Why conservatism can best address the real problems surrounding income inequality

Patrick Garry, RenewAmerica analyst

Throughout the Obama era, the issue of income inequality has been a central tool of political strategizing. Liberals have used the issue as a sword against conservatives, accusing the latter not only of indifference toward the plight of working Americans, but of actually welcoming the widening gulf between rich and poor, as if conservatives want nothing more than to see the wealthy become wealthier, even if it is at the expense of the poor. At the same time, conservatives have shied away from the issue, perhaps afraid of how the issue might feed the big-government agenda of liberalism.

For the past six years, even though they have controlled government policy, Democrats have used the inequality issue to put conservatives on the defensive, blaming conservatives for the failure of the middle and working classes to match the progress made by the upper income classes. This assault against conservatives has been deceptive and distorted, but at the same time, conservatives have often retreated from this assault by trying to dismiss the extent of the widening income gap.

The inequality problem is not the simplistic problem the Left makes it out to be. But there is a serious, underlying problem reflected by the growing income gap in America – a problem that strikes at the heart of the conservative vision of America. And if they are to provide a workable governing vision, conservatives must show their concern for this problem and articulate their solutions to it.

The widening income gap

Given the wage stagnation and weak employment gains of recent years, it is not surprising that many economists claim that the gap between rich and poor is at its widest since records began 45 years ago. This gap has widened even throughout the recovery. From 2010 to 2013, only the households at the very top of the income ladder saw gains, while families in the bottom 40 percent saw their incomes decline over that period, according to the Federal Reserve. Meanwhile, household incomes in the middle stagnated.

Since 2009, the real incomes of middle-class households have declined by thousands of dollars a year. The incomes of the poorest fifth of Americans have declined every year since 2008. Although the wealthiest Americans have seen substantial gains since the 2008 recession, the poverty rate remains two full percentage points above what it was in 2007, and more than three percentage points above what it was in 2000. If the rate today were what it was in 2000, ten million fewer Americans would be living in poverty.

For black Americans, the situation is much worse. Black median household income is almost 14 percent less than it was in 2000, and the poverty rate for black Americans is nearly 5 percentage points higher than in 2000.

These developments in turn have affected public opinion about the economy. In 2000, the majority of Americans believed job opportunities would be better for the next generation than for their own. Today, the number who think so stands at just 16 percent. Majorities now believe that the ability of young people to afford college will never return to the way it was, and that workers will never again feel as secure in their jobs as they once did.

The growing income gap has been driven by the anemic economic growth during the Obama era. But it has also been escalated by the Federal Reserve's attempt to counter the drag of the anti-growth policies of the federal government and artificially stimulate the economy through its $4 trillion Quantitative Easing policy – a policy that has driven short-term interest rates to nearly zero. This policy has led to a surging stock market that in turn has substantially increased the wealth of the richest Americans who had significant stock investments. At the same time, it has vastly decreased the income received by the elderly, who saw declining interest payments on their savings.

While Fed policy has boosted profits in the financial markets, it has done nothing to combat wage stagnation or the reduced share of wages in gross national income. The share of wages in the national income has decreased from 65 percent in 2008 to 61 percent in 2013, while the share of profits in the national income over the same period has risen from 11 percent to 15 percent. Indeed, a significantly smaller share of the nation's income goes to labor than it did 30 years ago.

A debt-based monetary system has produced a debt-driven economy, which rewards those with the financial acumen and assets to invest in the market, while eroding the earnings of working Americans. Increased financial sector profits accrue mainly to upper-income recipients, who are relatively few in number, while the decreased share of wages affects the relatively larger number of workers – thus leading to greater income inequality.

The liberal view of inequality

To Democrats over the past eight years, income inequality lies at the core of what is wrong with America. Consequently, the crisis of income inequality demands and justifies a more active government agenda of redistribution, they believe, including higher taxes, higher spending on government entitlements, and higher regulation of business: in other words, expanding the public sector. And the Left has used this call for bigger government to paint themselves as defenders of the working and middle classes, regardless of the fact that a bigger government has not only failed to alleviate the income gap, but has widened it.

