How Income Inequality Can Hurt the Economy
Business + Economy

How Income Inequality Can Hurt the Economy


Given that the adjectives most used in describing the economy’s recovery from the great recession include “sluggish” and “disappointing” it may come as a surprise to some that average household income in the U.S. is higher, in nominal terms, than it was in 2008. 

Not only that, it passed the 2008 average as long ago as 2012. So, if income has recovered, the stock market is at record highs, and corporate earnings are way up, how come it doesn’t feel like there’s been much of a recovery? 

Related: Income Inequality Greatest in Democratic States 

An analysis released last week by the Bureau of Labor Statistics provides a useful illustration of at least one thing that is unquestionably holding our economy back: income inequality. But maybe not for the reason most people think. 

The key here, though, is to remember that the study measured “average” household income when it found a return to pre-recession levels. The headline number on the day the story was released was that 82 percent of the income gains went to the top 20 percent of households measured by income. That top quintile saw its nominal income increase on average by $8,358 per year, while the bottom quintile saw income decline by $275 in the same time period. 

By this time, though, the fact that income gains are concentrated in the top of the distribution should surprise nobody. The really telling part of Corbet’s study is what he found when he looked at the change in spending across households in different quintiles. 

Related: Get Used to It – The Rich Do Get Richer 

When discussing income inequality, many people have a general sense that it is unjust for very low income people to see little or no increase in their purchasing power while the already-wealthy watch their real income increase. 

What many people don’t grasp is that when high income households see their income increase, they generally don’t spend it. Cobet found that the top quintile increased spending by only $2,365 per year, meaning they spent about 29 percent of the extra income they received. 

The next quintile down, which saw an annual increase in income of $1,862, spent an extra $1,348, or about 72 percent of the additional income.

But it’s in the three lowest quintiles where the story really gets interesting. For the second and third-lowest quintiles, total household spending increased by far more than income. 

Households in the middle quintile earned only $69 more per year, but spent an additional $345, meaning that they increased their spending by 500 percent of their income gain. The next lowest quintile saw income increase by $143, but increased spending by $881 – 616 percent of their income gain. 

Related: In American Politics, the Wealthy Get What They Want 

Cobet, the study’s author and a senior economist at BLS said that there is no way of explaining the spending patterns except to assume that families “are using either savings and some version of credit card and other debt.” 

For the first quintile, for whom income fell by $275, spending actually decreased. But the decrease -- $150 -- was not enough to offset the decline in income, meaning that they, too spent savings or borrowed. 

What this means is that in total, household income in 2012 was, on average, $10,157 higher than in 2008. But average spending only increased by $4,789 – and even getting spending to that level required households in the bottom three quintiles to go into debt. 

To economists, this shows the damage that income inequality can do to the economy as a whole. If the three lowest quartiles in income distribution had shared more equally in the increase in average income, they most certainly would have spent most or all of that increase. But as it is, $5,993 of the average increase of $10,157 – more than half – went into the savings of the highest quartile instead of being used for the purchase of goods and services, which boosts economic growth. 

Related: Broadening the Discussion About Economic Growth 

“We know that the economy has been growing since the second half of 2009 in GDP terms, and we know that most of that growth has eluded lower income people,” said economist Jared Bernstein, a senior fellow with the Center on Budget and Policy Priorities. “Folks at the top, their propensity to spend out of their income is not the same as folks at the bottom. They’re not income-constrained.” 

The concentration of income growth at the top, he said, “has surely hurt consumption.  Interestingly, it hasn’t helped investment much either, despite the higher savings rates of those at the top of the scale, since investment capital’s largely been hanging out on the sidelines given weak demand.” 

And while the concentration of income at the top is bad for the economy, it is also bad for the future of a large segment of the population: those three lowest quintiles.  

“It’s not like the folks at the bottom aren’t spending,” said Bernstein. “They are borrowing and spending. And as we should have learned, that’s not particularly sustainable.” 

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