the days
when General Motors was known in-house as Generous Motors,
many workers felt that they had considerable job security
-- the company wouldn't fire them except in extremis. Many
had contracts that guaranteed health insurance, even if
they were laid off; they had pension benefits that did not
depend on the stock market. Now mass firings from
long-established companies are commonplace; losing your job
means losing your insurance; and as millions of people have
been learning, a 401(k) plan is no guarantee of a
comfortable retirement.
Still, many people will say that while the U.S. economic
system may generate a lot of inequality, it also generates
much higher incomes than any alternative, so that everyone
is better off. That was the moral Business Week tried to
convey in its recent special issue with ''25 Ideas for a
Changing World.'' One of those ideas was ''the rich get
richer, and that's O.K.'' High incomes at the top, the
conventional wisdom declares, are the result of a
free-market system that provides huge incentives for
performance. And the system delivers that performance,
which means that wealth at the top doesn't come at the
expense of the rest of us.
A skeptic might point out that the explosion in executive
compensation seems at best loosely related to actual
performance. Jack Welch was one of the 10 highest-paid
executives in the United States in 2000, and you could
argue that he earned it. But did Dennis Kozlowski of Tyco,
or Gerald Levin of Time Warner, who were also in the top
10? A skeptic might also point out that even during the
economic boom of the late 1990's, U.S. productivity growth
was no better than it was during the great postwar
expansion, which corresponds to the era when America was
truly middle class and C.E.O.'s were modestly paid
technocrats.
But can we produce any direct evidence about the effects of
inequality? We can't rerun our own history and ask what
would have happened if the social norms of middle-class
America had continued to limit incomes at the top, and if
government policy had leaned against rising inequality
instead of reinforcing it, which is what actually happened.
But we can compare ourselves with other advanced countries.
And the results are somewhat surprising.
Many Americans assume that because we are the richest
country in the world, with real G.D.P. per capita higher
than that of other major advanced countries, Americans must
be better off across the board -- that it's not just our
rich who are richer than their counterparts abroad, but
that the typical American family is much better off than
the typical family elsewhere, and that even our poor are
well off by foreign standards.
But it's not true. Let me use the example of Sweden, that
great conservative bete noire.
A few months ago the conservative cyberpundit Glenn
Reynolds made a splash when he pointed out that Sweden's
G.D.P. per capita is roughly comparable with that of
Mississippi -- see, those foolish believers in the welfare
state have impoverished themselves! Presumably he assumed
that this means that the typical Swede is as poor as the
typical resident of Mississippi, and therefore much worse
off than the typical American.
But life expectancy in Sweden is about three years higher
than that of the U.S. Infant mortality is half the U.S.
level, and less than a third the rate in Mississippi.
Functional illiteracy is much less common than in the U.S.
How is this possible? One answer is that G.D.P. per capita
is in some ways a misleading measure. Swedes take longer
vacations than Americans, so they work fewer hours per
year. That's a choice, not a failure of economic
performance. Real G.D.P. per hour worked is 16 percent
lower than in the United States, which makes Swedish
productivity about the same as Canada's.
But the main point is that though Sweden may have lower
average income than the United States, that's mainly
because our rich are so much richer. The median Swedish
family has a standard of living roughly comparable with
that of the median U.S. family: wages are if anything
higher in Sweden, and a higher tax burden is offset by
public provision of health care and generally better public
services. And as you move further down the income
distribution, Swedish living standards are way ahead of
those in the U.S. Swedish families with children that are
at the 10th percentile -- poorer than 90 percent of the
population -- have incomes 60 percent higher than their
U.S. counterparts. And very few people in Sweden experience
the deep poverty that is all too common in the United
States. One measure: in 1994 only 6 percent of Swedes lived
on less than $11 per day, compared with 14 percent in the
U.S.
