The income gap

August 19, 2013, 3:34 PM UTC

President Obama pushing his economic agenda got me thinking about income equality lately. Some basic questions: Is it really true that income disparity in America has increased over the past several decades? If so, why? Is income disparity irrefutably a bad thing? And finally, if we agree that it is bad, how do we fix it?

Let’s start with the first question. Both liberal and conservative economists agree that, yes, income inequality has increased since the 1970s. The Congressional Budget Office October 2011 report “Trends in the Distribution of Household Income Between 1979 and 2007” shows that during that 28-year period overall real average (after-tax) household income grew 62%. But for the top 1% of earners, income grew 275%, and for the bottom 20% of earners, household income grew only 18%. Pretty bald, I’d say.

Why did it happen? The same CBO report suggests that a combination of tax cuts and reduced government transfers (e.g., welfare and financial aid) is partly the cause. Another factor: Over the past several decades the share of Americans’ income coming from capital gains and dividend income has increased, while the relative share coming from labor income has decreased. Some also point to trends like outsourcing, where the owners of businesses make out, but the folks who worked in the factory do not.

Next question: Is a widening income gap a bad thing? Depends on whom you ask. Obama’s former top economic adviser, Alan Krueger, in a speech last year said, “The rise in inequality in the United States over the last three decades has reached the point that inequality in incomes is causing an unhealthy division in opportunities, and is a threat to our economic growth.” Sometimes core GOPers seem to concur. Two years ago Eric Cantor talked about Republicans being best equipped to “take care of income disparities.” But a more typical take comes from Scott Winship, a self-described center-right-leaning fellow in economic studies at the Brookings Institution, who told Fortune recently that income inequality was a “distraction,” adding that “the evidence is weak” that rising inequality is harmful to the poor and middle class. “As many studies find that inequality has no impact on economic growth (or increases it) as find that it hurts growth. Growth of middle-class incomes has slowed since the 1960s in most developed countries, regardless of their inequality levels … and there is no consensus that economic mobility declined over the period that inequality has been rising.”

Sorry, Scott, I’m quite sure that a widening income gap is a negative, though I admit I am short on data. Big income disparities lead to fragmentation of a society, from gated communities with increasing security to, at the extreme, civil unrest and worse. How could they not? Look at history.

So if you are with me so far and believe that income inequality is a problem, how do we solve it? We have to take a hard look at the effective tax rates of our very wealthiest citizens and have the fortitude to change the tax code, especially rates on capital gains. On the other side of the coin, we should increase the minimum wage. The federal minimum wage was last raised in July 2009 to $7.25 an hour (which works out to $15,080 a year). Consider that in 1968 the minimum wage was $1.60, which is $10.74 in 2013 dollars, or $22,339 a year. Wow is right.

As for government transfers, I know there are questions about the efficacy of Head Start, for instance, but it’s hard to believe that sequestration cuts to that program are a benefit to society. And speaking of education programs, when Fortune asked Majority Leader Cantor about addressing income equality, his spokesperson responded that “the biggest impediment to success for children living in poverty is the inability to access a quality education …” Who could disagree?

It’s time to acknowledge that growing income inequality is a trend we need to reverse, and that we need to find ways to make that happen. The super-rich should realize that after decades of outpacing the mean, their income growth will revert to it at some point. How that happens is the biggest question of them all.

Editors Note: I wrote this Editor’s Desk piece with an eye to a online series we are doing about the Two Americas. The first one is here.

Reporter: Catherine Dunn

This story is from the September 2, 2013 issue of Fortune.