Examine Inequality's Causes Before Prescribing Solutions

Fear and loathing of income inequality is both totally understandable and ultimately misplaced.

Fear and loathing of income inequality is both totally understandable and ultimately misplaced.

It's understandable because everywhere around us it seems as if top income earners—those latter-day kulaks vilified as the "1 Percent" by the Occupy crowd and populist politicians—are gaining while the rest of us seem barely able to hang on to a lower-middle-class standard of living.

It's misplaced because it glosses over strong evidence that the ability to rise above your starting place—the American Dream, by most accounts—is better than it was 40 years ago.

There is no doubt that the spread between top earners and those below them has grown over time. The share of income earned by the top 1 percent in the United States has doubled since the early 1970s. The top 20 percent's share  has risen, too, though the increase is much smaller and has leveled off since the 1990s.

Yet it is far from clear that inequality is a bad thing when it's the result of market forces. Think about it: Do Bill Gates' billions take bread from your mouth, or have Microsoft products allowed you to put bread in your wallet by making you more productive and the goods and services you buy cheaper?

As important, it's not clear how to "compress" incomes even if we want to. The same trend toward greater inequality is happening in most advanced economies, across different tax and regulatory systems. Despite spending $1 trillion a year on the poor, federal and state governments report increases in poverty and need. The Congressional Budget Office estimates that President Barack Obama's proposed tax increases on individuals making over $200,000 and joint filers making over $250,000 would raise just $42 billion in 2013 and $39 billion in 2014. That's not enough either to strip the wealthy of their booty or lift the poor up—especially given the bad track record that government programs have in boosting the prospects of the least skilled among us.

Which isn't to say that government policies don't redistribute income and opportunity. They do in all sorts of ways, but typically in ways that work against leveling opportunity.

For instance, in terms of total compensation (salary plus benefits), federal workers earn 16 percent more on average than private-sector workers with the same experience, education, and responsibilities. They are paid out of your current and future taxes, not corporate profits. In what some have seen as an echo of the setting for The Hunger Games, the growing power of the federal government to dispense favors and direct whole industries has transformed the Washington, D.C., metro area into the nation's wealthiest, boasting 10 of the top 20 counties for median household income.

Then there is generational inequality, which is also goosed by government policy. The Pew Research Center finds that in 1984, households headed by someone 65 years or older possessed on average10 times the wealth of a household led by someone under 35. By 2010 that gap had widened to 22 times. Part of that disparity is the result of payroll taxes that take about 12.4 percent (half from the worker, half from the employer) of every dollar of earned income up to $110,000 to pay for Social Security (for the past two years, the worker's share of Social Security taxes has been reduced by 2 percentage points, a break that will expire at year's end). Another 2.9 percent of all wages—again split between employee and employer—goes to Medicare.

Payroll taxes take a relatively bigger bite out of the paychecks of younger and poorer Americans even as old-age benefits are disbursed generally without regard to need. To add insult to the situation, Social Security will be paying out fewer dollars than new and future retirees will have put into the system. So at the very time when younger Americans have lost ground to their elders, they are compelled to pay into a fund that will shortchange them when they become eligible for it. Given the already unsustainable benefits levels of both Social Security and Medicare—their major trust funds will be exhausted by 2033 and 2024, respectively—it's likely that those of us retiring in 20 or more years time will face even more sharply curtailed payouts. Would that we could use some of the 15 percent of our income that goes to payroll taxes to build for our futures.

However, all is not darkness, even in the Great Recession. A June study from Pew's Economic Mobility Project finds that 84 percent of Americans have "higher family incomes than their parents did." Among people raised in the bottom income quintile, the figure was 93 percent.

These findings are widely accepted. Brookings Institution scholar Scott Winship, who worked on the Pew study, has documented that even as the rungs on the income ladder have spread out, mobility has not diminished since the early 1970s. In fact, he argues that over the past four decades, "upward mobility from poverty to the middle class rose from 51 percent to 57 percent." As he told me in an interview earlier this year, "You can be concerned that there's not enough mobility or enough opportunity, but you don't have to also believe that things are getting worse."

That is good news, even as Winship and others grant that there is no simple, obvious way to increase mobility, especially for the poorest Americans.

But rather than looking at ways to slice money off the top of the income distribution and funnel it into government programs with spotty records of success, we should address the ways in which government is already stacking the deck against the younger and poorer among us.

This article originally appeared at Reuters.