The growth in income inequality in the United States since the 1980s stems from two different sources. The first is that the incomes of typical households have stagnated. The other is that the incomes at the very top of the income distribution have skyrocketed. Both sources will have to be corrected if the gap between the superrich and everyone else is to be narrowed.
In his very important new book, Capital in the Twenty-First Century (Harvard University Press, 2014), Thomas Piketty does not take up the fact that between 1986 and 2012 household income increased by a dismal 2.5 percent, from $49,764 to $51,017 (U.S. Bureau of the Census). Instead, he focuses on what happened to the second determinant of increased income inequality -- what was occurring at the top. For while there was next to no growth in median household income since the early 1980s, "those making more than $500,000 a year have seen their remuneration literally explode (and those above $1 million a year have risen even more rapidly)." (314) Piketty writes that this explosion "reflects the advent of 'supermanagers,' that is, top executives of large firms who have managed to obtain extremely high, historically unprecedented compensation packages for their labor." (302)
There was a period during the late 1990s when household income did increase, and for a short time the trend to inequality was slowed. Employment growth was strong and therefore workers were able to secure significant wage advances. But with the new century, unemployment trended upward. Never again did the unemployment rate approximate the low of 3.8 per cent that occurred in April 2000. The rise in unemployment after 2000 put an end to increased income for everyone but the very wealthy. High unemployment means that large numbers of unemployed people are clamoring for work and therefore employers have the upper hand in setting wages.
But what was happening at the other end of the pay scale is more difficult to explain. Why did managers experience giant increases when everyone else was treading water?
Piketty's surprising yet plausible explanation is that the impetus for managerial compensation increases was provided by the reduction in tax rates for high income earners that was passed during the Reagan administration (and the Thatcher government in Great Britain). Marginal tax rates for the rich in those countries fell from 80-90 percent to 30-40 percent. Accordingly, as he writes, "in the 1950s and 1960s, executives in British and U.S. firms had little reason to fight for such raises... because 80-90 percent of the increase would in any case go directly to the government." After 1980 however, he writes, "the game was utterly transformed." Executives "went to considerable lengths" to persuade compensation committees to grant them big increases. And they found it easy to do so because it was an inside job: "the members of compensation committees were often chosen in a rather incestuous manner." (510)
Piketty finds a consistent pattern among economically developed countries. The more that tax rates on high incomes were reduced, the more executive compensation grew. Conversely where taxes on high incomes did not change or changed only moderately, managers' compensation tended to grow only slowly. Piketty's research also importantly reveals that the increase in managerial compensation had no positive payoff for the economy. Productivity growth was not more rapid in the countries where executive compensation grew more than elsewhere.
The inescapable conclusion is that there is nothing foreordained about the growth in income inequality. It is not inevitable. Rather, it is the result of purposeful policies. Tax rates for the rich went down in the U.S. because Congress passed legislation to lower them. Unemployment remains high because that same legislative body is preoccupied with the budgetary deficit and so has rejected increasing government spending in order to reduce the unemployment rate.
What lies behind both trends is the agenda-setting role played by rich political donors, a large percentage of whom are corporate executives. It is their tax rates that have been reduced. And it is their corporations' profits that have been protected by keeping unemployment high and therefore wages stagnant.
Seen in this way, growing inequality is the logical outcome of the way we pay for our politics. When the super rich have disproportionate influence over political outcomes, they are the principle beneficiaries.
That disproportionate power is the real source of income inequality. Until we reduce the power of wealthy campaign contributors with a system of publicly funded election campaigns, there is little likelihood that we will be able to move effectively to a more egalitarian society and healthy economy.