The Rich and the Poor

From growth theory, we have learned that for an entire country, the following factors are important in determining the level of well-being.

  1. The savings rate, which determines the country's ability to accumulate capital

  2. The growth rate of the efficiency of labor, which in turn depends on

For individuals, these same factors affect relative well-being. For example, young people generally tend to be better off than preceding generations, because as society accumulates knowledge, this adds to wealth. Historically, it took hundreds of years for this accumulation of knowledge to have a noticeable effect. Now, you can see the effect within a generation. Even if your parents are in the top half of the wealth distribution and you wind up in the bottom half, you are almost sure to enjoy better health care, better technology products, and a higher standard of living in general.

For over 100 years, from the time of Karl Marx until the latter part of the 20th century, economists looked at capital accumulation as the main factor in economic growth and individual wealth. In Marxist economics, it is capitalists who save and accumulate the economy's capital. They become wealthier and wealthier, while workers stay miserable until they finally get fed up and launch the Communist revolution.

The view that saving leads to wealth is not wrong. However, saving is not the only road to wealth, for a nation or for an individual. In fact, one irony is the fact that most people living under Communist dictatorships are worse off than ordinary workers under capitalism, because Communist dictatorships do not do well at adapting to advances in knowledge.

Marx's jargon of "class struggle" continues to permeate political dialogue. Marx saw the struggle as taking place between the capitalist class of savers and the working class getting by on subsistence wages. Today, people talk about a number of supposed victim classes: women, gays, and ethnic minorities are spoken of using the "class struggle" jargon, even though the original economic basis for Marxist classes--savers vs. workers--does not apply to these victim classes.

In the twentieth century, particularly in the United States, poverty has been receding. Fewer and fewer people face the squalor that was typical 150 years ago, and that is still typical in some regions of the world. Most Americans live well above subsistence levels. In fact, researchers have found that saving takes place among Americans of all income groups (there are also people at all income levels who try to live beyond their means).

Differences in well-being reflect more than just differences in capital accumulation. Two hundred years ago, when the efficiency of labor was growing slowly, inherited wealth and the lack thereof played an important role in determining people's station. With the acceleration in the rate of technological change, your inherited financial capital matters relatively less and your personal earnings power and saving rate matter relatively more.

The growth rate of your personal "efficiency of labor" will be a big factor in determining your place in the distribution of well-being. If you make good use of your education and you adapt to readily take advantage of the technologies that emerge over the next 30 years, you will be rich. If you fail to do so, then you will gradually slip to a lower place in the wealth distribution.

Income, Consumption, Wealth, and Poverty

Statisticians collect three measures of economic well-being.

  1. Income is the amount of money that an individual or a household earns in a year. Income is a flow.

  2. Consumption is the value of goods and services that an individual or a household consumes in a year. Consumption is a flow.

  3. Wealth is the value of the assets of an individual or a household at a point in time. Wealth is a stock.

Economists have issues with using income as a measure of well-being.

Wealth also has some shortcomings as a measure of well-being. Statistical measures of wealth count only financial assets, without taking an individual's earning power into account. A new graduate of medical school may have no wealth (in fact, she could be carrying a large debt on a student loan), but her prospects for future earnings may be bright. In general, younger people have less wealth than what they will be able to accumulate later in their lives.

People seem to make consumption decisions more on the basis of long-term income and wealth than on the basis of current income and wealth. Therefore, it makes sense to focus on consumption as an indicator of how people view their economic circumstances. Using consumption as a measure, economists tend to find that poverty in the United States is shrinking.

For example, W. Michael Cox and Richard Alm, in Myths of Rich & Poor, present information on the ownership of durable goods in 1994 by households whose income was below the official poverty line of around $13,000 per year. On page 15, table 1.2, they compare this to the ownership of those same types of durable goods by all households in 1971.

Percent of Households with:Poor Households, 1994All Households, 1971
Washing Machine71.771.3
Clothes Dryer50.244.5
Color Television92.543.3
One or more cars71.879.5

Looking at the table, it seems reasonable to say that a "poor" household in 1994 was at least as well off as an average household in 1971. This is without taking into account the fact that a majority of poor households have microwave ovens, VCR's, and cable television hookups, none of which were available to the average household in 1971.