In the leftist view, the mere existence of income inequality provides an indictment of the free market economy. But this highly partisan position contains the wholly irrational presumption that everyone should have the same income, or that everyone wants to live the same kind of life that would produce similar incomes.

Although the Left frequently talks about income inequality, it is really focusing on wealth inequality. Income is more reflective of present economic trends. It is more essential to how people live and what opportunities exist for them. Income is more immediate and more vital to livelihoods. Wealth, on the other hand, is often more a product of what has happened in the past. Therefore, a focus on wealth misses the picture of what is happening to that broad group of people in the middle and lower end of the income distribution spectrum. A focus on wealth seems to reflect more a desire to confiscate or penalize a certain class of households, rather than to empower the broader group of households. For people in the middle and lower income levels, it's all about earnings and income, not about wealth.

The Fed's monetary policy during the Obama era has been much more effective in boosting balance sheet wealth than in spurring real income growth, which results from capital investment that in turn spurs job growth. Because of Fed policies, corporate managers have often chosen financial engineering tools – e.g., debt-financed share buybacks – over the kind of capital investment that would create wage-paying jobs. This is largely because financial markets have rewarded the former. In a rising asset-price environment, businesses engage in asset manipulation, not capital investment, and are more concerned with balance sheet wealth than business investment, which is the only way to boost real economic growth. Real wealth creation comes from strong, sustainable growth that turns productivity into labor income, and then to more business investment. Federal Reserve-engineered balance-sheet wealth creation provides no shortcut to real growth.

One way in which Democrats have attempted to reduce income inequality is by raising the minimum wage. But this is hardly a remedy. At least half of the minimum wage earners are not in the lowest household-income bracket, and even fewer are their household's primary earner. So raising the minimum wage is not a great way for lifting up the incomes of the poorest households in America.

The other liberal measure for addressing inequality is to raise taxes on the higher income households. But again, this measure greatly exaggerates what can actually be done. Currently, the top 20 percent of earners pay a net average of $46,500 in taxes. The next 20 percent pay a net average of $700. And the bottom 60 percent receive more in government transfer payments than they pay in taxes. In other words, the U.S. already has a great deal of economic redistribution, and it is questionable as to how much more can be achieved through tax increases and how negative an effect those increases would have on economic growth.

Revenues from a tax on high incomes also do not necessarily result in programs actually aimed at lifting up the lower and middle class incomes – e.g., education programs that expand the skill levels of working Americans. The only certainty produced by higher taxes is bigger government. Indeed, it is not even certain what revenues would be produced by such taxes, since higher income individuals will increasingly shift their money into various tax shelters. Thus, sky-high income and wealth taxes would not raise much revenue for very long, and any revenue is likely to fund government programs, not checks to the needy.

Contrary to the stated aims of liberalism, a state-by-state analysis shows that the blue states following liberal policies have bigger income gaps than do red states that follow more conservative, growth-oriented policies. So, at minimum, redistributionist policies like raising tax rates or the minimum wage fail to achieve greater income equality. And at worst, such policies actually worsen the inequality by dampening the economic opportunity and mobility needed by lower income individuals.

Reflecting the Leftist demagoguery over the inequality issue, Thomas Piketty writes in Capital in the Twenty-First Century that wealth inequality can lead to the rise of plutocracy and the end of democracy. But even more likely to lead to the rise of plutocracy is the massive growth of elite-led central government – with its corresponding crony capitalism – that the Left espouses as a remedy to wealth inequality. This isn't to say that extreme wealth inequalities pose no problem for a democracy; it just means that the Left's proposed cure is no cure at all.

