In the seemingly endless back-and-forth over income inequality, the debate typically is framed as a moral question: Is it right that most income goes to a small percentage of the population?
Less frequently is the issue framed in economic terms: Is income inequality hindering growth?
A new study by Standard & Poor’s Financial Services LLC tackles this question head-on, asking, “Would the U.S. economy be better off with a narrower income gap?”
The answer, the study’s author concludes, is yes: “The current level of income inequality in the U.S. is dampening GDP growth at a time when the world’s biggest economy is struggling to recover from the Great Recession and the government is in need of funds to support an aging population.”
Some degree of inequality is inevitable. Indeed, it can be the grease that keeps the economy running effectively, providing motivation to those who want to get ahead. But when the gap between rich and poor becomes excessively wide, it can choke growth.
Large income imbalances “dampen social mobility and produce a less-educated workforce that can’t compete in a changing global economy,” the Standard & Poor’s study notes. “This diminishes future income prospects and potential long-term growth.”
In fact, Standard & Poor’s has reduced its 10-year U.S. growth forecast to a 2.5 percent rate from the 2.8 percent rate it expected five years ago. Similarly, the Congressional Budget Office now predicts inflation-adjusted GDP will grow at an average annual rate of 2.3 percent over the next 25 years, versus 3.1 percent from 1970 to 2007.
The Standard & Poor’s study cautions against attempts to close the income gap that could do more harm than good. But its author says some measure of “rebalancing” and investment in areas such as education, health care and infrastructure could make a big difference.
The challenge is national in scope but evident at the local level too: From 2006 to 2011 in the city of Rochester, the mean household income of the poorest quintile dropped 6 percent while income for the top quintile rose more than 12 percent.
How much faster might the local economy grow with less income inequality?
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