The moral of this comparison is that even if you think that
America's high levels of inequality are the price of our
high level of national income, it's not at all clear that
this price is worth paying. The reason conservatives engage
in bouts of Sweden-bashing is that they want to convince us
that there is no tradeoff between economic efficiency and
equity -- that if you try to take from the rich and give to
the poor, you actually make everyone worse off. But the
comparison between the U.S. and other advanced countries
doesn't support this conclusion at all. Yes, we are the
richest major nation. But because so much of our national
income is concentrated in relatively few hands, large
numbers of Americans are worse off economically than their
counterparts in other advanced countries.
And we might even offer a challenge from the other side:
inequality in the United States has arguably reached levels
where it is counterproductive. That is, you can make a case
that our society would be richer if its richest members
didn't get quite so much.
I could make this argument on historical grounds. The most
impressive economic growth in U.S. history coincided with
the middle-class interregnum, the post-World War II
generation, when incomes were most evenly distributed. But
let's focus on a specific case, the extraordinary pay
packages of today's top executives. Are these good for the
economy?
Until recently it was almost unchallenged conventional
wisdom that, whatever else you might say, the new imperial
C.E.O.'s had delivered results that dwarfed the expense of
their compensation. But now that the stock bubble has
burst, it has become increasingly clear that there was a
price to those big pay packages, after all. In fact, the
price paid by shareholders and society at large may have
been many times larger than the amount actually paid to the
executives.
It's easy to get boggled by the details of corporate
scandal -- insider loans, stock options, special-purpose
entities, mark-to-market, round-tripping. But there's a
simple reason that the details are so complicated. All of
these schemes were designed to benefit corporate insiders
-- to inflate the pay of the C.E.O. and his inner circle.
That is, they were all about the ''chaos of competitive
avarice'' that, according to John Kenneth Galbraith, had
been ruled out in the corporation of the 1960's. But while
all restraint has vanished within the American corporation,
the outside world -- including stockholders -- is still
prudish, and open looting by executives is still not
acceptable. So the looting has to be camouflaged, taking
place through complicated schemes that can be rationalized
to outsiders as clever corporate strategies.
Economists who study crime tell us that crime is
inefficient -- that is, the costs of crime to the economy
are much larger than the amount stolen. Crime, and the fear
of crime, divert resources away from productive uses:
criminals spend their time stealing rather than producing,
and potential victims spend time and money trying to
protect their property. Also, the things people do to avoid
becoming victims -- like avoiding dangerous districts --
have a cost even if they succeed in averting an actual
crime.
The same holds true of corporate malfeasance, whether or
not it actually involves breaking the law. Executives who
devote their time to creating innovative ways to divert
shareholder money into their own pockets probably aren't
running the real business very well (think Enron, WorldCom,
Tyco, Global Crossing, Adelphia . . . ). Investments chosen
because they create the illusion of profitability while
insiders cash in their stock options are a waste of scarce
resources. And if the supply of funds from lenders and
shareholders dries up because of a lack of trust, the
economy as a whole suffers. Just ask Indonesia.
The argument for a system in which some people get very
rich has always been that the lure of wealth provides
powerful incentives. But the question is, incentives to do
what? As we learn more about what has actually been going
on in corporate America, it's becoming less and less clear
whether those incentives have actually made executives work
on behalf of the rest of us.
V. Inequality and Politics
In September the Senate debated a proposed measure that
would impose a one-time capital gains tax on Americans who
renounce their citizenship in order to avoid paying U.S.
taxes. Senator Phil Gramm was not pleased, declaring that
the proposal was ''right out of Nazi Germany.'' Pretty
strong language, but no stronger than the metaphor Daniel
Mitchell of the Heritage Foundation used, in an op-ed
article in The Washington Times, to describe a bill
designed to prevent corporations from rechartering abroad
for tax purposes: Mitchell described this legislation as
the ''Dred Scott tax bill,'' referring to the infamous 1857
Supreme Court ruling that required free states to return
escaped slaves.
