Restoring The American Dream

David Leonhardt of the New York Times has an opinion today about the research of a team of economists led by Raj Chetty to create an index of the American dream. The American Dream, Quantified at Last.

But first, Raj Chetty and his team of researchers write at The Hill, The fading American Dream:

One of the defining features of the “American Dream” is the ideal that children have a higher standard of living than their parents. But we know less than we should about whether we are living up to that dream.

Using data from historical Censuses, we estimate rates of “absolute income mobility” — the fraction of children who earn more than their parents — since 1940. We measure absolute mobility by comparing children’s household incomes at age 30 (adjusted for inflation using the Consumer Price Index) with their parents’ household incomes around age 30 (go here for a summary and here for the study).

The results are stark: We find that rates of absolute mobility have fallen from approximately 90 percent for children born in 1940 to 50 percent for children born in the 1980s. Absolute income mobility has fallen across the entire income distribution, with the largest declines for families in the middle class.

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These trends are unaffected by using alternative price indices to adjust for inflation, accounting for taxes and transfers, measuring income at later ages, and adjusting for changes in household size.

The same trend has played out across the country. Absolute mobility fell in all 50 states, although the rate of decline varied, with the largest declines concentrated in states in the industrial Midwest, such as Michigan and Illinois. The decline in absolute mobility is especially steep — from 95 percent for children born in 1940 to 41 percent for children born in 1984 — when we compare the sons’ earnings to their fathers’ earnings.

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Why have rates of upward income mobility fallen so sharply over the past half century? The key factors here are (1) the declining Gross Domestic Product (GDP) growth rates, and (2) the rising inequality in the distribution of growth.

Although both factors are important, we find that most of the decline in absolute mobility is driven by the more unequal distribution of economic growth rather than the slowdown in aggregate growth rates.

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When we simulate an economy that restores GDP growth to the levels experienced in the 1940s and 1950s, but distributes that growth across income groups as it is distributed today, absolute mobility increases to approximately 62 percent. In contrast, maintaining GDP at its current level but distributing it more evenly across income groups — at it was distributed for children born in the 1940s — increases absolute mobility to 80 percent, thereby reversing more than two-thirds of the decline.

These findings show that higher growth rates alone are insufficient to restore absolute mobility to the levels experienced in mid-century America. Under the current distribution of GDP, we would need real GDP growth rates above 6 percent per year to return to rates of absolute mobility in the 1940s.

Intuitively, because a large fraction of GDP goes to a small fraction of high-income households today, higher GDP growth does not substantially increase the number of children who earn more than their parents.

Of course, we still need GDP growth. It does not matter how growth is distributed if there is very little growth to be distributed. The main point is that increasing absolute mobility substantially would require more broad-based economic growth. If one wants to revive the “American Dream” of high rates of absolute mobility, one must have an interest in growth that is shared across the income distribution.

David Leonhardt extrapolates from this research, The American Dream, Quantified at Last:

The index is deeply alarming. It’s a portrait of an economy that disappoints a huge number of people who have heard that they live in a country where life gets better, only to experience something quite different.

Their frustration helps explain not only this year’s disturbing presidential campaign but also Americans’ growing distrust of nearly every major societal institution, including the federal government, corporate America, labor unions, the news media and organized religion.

Yet the data also helps point the way to some promising solutions.

It begins with children who were born in 1940, less than a decade after the publication of Adams’s book, “The Epic of America.” The researchers went into the project assuming that most of these children had earned more than their parents — but were surprised to learn that nearly all of them had, said David Grusky, one of the researchers, also of Stanford. About 92 percent of 1940 babies had higher pretax inflation-adjusted household earnings at age 30 than their parents had at the same age. (The results were similar at older ages and for post-tax earnings.)

The few 1940 children who earned less than their parents were also, for the most part, doing just fine. They were generally earning less because they had grown up rich — children of top corporate executives, say, who became, or married, doctors, lawyers or professors.

Achieving the American dream was a virtual guarantee for this generation, regardless of whether people went to college, got divorced or suffered a layoff. Why? Because they spent their prime working years in an economy with two wonderful features. It was growing rapidly, and the bounty from its growth flowed to the rich, the middle class and the poor alike.

Not even the oldest baby boomers, born in the late 1940s and early 1950s, would be quite so lucky. Economic growth began to slow as they were entering the job market in the 1970s, thanks in part to the energy crises. Still, more than three-quarters of these early Baby Boomers would ultimately make more than their parents.

* * *

In the 1980s, economic inequality began to rise, a result of globalization, technological change, government policies favoring the well-off and a slowdown in educational attainment and the work force’s skill level. Together, these forces pinched the incomes of the middle class and the poor. The tech boom of the 1990s helped — slowing the decline of the American dream — but only temporarily.

