Five Myths about Economic Inequality in America

Economic inequality has risen to the top of the political agenda, championed by political candidates and best-selling authors alike. Yet, many of the most common beliefs about the issue are based on misperceptions and falsehoods.

Although we are frequently told that we are living in a new Gilded Age, the U.S. economic system is already highly redistributive. Tax policy and social welfare spending substantially reduce inequality in America. But even if inequality were growing as fast as critics claim, it would not necessarily be a problem.

For example, contrary to stereotypes, the wealthy tend to earn rather than inherit their wealth, and relatively few rich people work on Wall Street or in finance. Most rich people got that way by providing us with goods and services that improve our lives.

Income mobility may be smaller than we would like, but people continue to move up and down the income ladder. Few fortunes survive for multiple generations, while the poor are still able to rise out of poverty. More important, there is little relationship between inequality and poverty. The fact that some people become wealthy does not mean that others will become poor.

Although the wealthy may indeed take advantage of political connections for their own benefit, there is little evidence that, as a group, they pursue a political agenda designed to suppress the poor or prevent policies designed to help them. At the same time, rather than reducing economic inequality, more government intervention may actually make the situation worse. Since policies to reduce inequality, such as increased taxes or additional social welfare programs, are likely to have unintended consequences that could cause more harm than good, we should instead focus on implementing policies that actually reduce poverty, rather than attacking inequality itself.

MYTH 1. Inequality Has Never Been Worse

MYTH 2. The Rich Didn’t Earn Their Money

MYTH 3. The Rich Stay Rich; the Poor Stay Poor

MYTH 4. More Inequality Means More Poverty

MYTH 5. Inequality Distorts the Political Process

Recently, a new argument against inequality has come to the fore: that inequality skews the political process in ways that benefit the wealthy and penalize the poor. In doing so, it locks in the status quo, limiting economic mobility, and enabling the wealthy to become still wealthier. There is certainly some merit to this argument. The federal government can and does dispense favors to those with connections to the levers of power. This has enabled some individuals to accumulate wealth that they could not have earned in a truly free market. In that sense, disparities of political power may exacerbate inequality. On the other hand, there is far less evidence that the wealthy are able to use their political power to enact a broad agenda that favors the wealthy or penalizes the poor.

Moreover, while many wealthy individuals are politically active, that activism is often offset by groups that represent lower-income individuals, or groups whose politics cut across the socioeconomic spectrum. For example, 14 of the top 25 spenders during the 2012 election were unions, which ostensibly advocate for the working class.

Conclusion

Of course, even if one accepts the premise that inequality is increasing, undeserved, and leads to the problems discussed above, the more interesting question from a policy perspective is what we can—or should—do about it. There are, after all, two ways to reduce inequality. One can attempt to bring the bottom up by reducing poverty, or one can bring the top down by, in effect, punishing the rich.

Traditionally, we have tried to reduce inequality by taxing the rich and redistributing that money to the poor. And, as noted above, we have achieved some success. But we may well have reached a point of diminishing returns from such policies. Despite the United States spending roughly a trillion dollars each year on anti-poverty programs at all levels of government, by the official poverty measure we have done little to reduce poverty.

Indeed, many advocates of increased taxes for the wealthy seem to concede that their efforts would do little to reduce poverty.

Other critics of inequality seem equally concerned with punishing the rich. Hillary Clinton, for instance, argues that fighting inequality requires a “toppling” of the one percent.89 But the ultimate losers of such policies are likely to be the poor. Piketty’s plan might indeed lead to a society that would be more equal, but it would also likely be a society where everyone is far poorer.

Economic growth, after all, depends on people who are ambitious, skilled risk-takers. We need such people to be ever-striving for more in order to fuel economic growth. That means they must be rewarded for their efforts, their skills, their ambitions, and their risks. Such rewards inevitably lead to greater inequality. But as Nobel Economics Prize–winning economist Gary Becker pointed out, “It would be hard to motivate the vast majority of individuals to exert much effort, including creative effort, if everyone had the same earnings, status, prestige, and other types of rewards.”

While inequality per se may not be a problem, poverty is. But there is little evidence to suggest that economic inequality increases poverty. Indeed, policies designed to reduce inequality by imposing new burdens on the wealthy may perversely harm the poor by slowing economic growth and reducing job opportunities.

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