Report: US Income Inequality Dampening Economic Growth

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Report: US Income Inequality Dampening Economic Growth

Standard & Poor's says U.S. is approaching threshold of extreme levels inequality.

"A rising tide lifts all boats…but a lifeboat carrying a few, surrounded by many treading water, risks capsizing." -Standard & Poor's (Photo: James O'Gordan)

Increasing income inequality is hindering U.S. economic growth and weakening the country's ability to recover from the Great Recession, according to a new analysis by the financial services agency Standard & Poor's.

The report released Tuesday incorporates data from the Organisation for Economic Cooperation and Development (OECD), the Congressional Budget Office (CBO), and the International Monetary Fund (IMF), among other sources, to show that the significant gap between America's wealthiest and everyone else has made the economy more susceptible to "a boom/bust cycle."

Since 1982, the income share of America’s top 1 percent has more than doubled, from 10.8 percent in 1982 to 22.5 percent in 2012.

At extreme levels, income inequality can harm sustained economic growth over long periods. The U.S. is approaching that threshold.
—Standard & Poor's

Such imbalance "may also spur political instability — thus discouraging investment," the report reads. "Inequality may make it harder for governments to enact policies to prevent — or soften — shocks, such as raising taxes or cutting public spending to avoid a debt crisis. The affluent may exercise disproportionate influence on the political process, or the needs of the less affluent may grow so severe as to make additional cuts to fiscal stabilizers that operate automatically in a downturn politically unviable."

The analysis has led Standard & Poor's (S&P) to lower its economic growth forecast for the U.S., from a 2.8 percent rate over the next decade to 2.5 percent rate. 

"At extreme levels, income inequality can harm sustained economic growth over long periods," S&P says. "The U.S. is approaching that threshold."

The agency cites an education gap as a primary reason for the growing income divide, counseling that "with wages of a college graduate double that of a high school graduate, increasing educational attainment is an effective way to bring income inequality back to healthy levels."

In fact, S&P believes that investing in education would be more effective than changing tax codes or even raising the minimum wage when it comes to restoring balance within the economy.

With student debt soaring and recent reports suggesting that minimum wage is in no way the "job killer" that opponents make it out to be, S&P's prescriptions may not be as welcome as its diagnosis.

Still, at the New York Times, Neil Irwin explains why this report — one of many such analyses — is important:

The fact that S&P, an apolitical organization that aims to produce reliable research for bond investors and others, is raising alarms about the risks that emerge from income inequality is a small but important sign of how a debate that has been largely confined to the academic world and left-of-center political circles is becoming more mainstream.

S&P acknowledges that "a degree of inequality is to be expected in any market economy, given differences in 'initial endowments' (of wealth and ability), the differential market returns to investments in human capital and entrepreneurial activities, and the effect of luck."

But ultimately, the agency reaches this conclusion:

We see a narrowing of the current income gap as beneficial to the economy. In addition to strengthening the quality of economic expansions, bringing levels of income inequality under control would improve U.S. economic resilience in the face of potential risks to growth. From a consumer perspective, benefits would extend across income levels, boosting purchasing power among those in the middle and lower levels of the pay scale — while the richest Americans would enjoy increased spending power in a sustained economic expansion.

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