For babies born in 1980 — today’s 36-year-olds — the index of the American dream has fallen to 50 percent: Only half of them make as much money as their parents did. In the industrial Midwestern states that effectively elected Donald Trump, the share was once higher than the national average. Now, it is a few percentage points lower. There, going backward is the norm.

Psychology research has shown that people’s happiness is heavily influenced by their relative station in life. And it’s hard to imagine a more salient comparison than to a person’s own parents, particularly at this time of year, when families gather for rituals that have been repeated for decades. “You’re going home for the holidays and you compare your standard of living to your parents,” Grusky, a sociologist, says. “It’s one of the few ties you have over the course of your entire life. Friends come and go. Parents are a constant.”

How, then, can the country revive Adams’s dream of a “better and richer and fuller” life for everyone? The solution has to involve some combination of faster economic growth and more widely shared growth.

The bad news is that lifting G.D.P. growth is terribly difficult. Trump has promised to do so, but offered few specifics. If anything, he favors some of the same policies (deregulation and tax cuts) that have failed in recent decades.

The better news — potentially — is that lifting growth is the less important half of the equation, notes Nathaniel Hendren of Harvard, another of the researchers: The rise of inequality has damaged the American dream more than the growth slowdown.

One way to think about inequality’s role is to remember that the American economy is far larger and more productive than in 1980, even if it isn’t growing as rapidly. Per-capita G.D.P. is almost twice as high now. By itself, that increase should allow most children to live better than their parents.

They don’t, however, because the fruits of growth have gone disproportionately to the affluent.

The researchers ran a clever simulation recreating the last several decades with the same G.D.P. growth but without the post-1970 rise in inequality. When they did, the share of 1980 babies who grew up to out-earn their parents jumped to 80 percent, from 50 percent. The rise was considerably smaller (to 62 percent) in the simulation that kept inequality constant but imagined that growth returned to its old, faster path.

“We need to have more equal growth if we want to revive the American dream,” Chetty says.

Given today’s high-tech, globalized economy, the single best step would be to help more middle- and low-income children acquire the skills that lead to good-paying jobs. Notably, most college graduates still earn more than their parents did, other data show — yes, even after taking into account student debt.

But education is not the only answer. Incomes have also stagnated because of the rise of corporate power and the weakening of labor unions, leading profits to rise at the expense of wages. The decline of two-parent families plays a role, too. And tax policy has not done enough to push back against these forces: The middle class, not the affluent, deserves a tax cut.

The painful irony of 2016 is that nostalgia and anger over the fading American dream helped elect a president who may put the dream even further out of reach for many people — taking away their health insurance, supporting ineffective school vouchers and showering government largess on the rich. Every one of those issues will be worth a fight.

If the American dream could survive the Depression, and then thrive in a way few people imagined, it can survive our current troubles.

This requires rejecting “Reaganomics,” the trickle-down fantasy that has driven government policy since 1981. Donald Trump and the Tea-Publicans show no signs of wavering from this false economic religion orthodoxy. And the American public has consistently rewarded the very people who are responsible for undermining the middle class and their upward mobility. Like Pogo surmised, “We have met the enemy and he is us.”

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4 responses to “Restoring The American Dream

  1. John Huppenthal

    Excellent analysis Steve. A few addtional points.

    Income inequality is not linked to lower growth rates. There is a positive interdependence between the wealth accumulation and outcomes for the poor. A family of four in the United States, even if all they have are food stamps, are at the 80th percentile world wide. In other words, they are income rich by world standards. World wide, you see a direct correspondence between incomes of the poor and incomes of the rich – as the rich get rich, the poor get rich. Just look at the census data, our poor have TV’s, refrigerators, air conditioning and never experience hunger things the middle class in most countries can’t even conceive of.

    Look at the gilded era, from 1865 to 1900, when there was no income tax. That was the most astonishing era in human history, from a household income standpoint and a human progress standpoint.

    We have still made progress over the last two decades despite the income tax rate being well above both the revenue maximizing tax rate and the prosperity maximizing tax rate because of untaxed capital gains. The stock market is sitting there working away for us with over 12 trillion dollars of untaxed income. Warren Buffett’s, the Google boys, Zuckerberg haven’t paid a penny on their hundreds of billions of income and never will. That money just sits there working for us.

    So, that money keeps working for us instead of luring more people into the democrats welfare and vote trap.

    I know someone in this trap, a young man with a family of four on AHCCS and foodstamps. He would have to earn $60,000 to equal his welfare income. Looking at his family history, he is fully capable of working up to making a $240,000 per year but he will never start at $60,000 – $40,000 would be his target zone.

    You all and your false compassion have trapped millions of people like this.

    When Gingrich and Clinton reformed welfare in the 90’s, half of all people poured off of welfare and into the job market, the federal budget balanced and incomes grew by a staggering amount.

    The stock market has to be anticipating something similar because it has gone up by well over $2 trillion anticipating the end of the Obama era and that is just listed companies.

