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The Incredible Shrinking Middle Class: Where Is America’s Middle Class Really Going?

Jan. 2, 2013
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Pundits have been lamenting the decline of the middle class for generations, and the rhetoric only grows more heated every year.  Yet somehow, as we head into 2013, the middle class remains stubbornly resilient.  Despite generation after generation of wholesale destruction – just ask whatever political party is out of power at the moment – it was still powerful enough in the 2000s to fuel a gargantuan sub-prime mortgage bubble.

Is the middle class hurting as much as they say? Is it shrinking? A lot of it depends on your definition and your point of view. There’s more than a bit of gamesmanship and rhetoric surrounding the question – especially in election years.

America’s Middle Class By the Numbers

Some people lament the decline and fall of the middle class by pointing to a rise in income inequality. They’ve got this data on their side:

  • The share of national income earned by the top 1 percent of earners doubled, from 8 percent in 1979 to 17 percent in 2007, according to the Congressional Budget Office.
  • The top 20 percent of income earners now earns more than the other 80 percent combined. This shouldn’t surprise nearly any sales manager in the country, who know full well that 80 percent of the revenues are generated by 20 percent of the sales reps.
  • But the top fifth’s share of the total national income rose from 43 percent in 1979 to 53 percent in 2007 – and seems to continue to grow.
  • Meanwhile, the bottom 20 percent’s share of national income fell from 7 to 5 percent, during the same period.

On one hand, all these numbers reflect a zero sum game.  However, economies don’t behave that way, according to conservatives and supply-siders. Rather, they argue that a high tide lifts all boats. The actual consumption power of all income quintiles actually rose – buoyed, in part, by the Walmart effect, which allowed incomes at the bottom end of the spectrum to stretch by about 6 percent.

What Does Rising Income Inequality Mean for A Middle Class?

A rise in income inequality, while hardly a desirable policy aim in and of itself, does not necessarily mean anyone else loses. The fiery former British Prime Minister Margaret Thatcher and her labor party opponents in Parliament memorably clashed on this very point in 1990 in this entertaining exchange.

Nevertheless, liberals continue to remind us of the fact that income taxes have less of a redistributive effect on the economy than in years past; this New York Times article states:

“Government policy has become less redistributive since the late 1970s, doing less to reduce the concentration of income. ‘The equalizing effect of federal taxes was smaller’ in 2007 than in 1979, as ‘the composition of federal revenues shifted away from progressive income taxes to less-progressive payroll taxes,’ the budget office said.”

Whether the forcible redistribution of wealth is a legitimate aim of a constitutional republic is left as an exercise for the reader. However, the payroll tax feeds Social Security – which is itself at least mildly redistributive: 85 percent of beneficiaries in the lowest income quintile receive substantially more than they pay in.

So if the tax system is to blame for rising income inequality, it shouldn’t be – and I would posit that any fundamentally sound tax programme should be roughly Gini neutral – with the exception of the disabled and those otherwise basically unable to care for themselves.

But there is no doubt that those we used to consider the middle class – the backbone of the country, however you define it – are under a great deal of financial pressure.

The newly elected Senator from Massachusetts, former Harvard Professor Elizabeth Warren, put her finger on the pulse of the pressure nearly a decade ago with her book, The Two Income Trap: Why Middle Class Parents Are Going Broke.

The nub: Traditional nuclear families with two-income parents were flocking to favorable school districts – and bidding up the price of three-bedroom houses in these areas to levels where only a two-income family could afford them. As a result, most of a 2nd income went to housing expenses, together with increased food, wardrobe and transportation costs associated with running a home with two careers and two cars.

Specifically, Warren shows that the two income family has 75 percent more income than their forebears a generation ago – but has 25 percent less disposable income than before.

This group was particularly hard hit by the foreclosure crisis: Because their mortgages were underwritten assuming the two combined incomes would continue, a layoff of one spouse caused the whole house of cards to collapse.

These families are earning more – but can invest almost none of the excess for future consumption.

Changing Family Financial Trends Create a Squeezed Middle Class

Meanwhile, a parallel dynamic is taking a sledgehammer to middle class financial kneecaps: Divorce.

The massive disruption of a divorce cannot be overestimated. Women must sacrifice careers to raise children alone after divorce… and transaction costs are huge. It’s not just the cost of attorneys’ fees – it’s the difference in cost between running one household and running two. Rent or mortgage costs and utilities, for example, are nearly doubled.

A 2012 study from the Marriage and Religion Research Institute finds that divorce robs American families of a fourth of the head of household’s productivity growth.

That’s money that should go to savings and investment. To college funding, debt payoff, homes, annuities, life insurance and health care. To help middle class families build a foundation for future wealth generation. Instead, it is going to point-blank subsistence.

Yes, marriage rates are down, which helps take the edge off of divorce rates per capita, for all the wrong reasons. This sidesteps the trauma of divorce, yes. But the economic consequences are still there – couples that should become economic units are not – they maintain separate households, or if they live together, frequently maintain separate accounts. Assets that should go to investment and wealth-building go to consumption.

Total outstanding student loan debt, meanwhile, now tops $1 trillion – and is not dischargeable in bankruptcy, like other forms of debt. This is distorting the economy in a myriad of ways, forcing students to take risk-adverse low-wage jobs rather than start businesses that may fail, causing them to put off marriage, family and home purchases – and thereby depressing demand for single-family homes.

Meanwhile, the vital third leg of the three-legged stool of retirement security, the defined benefit pension, is going the way of the smokestack industry: largely extinct.  They survive and thrive only for public employees, who must collect their benefit at the expense of the private sector working to support them. The rest of us, meanwhile, must make do with defined contribution plans such as 401(k)s. This is essentially a deferred compensation arrangement. But it is the worker who must fund them, rather than the company.

The Middle Class: Past, Present, and Future

The middle class worker has made gains in the last generation, yes. But much of these gains have to be diverted into retirement savings to replace the security they lost with the demise of the traditional pension. The upper middle class is in a position to handle it – to an extent (DALBAR demonstrates every year that retail investors only realize a fraction of the market returns that professional money managers who manage pension funds can get on behalf of their plan beneficiaries, however).  The lower middle class, however, cannot make the contributions… and the damage, for these families, is permanent.

These and other demographic factors are putting the squeeze on traditional middle class families, and unfortunately they aren’t likely to go anywhere in 2013.