Report: How the Wealth Gap is Damaging the U.S. Economy

By: CBS MoneyWatch
By: CBS MoneyWatch
S&P warns that America is nearing an extreme level of inequality that will hurt long-term economic growth.

CBS / AP

Aug. 5, 2014

CBS MoneyWatch - What's so bad about the rich getting richer?

Plenty, according to ratings agency Standard & Poor's. While the issue has been debated for decades, the actual income gap in the U.S. has been worsening and now is approaching an "extreme" threshold that threatens to hamper long-term economic growth, the agency said in a report on Monday.

Already, the huge gap between the haves and have-nots is crimping the U.S. economy, with the agency cutting its 10-year U.S. growth forecast to 2.5 percent, down from its forecast of 2.8 percent five years ago. The wealth gap undermines economic growth by dampening social mobility and creating a less-educated workforce unable to compete in the global economy.

"Higher levels of income inequality increase political pressures, discouraging trade, investment, and hiring," the report notes. "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."

Figuring out a way to narrow the income gap would help the economy, although policy makers need to "avoid policies and practices that are either too heavy handed or foster an unchecked widening of the wealth gap," the agency writes.

Helping Americans gain more education, such as college degrees, could help narrow the gap and expand the economy, given that wages of college grads are double that of high school grads, S&P notes. While raising the minimum wage would lift 900,000 above the poverty line, it also carries a tradeoff, such as the potential for some job losses, the report added.

Income inequality has become a hot-topic button this year, thanks in part to the best-selling economics doorstopper "Capital in the Twenty-First Century" by economist Thomas Piketty. His thesis is that the rate of return on capital, such as stocks or real estate, outpaces that of economic growth. The result is that the wealthiest grasp a growing share of wealth, leading to increasing inequality.

In the U.S, that gap has reached "spectacular" heights, Piketty told CBS MoneyWatch earlier this year.

And the rich might actually be wealthier than previously thought. A recent working paper from a European Central Bank senior economist estimates that America's top 1 percent control between 35 percent to 37 percent of wealth, rather than the 30 percent than had previously been estimated.

Aside from dampening economic growth, wealth inequality also leads to boom/bust cycles, S&P noted. That's because the less affluent will borrow more to keep with the Joneses, a phenomenon seen before the housing crisis. Many Americans not only took out more debt to buy homes, but they also borrowed against their new homes' equity, despite slow income growth.

The key to getting America back on a path to more sustainable growth is boosting the purchasing power of the middle class and drawing people out of poverty, S&P wrote.

The analysis added, "A rising tide lifts all boats...but a lifeboat carrying a few, surrounded by many treading water, risks capsizing."


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