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The rich get more, so the poor want more

INCOME INEQUALITY IN THE U.S.

BETWEEN 1949 and 1979, incomes across all classes in the United States grew at about the same rate of 3 per cent a year. The before-tax income of the bottom 20 per cent of households increased by 116 per cent over those three decades, that of the median households by 111 per cent, and that of the top 5 per cent by 86 per cent.

Spending also increased at a fairly uniform rate across the board during this period. The houses of the rich grew larger, but so did the houses of the poor as well as those of the median households – and by roughly the same proportion. A rising tide lifted all homes, as it were, equally.

Between 1979 and 2003, the before-tax income of the bottom 20 per cent of households rose by just 3.5 per cent, that of the median households by just 12.6 per cent, and that of the top 5 per cent by a staggering 68 per cent. The average net worth of the bottom 40 per cent of households actually shrank by 76.3 per cent in that 24-year period, while that of the top 1 per cent of households grew by 42.2 per cent.

In 1982, there were only 13 billionaires on Forbes’ list of the 400 richest Americans – five of them the children of Texas oil tycoon H.L. Hunt. In 2005, there were 374 billionaires. Forbes’ 400 richest Americans are now collectively worth US$1 trillion (S$1.5 trillion) – about 25 per cent of the GDP (in purchasing power parity terms) of India, a nation of 1.1 billion people.

Their houses, of course, have expanded by leaps and bounds as their net worths have grown. Even Mr Bill Gates’ 4,600-sq-m mansion overlooking Lake Washington has become something of a pondok.

There are houses in the same area even larger than his – quite a few over 5,600 sq m, and at least one over 6,500 sq m. And not only their houses, their yachts and jets as well, their ski chalets and beach homes, their cars and toys, their pools and Jacuzzis, their barbecue pits, their carbon prints, have all grown bigger and more extravagant. None of this should be surprising, for that US$1 trillion has to be spent somehow.

What is astonishing is that median household spending has also grown in the same period. Average median household income and net worth have remained virtually stagnant since 1979, but the median size of a newly constructed house has increased by more than 25 per cent in that period – from 147 sq m in 1980 to 186 sq m in 2001.

The average household spends far more on housing now than it used to just 30 years ago, although its income has not grown. And it is not only houses, but also cars and clothes, entertainment and food, haircuts and what not.

Why should this be so?

According to Cornell University economics professor Robert Frank, it is because concentrations of wealth at the very top have set off ‘expenditure cascades’ among the middle class. In a brilliant recent book entitled Falling Behind: How Rising Inequality Harms The Middle Class, Prof Frank argues: ‘As incomes continue to grow at the top and stagnate elsewhere, we will see even more of our national income devoted to luxury goods, the main effect of which will be to raise the bar that defines what counts as luxury.’

The average American will work harder, spend and borrow more and save less, just so as to keep up with the few Joneses who keep getting richer. He will be doubly impoverished – by income inequality in the first instance, and by the ‘expenditure cascade’ that inequality instigates in the second.

He will shed new economic light on the Biblical insight: ‘For he that hath, to him shall be given: and he that hath not, from him shall be taken even that which he hath.’

Prof Frank’s argument is simple. Income inequality has led to a concentration of wealth at the top. The consumption patterns of the wealthy have set an expensive template for the rest of society and shifted the ‘frames of references’ of everyone.

The mere presence of a mansion in an otherwise ordinary neighbourhood shifts perceptions in that neighbourhood as to how large a house should be. ‘Relative deprivation’ – I don’t have what you have – leads to an ‘expenditure arms race focused on positional goods’ – I want what you have.

Mr Gates has a 4,600-sq-m house. In response, his Microsoft co-founder Paul Allen builds a 6,500-sq-m house and, down the line, Mr and Mrs Average scrimp and save to upgrade from a McHouse to a McMansion. Mr Allen can afford to keep up with Mr Gates; Mr and Mrs Average cannot keep up with Mr and Mrs Above-Average, let alone Mr and Mrs Gates. They assume large mortgages, they work harder and longer hours to afford their ‘positional goods’, they do not spend enough on their children’s education, they do not save enough for their retirement. The end result is relative welfare loss all round.

Income inequality has ‘imposed not only important psychological costs on middle-income families but also a variety of more tangible economic costs’, writes Prof Frank.

His solution to this problem is unlikely to be adopted in the US, given the political gridlock in Washington, but it is worth considering – a ‘progressive consumption tax’. Not a steeply progressive income tax, not a soak-the-rich

hiking of the top marginal income tax rate to 99 per cent, not middle-class welfare – but a progressive consumption tax to render expenditure on certain forms of positional goods ‘less attractive by taxing them’.

How many people in Singapore would object if the GST on S$50 electronic watches was 5 per cent, and the GST on S$50,000 Patek Philippe watches was 50 per cent?

It is not clear if income inequality in Singapore has harmed the middle class to the same extent that it has in the US, but it is likely that some degree of ‘expenditure cascade’ does exist here. Median real wages in Singapore have risen only marginally since 1998. And yet the median household does not seem to be spending less on housing or clothes or entertainment.

Are we sure keeping up with the Joneses has not worsened the effects of income inequality in Singapore?

 

Source: The Straits Times 31 Aug 07

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