How income inequality hurts the economy

When wealthy households see their income increase, they generally don't spend the extra money.

By The Fiscal Times Apr 22, 2014 2:29PM

By Rob Garver, The Fiscal Times

Given that the adjectives most used in describing the economy's recovery from the recession include "sluggish" and "disappointing," it may come as a surprise to some that average household income in the U.S. is higher, in nominal terms, than it was in 2008.

Not only that, it passed the 2008 average as long ago as 2012. So, if income has recovered, the stock market is at record highs, and corporate earnings are way up, how come it doesn't feel like there's been much of a recovery? 

An analysis released last week by the Bureau of Labor Statistics provides a useful illustration of at least one thing that is unquestionably holding our economy back: income inequality. But maybe not for the reason most people think.

The key here, though, is to remember that the study measured "average" household income when it found a return to pre-recession levels. The headline number on the day the story was released was that 82 percent of the income gains went to the top 20 percent of households measured by income. That top quintile saw its nominal income increase on average by $8,358 per year, while the bottom quintile saw income decline by $275 in the same time period. 

By this time, though, the fact that income gains are concentrated in the top of the distribution should surprise nobody. The really telling part of Corbet's study is what he found when he looked at the change in spending across households in different quintiles. 

When discussing income inequality, many people have a general sense that it is unjust for very low income people to see little or no increase in their purchasing power while the already-wealthy watch their real income increase. 

What many people don't grasp is that when high-income households see their income increase, they generally don't spend it. Cobet found that the top quintile increased spending by only $2,365 per year, meaning they spent about 29 percent of the extra income they received. 

The next quintile down, which saw an annual increase in income of $1,862, spent an extra $1,348, or about 72 percent of the additional income.

But it's in the three lowest quintiles where the story really gets interesting. For the second and third-lowest quintiles, total household spending increased by far more than income. 

Households in the middle quintile earned only $69 more per year, but spent an additional $345, meaning that they increased their spending by 500 percent of their income gain. The next lowest quintile saw income increase by $143, but increased spending by $881 -- 616 percent of their income gain. Image: Man holding empty wallet ©, Image Source, Getty Images

Cobet, the study's author and a senior economist at BLS said that there is no way of explaining the spending patterns except to assume that families "are using either savings and some version of credit card and other debt."

For the first quintile, for whom income fell by $275, spending actually decreased. But the decrease -- $150 -- was not enough to offset the decline in income, meaning that they, too spent savings or borrowed. 

What this means is that in total, household income in 2012 was, on average, $10,157 higher than in 2008. But average spending only increased by $4,789 -- and even getting spending to that level required households in the bottom three quintiles to go into debt. 

To economists, this shows the damage that income inequality can do to the economy as a whole. If the three lowest quartiles in income distribution had shared more equally in the increase in average income, they most certainly would have spent most or all of that increase. But as it is, $5,993 of the average increase of $10,157 -- more than half -- went into the savings of the highest quartile instead of being used for the purchase of goods and services, which boosts economic growth. 

"We know that the economy has been growing since the second half of 2009 in GDP terms, and we know that most of that growth has eluded lower income people," said economist Jared Bernstein, a senior fellow with the Center on Budget and Policy Priorities. "Folks at the top, their propensity to spend out of their income is not the same as folks at the bottom. They're not income-constrained."

The concentration of income growth at the top, he said, "has surely hurt consumption.  Interestingly, it hasn't helped investment much either, despite the higher savings rates of those at the top of the scale, since investment capital’s largely been hanging out on the sidelines given weak demand."

And while the concentration of income at the top is bad for the economy, it is also bad for the future of a large segment of the population: those three lowest quintiles.  

"It's not like the folks at the bottom aren't spending," said Bernstein. "They are borrowing and spending. And as we should have learned, that’s not particularly sustainable."

More from The Fiscal Times

Apr 22, 2014 7:02PM
Biden gave the Ukraine 50 million dollars. Your dollars not his. And we have people in this country that don't have enough food to eat. Inequity for sure.
Apr 22, 2014 4:24PM
Income inequality has little or nothing to do with our sluggish ecconomy.  This disasterous recovery and the lack of growh of good paying jobs is what is hurting the ecconomy.  We have always had income inequality and, in the past, have always experienced strong recoveries after a downturn.  Not this time.  Government regulations, high taxes, corporate and personal, and now Obamacare are choking the otherwise dynamic American ecconomy.  After 5 years in office, this president has failed the American people with his "progressive" ecconomic model.  We have the smallest number of people in the work force in a decade, a record number of Americans on food stamps and disability and good paying jobs have been replaced by low wage service sector jobs.  The energy sector could be a life line for this struggling ecconomy and our president dithers rather approve the Keystone pipeline that now has even unions screaming foul.  Don't expect much improvement until this guy is out of office.
Apr 22, 2014 4:15PM

You are responsible for yourself. I am not responsible for you, your actions, your faults, your addictions, your screw-ups, your children or your choice of where to live. I am not your keeper. It is not my job to protect you or secure my property from your lack of intelligence. There are no excuses for true irresponsibility. You screw up, you deal with the consequences. I am not responsible for your self esteem or hurt feelings. It is not my responsibility to make sure you are not offended. I owe you nothing, the world owes you nothing. This country owes you nothing except a return on what you have given; Nothing more. WHAT HAVE YOU GIVEN?

Apr 22, 2014 3:58PM

What about ability/drive inequality???


We have people who are part of a team which designs an iPhone, and then we have people who can barely read, barely add, and lack motivation to improve their situation.


Of course there will be income inequality.


Dysgenics is out in full force.

Apr 22, 2014 3:13PM
so the top 20% made about $8k more and spend about 30% of that and now the media says they should spend more?