Cox and Alm examine a large study of income dynamics undertaken by the University of Michigan. It tracked income of specific households from 1975 through 1991. As Cox and Alm report (p. 73),

Those who started in the bottom 20 percent in 1975 had an inflation-adjusted gain of $27,745 in average income by 1991. Among workers who began in the top fifth, the increase was just $4,354. The rich may have gotten a little richer, but the poor have gotten much richer.

The University of Michigan data suggest that low income is largely a transitory experience for those willing to work...Nearly a quarter of those in the bottom tier in 1975 moved up the next year and never again returned. By contrast, long-term hardship turned out to be rare: Less than 1 percent of the sample remained in the bottom fifth every year from 1975 to 1991.

Cox and Alm argue that if one counts as poor only households that remain below the poverty line for at least two years, then the poverty rate is 4 percent, rather than the 13 percent that was reported at the time. It may be that true poverty among the able-bodied and able-minded (meaning people who are not substance abusers or otherwise incapacitated by mental illness) has been essentially eradicated in this country.

Resenting the Rich

If you compare people at a single point in time in terms of either income or wealth, then disparities stand out. Today, the top-to-bottom ratio of income or wealth is larger than ever. Some economists would downplay this fact, and instead focus on absolute levels of well-being.

However, people seem to care about relative economic standing as well as their absolute standing. For example, Reason's Ronald Bailey cites a fascinating experiment conducted by British economists Daniel John Zizzo and Andrew Oswald. First, the researchers placed subjects in a gambling game. Then, as Bailey reports,

At the conclusion of the gambling sessions, each player was given the chance to spend his own money to anonymously "burn" some of the cash won by his fellow participants. It was made clear that there was no prospect that burning his fellow player’s winnings would in any way make him richer. In fact, if he chose to burn another player’s money, he had to pay between 2 cents and 25 cents for each dollar subtracted from the other player’s take.

Zizzo and Oswald found that nearly two-thirds of players happily paid for the privilege of impoverishing their fellow participants.

This suggests that a political platform of "soak the rich" will have support. In fact, one consequence of the increased dispersion in incomes is that in the United States the income tax is focused on the upper end of the income distribution.

Since the 1960's, the share of income accounted for by the top fifth of households is up somewhat. More important has been the increase in all levels of income. The average real income of people in the second fifth of households today exceeds the average real income of people in the top twenty percent in the 1960's. See the following table, which comes from the census report on income distribution, in dollars of constant purchasing power.

Income Statusmean real income, 1966mean real income, 1999
Top 20 percent$123.7$254.8
Second 20 percent80.5147.8
Middle 20 percent47.272.2
Next 20 percent35.348.9
Bottom 20 percent24.731.0

The combination of a large rise in overall income and a slight increase in the share at the top means that households earning over $100,000 now account for something close to three-fourths of all income. If we think of "rich" in absolute terms ($100,000 per year in household income, adjusted for inflation) rather than in relative terms (the top 20 percent), the "rich" now earn enough income to fund both baseline government functions plus programs to help the poor.

We do not need the middle class to pay taxes any more. In fact, with income taxes, the middle-class taxpayer is on the road to extinction. Data from the U.S. Treasury compiled by Daniel Mitchell for the Heritage Foundation show that the bottom 50 percent of the income distribution accounts for only 4.2 percent of tax revenues, as shown in the follwing table:

Income StatusShare of Total Income Tax Revenues
Top one percent34.8 %
Rest of top ten percent30.2
Rest of top 25 percent17.6
Rest of top 50 percent13.1
Bottom 50 percent4.2

If the distribution of income were static, then these data would suggest that most people are unaffected by tax cuts, because they pay so little in taxes already. However, keep in mind that the distribution of income is fluid, so that people who are in the bottom 50 percent one year may be in the top ten percent the next year.


  1. Individual well-being is affected by the same factors that determine economic growth, including the level of cumulative knowledge when the person is born as well as the person's saving rate, education, and ability to adapt to new technology.

  2. Income in any given year is not a reliable indicator of an individual's wealth or poverty. A large percentage of today's "poor" people own durable goods that are as good or better than those of the average household thirty years ago. Most people with low income one year will do much better in other years. Only about 4 percent of the population has an income below the poverty line for two years or more.

  3. Income disparities, which may lead to resentment, are widening. This shows up clearly in data on Federal tax revenues, where very little is collected from people in the bottom 50 percent of the income distribution in any given year.

"Even though people cannot preserve their children's place in the social hierarchy through bequests of financial assets, it is still possible for a well-off couple to maintain their children's status by giving them an expensive education." Comment.