It often appears that the liberal approach reflects not a desire to uplift the lower income classes but an envy toward the upper classes. Government policy based on social envy can be toxic for American culture, just as it has been for many Latin American countries. Social envy and anger over income inequality might make for potent politics, but it only damages the cultural cohesion that lower income Americans desperately need. There is no reason to cater to the rich, but it does no good to vilify them. The challenge is to rally the nation around a unifying vision that can produce upward mobility for all.

The conservative approach to inequality

The conservative approach takes a bottom-up focus, rather than a top-down one. It seeks to lift up the bottom, rather than to bring down the top. It seeks to maximize the opportunities for the least well-off, through maximizing the income and economic opportunities of the whole society – rather than simply target the most well-off for what may eventually become punitive taxation, irrespective of how this taxation would affect all the lower brackets.

A policy agenda serving this focus includes increasing upward mobility through education that empowers workers, and regulatory and tax reform that sparks job creation and wage growth. Conservatives must fight crony capitalism, which benefits the politically connected, and orient tax policy to benefit families and the middle class, not just penalize the rich. (One of the most significant proven impediments to upward mobility, family breakdown, will be discussed in a future essay.)

Welfare programs that incentivize work have been far more successful in boosting incomes and mobility than simple cash assistance programs. The U.S. Census Bureau estimates that the earned income tax credit lifted 5.4 million people out of poverty in 2010 alone. Conservatives advocate expanding this EITC to childless adults, reducing the marriage penalty by adding a second-earner deduction, and reducing the disincentives to work in other welfare programs. Conservatives also propose reforming the childcare tax credit to make it easier for single mothers to re-enter the workforce, get off welfare, and take advantage of opportunities for upward mobility.

A fundamental flaw of the current welfare system is that it largely serves to provide a social safety net, rather than move people out of poverty. Although the first goal is necessary for survival, the second goal is vital for achieving upward mobility. Unfortunately, the overall design of the entitlement and social welfare system has greatly decreased the motivation of recipients to find work that would take them off those benefits. Additionally, government housing policies expanding home ownership have made it more difficult for the poor and working class to move to geographic areas where jobs are more plentiful. Because it is especially difficult to sell a house in an economically depressed area, the people most in need of mobility become trapped in that depressed area. Many states have labor shortages, which is why business groups strongly support immigration reform, but those shortages are not being met by native workers. Therefore, one immediate way to improve upward mobility is to refrain from adopting policies trapping low income people in low income regions.

Since the recession's "official" end in 2009, real hourly wages have fallen by 2.6 percent. In large part, this has occurred from a hollowing out or polarization of the labor market, through which middle-skill and middle-earning occupations have disappeared. A study by the National Employment Law Project found that between 2008 and 2012, mid-wage occupations represented 60 percent of jobs lost, but only 22 percent of jobs recovered. Meanwhile, lower-wage occupations accounted for only 21 percent of jobs lost, but 58 percent of jobs gained back. This downward mobility in terms of job availabilities stems from current government policies. And a widening income inequality is an inevitable result of downward mobility. No government tax hikes or entitlement programs can ever make up for this hollowing-out effect.

Current social polarization between a small upper class, an eroding middle class, and a large lower class will only intensify, predicts economist Tyler Cowen in his book Average is Over. But contrary to such predicted trends, conservatives want to preserve the traditional American upward mobility for all income and skill levels. Cowen's world is not the preferred world of conservatives; in his world, the top 10 to 15 percent do very well, the middle stagnates, and the bottom falls further behind, on the assumption the middle and bottom will not have sufficient education to advance, despite the fact that in the modern world, the economic returns for improving job skills have increased, as have the penalties to the unskilled.

As we've argued, conservatives need to recognize that a core challenge facing America is not simply income inequality, per se, but rather wage stagnation and a restriction of upward mobility. The problem is a declining mobility from the bottom and a wage stagnation for the middle class. The real issue is not income inequality, but the level of opportunity for economic mobility. A study published by the National Bureau of Economic Research found that the widening income gap has not translated into a lowered economic mobility – in fact, there is a .6 percent higher chance for a child born in 1986 to move from the bottom 20 percent of household income to the top 20 percent than for a child born in 1971. Nonetheless, the study did conclude that the rate of upward mobility has essentially flattened in recent years, despite periods of economic growth and an expansion of welfare programs. This stagnating rate of upward mobility is the primary conservative concern, not simply the abstract levels of income differences.

