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How income inequality is hurting the economy

Income inequality is hurting the economy S&P found. The disparity in income is slowing our recovery from the Recession.
Income inequality is hurting the economy S&P found. The disparity in income is slowing our recovery from the Recession.
John Moore/Getty Images

The growing inequality in wealth and income in the United States is actually hurting the economy and suppressing the GDP. Some inequality is natural but too much inequality can undermine growth. This is not the ranting of a liberal Democrat; it is the finding of a study by Standard and Poor’s, which was released Tuesday.

The S&P report concluded that at extreme levels, income inequality can harm sustained economic growth over long periods, and the U.S. is approaching that threshold. Standard & Poor's sees extreme income inequality as a drag on long-run economic growth. They have now reduced their 10-year growth forecast for the United States to a 2.5 percent rate. Five years ago, they expected 2.8 percent.

Economist Keynes first showed that income inequality leads affluent households to decrease consumption and increase savings. Much of that savings is in offshore accounts. Those with less means must increase consumer borrowing in order to sustain consumption. When they can no longer borrow, or service their debt, these imbalances can no longer be sustained. This causes a boom/bust cycle such as the one that culminated in the Bush Recession.
Aside from the extreme economic swings, S&P reported that high income imbalances tend to dampen social mobility and produce a less-educated workforce that can't compete in a changing global economy. This diminishes future income prospects and potential long-term growth, becomes entrenched as political repercussions extend the problems.

The S&P report referred to several institutions, including the Organization for Economic Co-operation and Development (OECD), the Congressional Budget Office (CBO), and the International Monetary Fund (IMF) that have published studies showing that income inequality has been increasing for the past several decades.

In the U.S. the average CEO earns 331 times the income of the average worker, and 774 times the wage of a minimum wage worker. This, coupled with a tax policy that is shifted in favor of the wealthy and corporations, is the reason the inequality has reached the point where it is pulling the economy down.

According to a 2011 review by the OECD, the average income of the richest 10 per cent of the population is nine times that of the poorest 10 per cent-in other words, a ratio of 9-to-1. The U.S. ratio is much higher, at 14-to-1. The U.S. Gini coefficient, after taxes, has increased by more than 20 percent from 1979--to 0.434 in 2010.

So what can be done about it? S&P did not say this but the first thing is to raise the minimum wage to at least $10.10 an hour. This would raise millions out of poverty and turn them in to consumers. To prevent this from happening again, we need to index the minimum wage adjusting it annually to reflect the cost of living. That indexing should give special weight to the costs of food, utilities, housing and health care—the things that take most of the earning of low-income workers.

Secondly, we need to eliminate all the loopholes and special breaks that allow the wealthiest to pay a lower effective rate than middle income taxpayers. This includes raising the cap on Social Security and Medicare tax, or eliminating the cap all together. Not only would this make both programs solvent, it would allow for the payroll tax rate to be lowered, helping low income workers spend more on goods and services supplied by businesses.

Thirdly, we need to make sure a college education is affordable without forcing a student to rack up unsustainable debt. S&P found that increasing educational attainment is an effective way to bring income inequality back to healthy levels. It also helps the U.S economy. Over the next five years, if the American workforce completed just one more year of school, the resulting productivity gains could add about $525 billion, or 2.4%, to the level of GDP, relative to the baseline.

One thing this study pointed out is that doing something about income inequality is not an option; it is a necessity if we want to continue to prosper. But, do not expect the do-nothing Congress to address this or any issue. Perhaps the states will lead the way, making changes on a local level to address this extreme inequality before it is too late.

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