Twenty years ago, would a prominent senator have likened
those who want wealthy people to pay taxes to Nazis? Would
a member of a think tank with close ties to the
administration have drawn a parallel between corporate
taxation and slavery? I don't think so. The remarks by
Gramm and Mitchell, while stronger than usual, were
indicators of two huge changes in American politics. One is
the growing polarization of our politics -- our politicians
are less and less inclined to offer even the appearance of
moderation. The other is the growing tendency of policy and
policy makers to cater to the interests of the wealthy. And
I mean the wealthy, not the merely well-off: only someone
with a net worth of at least several million dollars is
likely to find it worthwhile to become a tax exile.
You don't need a political scientist to tell you that
modern American politics is bitterly polarized. But wasn't
it always thus? No, it wasn't. From World War II until the
1970's -- the same era during which income inequality was
historically low -- political partisanship was much more
muted than it is today. That's not just a subjective
assessment. My Princeton political science colleagues Nolan
McCarty and Howard Rosenthal, together with Keith Poole at
the University of Houston, have done a statistical analysis
showing that the voting behavior of a congressman is much
better predicted by his party affiliation today than it was
25 years ago. In fact, the division between the parties is
sharper now than it has been since the 1920's.
What are the parties divided about? The answer is simple:
economics. McCarty, Rosenthal and Poole write that ''voting
in Congress is highly ideological -- one-dimensional
left/right, liberal versus conservative.'' It may sound
simplistic to describe Democrats as the party that wants to
tax the rich and help the poor, and Republicans as the
party that wants to keep taxes and social spending as low
as possible. And during the era of middle-class America
that would indeed have been simplistic: politics wasn't
defined by economic issues. But that was a different
country; as McCarty, Rosenthal and Poole put it, ''If
income and wealth are distributed in a fairly equitable
way, little is to be gained for politicians to organize
politics around nonexistent conflicts.'' Now the conflicts
are real, and our politics is organized around them. In
other words, the growing inequality of our incomes probably
lies behind the growing divisiveness of our politics.
But the politics of rich and poor hasn't played out the way
you might think. Since the incomes of America's wealthy
have soared while ordinary families have seen at best small
gains, you might have expected politicians to seek votes by
proposing to soak the rich. In fact, however, the
polarization of politics has occurred because the
Republicans have moved to the right, not because the
Democrats have moved to the left. And actual economic
policy has moved steadily in favor of the wealthy. The
major tax cuts of the past 25 years, the Reagan cuts in the
1980's and the recent Bush cuts, were both heavily tilted
toward the very well off. (Despite obfuscations, it remains
true that more than half the Bush tax cut will eventually
go to the top 1 percent of families.) The major tax
increase over that period, the increase in payroll taxes in
the 1980's, fell most heavily on working-class families.
The most remarkable example of how politics has shifted in
favor of the wealthy -- an example that helps us understand
why economic policy has reinforced, not countered, the
movement toward greater inequality -- is the drive to
repeal the estate tax. The estate tax is, overwhelmingly, a
tax on the wealthy. In 1999, only the top 2 percent of
estates paid any tax at all, and half the estate tax was
paid by only 3,300 estates, 0.16 percent of the total, with
a minimum value of $5 million and an average value of $17
million. A quarter of the tax was paid by just 467 estates
worth more than $20 million. Tales of family farms and
businesses broken up to pay the estate tax are basically
rural legends; hardly any real examples have been found,
despite diligent searching.
You might have thought that a tax that falls on so few
people yet yields a significant amount of revenue would be
politically popular; you certainly wouldn't expect
widespread opposition. Moreover, there has long been an
argument that the estate tax promotes democratic values,
precisely because it limits the ability of the wealthy to
form dynasties. So why has there been a powerful political
drive to repeal the estate tax, and why was such a repeal a
centerpiece of the Bush tax cut?
There is an economic argument for repealing the estate tax,
but it's hard to believe that many people take it
seriously. More significant for members of Congress,
surely, is the question of who would benefit from repeal:
while those who will actually benefit from estate tax
repeal are few in number, they have a lot of money and
control even more (corporate C.E.O.'s can now count on
leaving taxable estates behind). That is, they are the sort
of people who command the attention of politicians in
search of campaign funds.
