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How Income Inequality Helped Spark the Great Recession

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Thirteen years ago, the economists Sara Solnick and David Hemenway conducted a study that revealed a great deal about how Americans define happiness. Subjects, all of whom were middle class or lower, were asked which they wanted more: to earn $50,000 while everyone else got only half as much, or to earn $100,000 while everyone else earned $200,000. The increase in the subject's earnings from the first scenario to the second was, of course, dramatic. But that didn't matter to most. What mattered was how rich they were compared to others: 56 percent said they would take $50,000 less as long as they were richer than everyone else.

This study has important implications when assessing the growing divide between America's rich and poor. What it suggests is that it's extremely important for us to feel successful next to our peers. In fact, when our peers are significantly wealthier, we become unhappy and anxious. Other studies show increased rates of crime, depression, divorce and stress-related illnesses in regions where income inequality is the most gaping.

And it's gaping in a lot of places. In case you haven't heard, the gap between the rich and poor in the U.S. is currently wider than it's been since the Great Depression. It's even worse here than in Egypt or Tunisia, where the income gap helped ignite the unrest. In the last thirty years, the richest one percent of Americans has seen its share of wealth jump from under nine percent of the total pie to approximately 25 percent. Many fiscal Conservatives argue that this is good because of the trickle-down theory that says increased riches for the wealthy eventually find their way to everyone else. But this simply hasn't happened. Over the past three decades -- the period when the rich have become superrich -- real wages for the middle class have declined and the poor have only gotten poorer. The truth is that the dramatic increase in the wealth of our richest citizens has had devastating consequences for our middle and lower classes.

Because while wealth hasn't trickled down, something else has. As pointed out by Robert H. Frank, an economics professor at Cornell, increased inequality has spawned "expenditure cascades" that have wreaked havoc with those at the lower half of the economic ladder. These cascades occur when the superrich begin spending more simply because they have so much more. The group just below them, which often travels in the same social circles, starts spending more to keep up with the superrich. This continues down the income ladder until a situation is created where everybody believes they should be significantly wealthier -- or at least, look like they are. This has resulted in a huge rise in Americans spending above their means.

Take the housing crisis. While there were certainly a slew of causes of the housing collapse -- predatory lending, Wall Street's partnering with mortgage lenders, financial deregulation, among others -- expenditure cascades played a significant role. As supported by Solnick and Hemenway's study, when people with modest homes saw McMansions constructed up and down their blocks, or saw their neighbors suddenly installing new additions, granite countertops, stainless steel appliances and the like, the social pressure to do the same became, for many, overwhelming. The result was hoards of people pilfering their equity and buying houses they couldn't afford. Moreover, this social pressure to spend was compounded by powerful political and corporate pressures.

What political and corporate pressures? Congresswoman Marcy Kaptur, the longest serving woman in the U.S. House of Representatives, told me in an interview that when Republicans took control of Congress in 1994, one of the first things they did was to impose fees on savings accounts to encourage spending. At about the same time, as a recent book about the 2008 financial crisis reveals, the large banks and mortgage companies undertook an advertising campaign to de-stigmatize second mortgages and home equity loans. These efforts went far in changing American thinking that had previously held saving money and fiscal responsibility in high regard. Suddenly being in debt wasn't frowned upon. In fact, it became the norm -- for the middle and lower classes, that is.

So why aren't Americans more alarmed by the growing gap between the rich and poor? And in light of how enormous it's become, why isn't there more support for attempting to alleviate it by taxing the rich? Polls show that a large proportion of Americans still want and expect to become rich, and so presumably they'd rather not be saddled with high taxes when they do. But the truth is that it's more difficult than ever for poor Americans to climb the income ladder. According to a 2007 study, the likelihood that a poor American will attain even upper middle class status has become extremely slim, having steadily plummeted since the 1940s.

A healthy society depends upon a large and vibrant middle class. While virtually every American politician would agree with this, governmental policies over the past three decades have resulted in a smaller and indebted middle class, alarming divide between our richest and poorest, and made upward mobility more difficult. It's time to admit that these policies have failed and try new ones. Obama made a huge mistake when he agreed to extend the Bush tax cuts for the wealthiest Americans for another two years. Let's make sure he doesn't do it again.

This has been cross-posted at GuernicaMag.com