    Maybe we will see it all, reduction of tax rates, welfare reform and a reduction of regulation. The stock market says we are about to take off like a rocket ship.

  2. Senator John Kavanagh

    Income inequality does play a role but as incomes rise, it becomes harder for children to best their parents. That is also a factor.

    My high school educated parents sacrificed to get me a good college education, which I boosted to a PhD. That made it easy for me to earn more than my parents but harder for my kids to best me.

    You cannot ignore other factors. Other things are at play besides income inequality. Life is multivariate not bivariate.

  3. “The decline in absolute mobility is especially steep — from 95 percent for children born in 1940 to 41 percent for children born in 1984 — when we compare the sons’ earnings to their fathers’ earnings.”

    It is funny that they didn’t compare daughters’ earnings to their mothers’ earnings. During the time cited, women entered the workforce in HUGE numbers, yet none of the charts shown seem to account for the impact such a doubling of the workforce, not to mention the rapid increase in the population (approximately 120 million in 1940 to 240 million in 1980) had on overall employment and wages. We are also largely a nation of two income households but I don’t see anything addressing how total household income in 1940 compares to total household income in 1980.

    “Economic growth began to slow as they were entering the job market in the 1970s, thanks in part to the energy crises.”

    And in part to the huge influx of women into the workforce. Funny how that doesn’t get mentioned. Too politically incorrect, I guess.

    The culture and the way of life in 1940 compared to the culture and way of life in 1980 is like comparing pancakes to tires. We made many decisions between 1940 to 1980 that had profound impacts on our nation and the economy. There were different outlooks and expectations for America in 1940 that had to change as the culture changed and by 1980 very little remained the same. To expect the “American Dream” to remain unchanged during that transitional period is ridiculous.

    Ignoring the silliness of comparing 1980 to 1940, there is a problem with our economy with wealth collecting at the top. An answer needs to be found but it isn’t by raising taxes to exorbitant rates on the wealthy. When that was tried in the early 1960s, it failed. The wealthy found ways to avoid the 95% tax rate and paid very little and they will do so if the rate is jacked back up. You talk about Reaganomics failing but you want to try raising taxes which is also a failed effort. It isn’t just the GOP that is a one trick pony…the democrats are equally limited in the idea arena.

    • “Ignoring the silliness of comparing 1980 to 1940, there is a problem with our economy with wealth collecting at the top. An answer needs to be found but it isn’t by raising taxes to exorbitant rates on the wealthy. When that was tried in the early 1960s, it failed. The wealthy found ways to avoid the 95% tax rate and paid very little and they will do so if the rate is jacked back up. You talk about Reaganomics failing but you want to try raising taxes which is also a failed effort. It isn’t just the GOP that is a one trick pony…the democrats are equally limited in the idea arena.”

      Income inequality itself isn’t itself a priori problematic. However, high levels of income inequality are generally linked with lower growth rates and worse economic outcomes altogether. A Keynesian such as myself would attribute the bulk of the impact to the fact that the wealthy are less likely to consume that income, and instead, save it either in bank accounts or capital markets, contributing to a glut of liquidity against a limited demand for real investment from the business sector. Those with more libertarian or Austrian bents claim that high amounts of income inequality are problematic insofar as they are caused by an entrenched political class engaging in rent-seeking behavior (campaign contributions, lobbying, etc.) to pull economic surplus toward themselves at the expense of the broader economy. It sure seems like we can agree that there is a problem; whether there’s a good solution is another question.

      One of the things I have long advocated for, both during my run for the legislature, as well as before that point, is working to reduce or eliminate the preferential tax treatment that dividends, capital gains, and other unearned income currently enjoys at the federal level. Because 90% of stock wealth and earnings are currently accruing to the top 10% of Americans by wealth, this is a massive net loss of potential tax revenue, and provides a large loophole for wealthy people to use stock options and similar tools to ‘convert’ their earnings into what is legally capital gain income (and therefore push their effective tax rate far lower than would otherwise be the case); the carried-interest loophole is another such example of the same.

      I would not have any objections to lowering personal income taxes a bit across the board if we could recapture the lost revenue in this manner. And, going against the acceptable orthodoxy among progressives, I am at least willing to consider some level of topline corporate tax rate reductions as long as they are accompanied by closing loopholes totaling an equal or greater amount; there is certainly the problem where entrenched players are using special one-off deals with the government and/or writing narrow exemptions in the tax code via lobbying in order to enrich their shareholders and give themselves an unfair competitive edge over new businesses.

      For a more out-there idea, the Georgist economics school has long been advocating for a tax on land (but not necessarily the real property superimposed upon it), as such taxes are nondistortionary and therefore do not reduce economic efficiency. Again, land ownership is largely concentrated among a fairly small segment of society, and such a tax may help to mitigate inequality, if the excess revenue is wisely allocated or returned to workers in the form of lower taxes on labor or real investment.

      Just a couple of thoughts.