But it's not just about campaign contributions: much of the
general public has been convinced that the estate tax is a
bad thing. If you try talking about the tax to a group of
moderately prosperous retirees, you get some interesting
reactions. They refer to it as the ''death tax''; many of
them believe that their estates will face punitive
taxation, even though most of them will pay little or
nothing; they are convinced that small businesses and
family farms bear the brunt of the tax.
These misconceptions don't arise by accident. They have,
instead, been deliberately promoted. For example, a
Heritage Foundation document titled ''Time to Repeal
Federal Death Taxes: The Nightmare of the American Dream''
emphasizes stories that rarely, if ever, happen in real
life: ''Small-business owners, particularly minority
owners, suffer anxious moments wondering whether the
businesses they hope to hand down to their children will be
destroyed by the death tax bill, . . . Women whose children
are grown struggle to find ways to re-enter the work force
without upsetting the family's estate tax avoidance plan.''
And who finances the Heritage Foundation? Why, foundations
created by wealthy families, of course.
The point is that it is no accident that strongly
conservative views, views that militate against taxes on
the rich, have spread even as the rich get richer compared
with the rest of us: in addition to directly buying
influence, money can be used to shape public perceptions.
The liberal group People for the American Way's report on
how conservative foundations have deployed vast sums to
support think tanks, friendly media and other institutions
that promote right-wing causes is titled ''Buying a
Movement.''
Not to put too fine a point on it: as the rich get richer,
they can buy a lot of things besides goods and services.
Money buys political influence; used cleverly, it also buys
intellectual influence. A result is that growing income
disparities in the United States, far from leading to
demands to soak the rich, have been accompanied by a
growing movement to let them keep more of their earnings
and to pass their wealth on to their children.
This obviously raises the possibility of a self-reinforcing
process. As the gap between the rich and the rest of the
population grows, economic policy increasingly caters to
the interests of the elite, while public services for the
population at large -- above all, public education -- are
starved of resources. As policy increasingly favors the
interests of the rich and neglects the interests of the
general population, income disparities grow even wider.
VI. Plutocracy?
In 1924, the mansions of Long Island's
North Shore were still in their full glory, as was the
political power of the class that owned them. When Gov. Al
Smith of New York proposed building a system of parks on
Long Island, the mansion owners were bitterly opposed. One
baron -- Horace Havemeyer, the ''sultan of sugar'' --
warned that North Shore towns would be ''overrun with
rabble from the city.'' ''Rabble?'' Smith said. ''That's me
you're talking about.'' In the end New Yorkers got their
parks, but it was close: the interests of a few hundred
wealthy families nearly prevailed over those of New York
City's middle class.
America in the 1920's wasn't a feudal society. But it was a
nation in which vast privilege -- often inherited privilege
-- stood in contrast to vast misery. It was also a nation
in which the government, more often than not, served the
interests of the privileged and ignored the aspirations of
ordinary people.
Those days are past -- or are they? Income inequality in
America has now returned to the levels of the 1920's.
Inherited wealth doesn't yet play a big part in our
society, but given time -- and the repeal of the estate tax
-- we will grow ourselves a hereditary elite just as set
apart from the concerns of ordinary Americans as old Horace
Havemeyer. And the new elite, like the old, will have
enormous political power.
Kevin Phillips concludes his book ''Wealth and Democracy''
with a grim warning: ''Either democracy must be renewed,
with politics brought back to life, or wealth is likely to
cement a new and less democratic regime -- plutocracy by
some other name.'' It's a pretty extreme line, but we live
in extreme times. Even if the forms of democracy remain,
they may become meaningless. It's all too easy to see how
we may become a country in which the big rewards are
reserved for people with the right connections; in which
ordinary people see little hope of advancement; in which
political involvement seems pointless, because in the end
the interests of the elite always get served.
Am I being too pessimistic? Even my liberal friends tell me
not to worry, that our system has great resilience, that
the center will hold. I hope they're right, but they may be
looking in the rearview mirror. Our optimism about America,
our belief that in the end our nation always finds its way,
comes from the past -- a past in which we were a
middle-class society. But that was another country.