There is a problem associated with income inequality, but it is not a problem of the wealthy not "paying their fair share," as President Obama has so often proclaimed. A new CBO study on The Distribution of Household Income and Federal Taxes finds that the top 20 percent of American households finance 100 percent of the transfer payments to the bottom 60 percent, as well as almost 100 percent of the tax revenue collected to run the federal government. Thus, 60 percent of U.S. households are already net tax recipients, collecting more in transfer payments than they pay in federal taxes – about $10,000 more. The next highest 20 percent pays only $700 more (as we noted earlier) in federal taxes than it receives in government transfer payments. Therefore, the top 20 percent of households are financing nearly the entire federal tax burden, along with almost the entire system of entitlements and transfer payments. For the Left to claim that these taxpayers are not paying their fair share is just plain demagoguery. In fact, the top 20 percent are not only paying their fair share, they are paying everyone else's share. This is not to say that the top income group should not pay any more taxes, it is just to say that the Leftist argument that they are not currently paying their fair share is pure partisan propaganda.

The Left is completely off base if it expects to address the income inequality problem through heavier taxation of the rich. Again, this is not to say that taxes cannot or should not be increased on the wealthy, depending on what effect those taxes would have on economic growth; it is just to say the current taxation system is not the cause of or the remedy for inequality. The problem is much more complex than simply taxing the rich.

Getting real about inequality

Middle-class incomes have fallen during the Obama era not because the rich have gotten richer, which they have, but because of bad federal policies that have yielded the weakest recovery in the postwar history of America. Yet even as this recovery fails to lift the working and middle classes, the Left continues to take a simplistic view of inequality, arguing that it is the cause of all other economic woes, specifically a diminishing upward mobility. But in reality, it is just the other way around. The widening income disparity is a result of diminishing upward mobility, which in turn is the result of various technological, globalization, and governmental policy factors. For the Left to ignore these factors and focus only on taxing the rich is to ignore all the obstacles facing upward mobility. The Left has not been honest with the public in so mischaracterizing this issue; its reliance on simplistic demagoguery tries to hide its own policy mistakes that have impeded upward mobility.

The public is right to worry about wage stagnation and economic mobility, as well as the rising costs of education, healthcare, and raising a family. But all these problems are not simply the result of income inequality. If anything, inequality is a reflection of these problems. Therefore, conservatives must address the actual problems being felt by working and middle class America, through lowering the cost of higher education, improving secondary education, and easing the cost of raising a family through expanding the child tax credit.

Conservatives cannot just oppose the Left's polarizing use of the inequality issue, for to do so would reinforce the image that conservatives are not concerned about the growing income gaps, and thus not concerned about the struggles of working and middle class America. What conservatives must do is articulate a broad agenda that seeks to lift burdens from workers and middle class families, as well as open up opportunities for economic advancement. And this broader agenda must go beyond the traditional mainstays of conservative policy – e.g., across-the-board tax cuts and regulatory reform. Such an agenda would do much in erasing the image of conservatism as caring only about the rich.

Economic growth and economic mobility are not the same thing, and conservatives must resist presuming that strength in the former translates to strength in the latter. Conservatives do not want to repeat the performance of the Bush years – when economic growth coincided with stagnant wages and rising healthcare costs. Instead, conservatives must speak directly to the desire of working and middle-class voters for economic opportunity and mobility – a desire that is far deeper than any desire to simply tax the rich more. This is why the Democratic focus on income inequality may unite their activists but does not speak powerfully to voters. This Democratic failure gives conservatives the opportunity to offer voters a true understanding of today's real economic challenge and how it might be addressed.

© Patrick Garry