Why the poor don't get rich.

Why the poor don't get rich.

Why the poor don't get rich.

Moneybox
Commentary about business and finance.
June 24 2003 6:12 PM

The Rich Do Get Richer

How the decline in income mobility undercuts one argument for the Bush tax cut.

A fundamental principle of American life is this: Anyone can rise from poverty to wealth. That's a promise that the United States has fulfilled better than any other country, in part because the government has given that mobility a helping hand. The spread of universal public education, expansive immigration policies, and rigorous patent and intellectual-property protection have given successive generations the tools and incentives to create wealth. Meanwhile, the abolition of primogeniture, antitrust policies, and estate taxes have ensured that fortunes and status gained in one generation aren't handed down in perpetuity. As a result, fortunes large and small have continually been made and lost in the United States. In the words of Joseph Schumpeter, the rare economist with a penchant for bons mots,"The upper strata of society are like hotels which are indeed always full of people, but people who are forever changing."

Modern conservative economists love this mobility, and they often cite it as a reason why income inequality isn't troubling. A college student has virtually no income today—and thus is counted poor—but in 15 years will assuredly rank as comparatively wealthy. High-wage-earners, upon retirement, may descend the income ladder as they live off of their pensions and Social Security. As a result, "the effect of the tax system on an individual taxpayer is not well represented by a one-year static snapshot of his or her income," as R. Glenn Hubbard, the personable former chairman of the Council of Economic Advisers, put it in the 2003 President's Economic Report. And that's why many economists object to the sort of analyses issued by the Center for Budget and Policy Priorities, which notes that a select few will benefit disproportionately from tax cuts. The critics assume that the only people who benefit from a tax cut are those in a tax bracket at the moment of the cut. In fact, as Hubbard argues, today's top 1 percent receiving the best of the Bush tax benefits will differ significantly from the top 1 percent in 2010, who will also receive the benefits. A table in Hubbard's report shows how taxpayers would have moved among brackets between 1987 and 1996—assuming the 2001 tax cuts were in effect then. More than half the taxpayers changed brackets by the end of the period, with 28 percent having moved to a higher tax bracket and 26 percent of taxpayers moving to a lower bracket.

But what if people are less and less likely to move up or down the income ladder? This paper by Jane Katz and Katharine Bradbury, economists at the Federal Reserve Bank of Boston, confronts this question and finds a troubling set of answers.

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After analyzing the performance of all U.S. households based on their standing by quintiles in the 1970s, 1980s, and 1990s, Katz and Bradbury conclude that while mobility stayed steady in the first two decades, it "declined noticeably" in the 1990s. "Overall, about 40 percent of families ended the 1990s where they began, as compared with 36 and 37 percent in the 1970s and 1980s, respectively."

The slowing mobility was evident at both the bottom and the top. In the 1970s, 49.4 percent of those in the poorest quintile were stuck there at the end of the decade, while 24.5 percent had moved up to the second-poorest quintile. But in the 1988-1998 decade, 53.3 percent of the bottom quintile stayed put while 23.6 percent rose one quintile. Among those in the top income quintile at the beginning of the 1970s, 49.1 percent remained there at the end of the decade; in the 1990s, 53.2 percent did. Of the richest fifth in the 1970s, 72.8 percent ended up in the top two income quintiles; in the 1990s, 79 percent did.

When inequality rises—as everyone concedes it has—and mobility falls, American society becomes much less fluid, much more stratified. As a result, "Compared to 30 years ago, families at the bottom are poorer relative to families at the top and also a bit more stuck there," Katz and Bradbury conclude.

Keep in mind that inequality rose and mobility decreased in the 1990s, when taxes were raised on the wealthiest. Bush administration policies—sharply reduced marginal rates, a gradual abolition of the estate tax, a reduction in the dividend tax—will surely amplify the trend. To borrow another phrase from Schumpeter, our bias in recent years has switched from creative destruction toward creative preservation. The rich have figured out how to use the federal government to help them stay that way.