They aren't happy with people saving money?  Yet at the same time on msn they say how to invest for the biggest returns and tell people how to save for retirement.  Yet somehow when the top 20% are saving for retirement thats a bad thing now?

Make up your mind MSN.  you guys suck

Apr 22, 2014 4:17PM
The real reason how income inequality is hurting the economy is due to Fed monetary policy, know the truth. Get rid of the Fed, restore free markets absent central planners and prosperity shall return for all.
Apr 22, 2014 4:22PM
When you spend years demonizing wealthy people, you shouldn't be surprised when they decide against demonstrating their wealth by spending more of their own money.

There is only one real viable option to address income inequality - create more jobs, thereby driving up wages and narrowing the gap.   Unfortunately, everything that has been done over the last 5 years has had the opposite effect.
Apr 22, 2014 3:34PM
I am sure paying that $8k deductible thanks to obamacare will help with income inequality right?

thanks for nothing obama

Apr 22, 2014 3:39PM
existing home sales down to its lowest in the past 20 months.

How will liberals claim this is Bush's fault?

This is obama's recovery right?

Apr 22, 2014 9:47PM

Of course there will be income inequality, between those that WORK and those that sit back and collect government benefits.   Should we increase welfare to equal the same as someone that EARNS a living?

We already have 47% living off he 53%  that work.   These same 47% parasitic leeches demand even more?  What are we to do with democrats?  

Sorry, but we have democrat problem.   We grow tired of supporting these parasites.  Let them WORK, EARN and PAY taxes.  Income inequality will always exist, as long as we have lazy democrats.

Apr 22, 2014 8:29PM
The real thing hurting the economy is ignorance!  And whose fault is it our public schools are dismal failures?  The same ones who've been controlling the schools for so long.  The Left!!!

Apr 22, 2014 4:07PM
Actually those with discretionary capital do spend their money -  just differently.  While the average person spends their money on consumable goods that are quickly used up and have no future value, the wealthy just "convert" their capital to a different asset, such as stocks, r.e. investments, etc. which will likely over time return more than their original cost back to them.   

Not too shabby.  Of course there is no law against any of us doing that too.

Or, are there laws that effectively restrict some from accomplishing this too??  Can you say DoddFrank Act and Obamacare.
Apr 22, 2014 3:55PM
Unfortunately the Democrat's over-all response to the recession has favored those with discretionary capital already accumulated.  The DoddFrank Act so restricted the standard person from gaining access to borrowed capital that they could not participate in the low priced real estate market  at a time of historically low interest rates.  A real tragedy and squandering of a perfect opportunity to  assist main street America ( with  side effects of "stopping the domino like fall in real estate prices and getting the construction industry back on its feet sooner).  Total mismanagement at the highest levels of Government (Obama). 

 Secondly, Obamacare purports to assist those in need when, in reality, it sentences those folks to a life of government assistance.  Once on Obamacare, very few people will work to leave that comfort zone as the tax cost of making additional taxable income combined with having to repay Obamacare subsidies will be insurmountable (unless a gigantic increase in income occurs-not likely as most people gradually climb up the income ladder).  Effectively, these people have had several rungs cut out of their ladder and can only get to the top by jumping way up the ladder in one great leap.

All in all, the "NEW" system we have now separates us into two categories - the "haves" and the "have-nots" with little opportunity to climb the ladder that we had only six long years ago.

Obama is great at assisting people with other peoples money in exchange for no possibility of "opportunity" and the self-esteem that comes from having a job and controlling one's own destiny.

Everyone can walk down the street dropping 1 trillion dollars of other peoples money and get 8 million people to follow behind and pick it up - Duh. 

 Oh, and cut Obama a break - he had no idea of the consequences of his blind experiments.
Apr 22, 2014 9:15PM
Jared Bernstein? He worked in the Obama administration. Sorry, I don't believe any conclusions drawn from their biased research.
Apr 23, 2014 7:43AM

It's time to take care of our own, weed out those who collect benefits illegally, make ex-patriots who retired out of country prove they are still alive(or approaching 100 years old haha) and aggressively go after scammers especially medical fraud. Simplify the tax codes and have the excess bean counters investigate this fraud. On a different note there was an article this AM with nowhere to comment so here goes:

IRS awards bonuses to 1,100 who owe back taxes

Why in hell do civil servants get bonuses at all? I don't think any civil servant at any level whether it be local, county, state or federal should be getting bonuses. They get decent wages and a pretty good perk package as it is. Remember these bonuses are OUR TAX DOLLARS not profits from selling a product or service like private companies do.

Apr 22, 2014 3:26PM
LOL I love the last two sentences of this article.

""It's not like the folks at the bottom aren't spending," said Bernstein. "They are borrowing and spending. And as we should have learned, that’s not particularly sustainable.""

LOL maybe should tell that to obama with his spending policies.  Democrats everywhere are apologizing to Jimmy Carter for him being such a bad pres.  Obama is the new worst.

Apr 22, 2014 4:07PM
A better title "How being stupid and not taking advantage of free education hurts the economy".
Apr 22, 2014 8:35PM
This study is fascinating. It seems to imply a benefit of not spending all of ones income gains. The benefit would appear to be wealth. People with ascending incomes who restrain spending get wealthy, who knew! I can hardly wait for MSN MONEYS next little nugget of wisdom. 
Apr 22, 2014 3:51PM
O...M....G!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! The media agenda/propaganda train is rolling again today!!!!!!!!!!!!!!
Apr 22, 2014 3:35PM
Obama protecting his rich cronie bankers.  They get rich along with obama.  Obama is a millionaire yet I don't see him handing out his money
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