Inequality and Civil Society

James K. Galbraith

Is this improvement in the circumstances of the lower ranks of the people to be regarded as an advantage or an inconveniency? The answer seems at first sight abundantly plain. Servants, labourers and workmen of different kinds, make up the far greater part of every political society. But what improves the circumstances of the greater part can never be regarded as an inconveniency to the whole.

--- Adam Smith, Inquiry into the Nature and Causes of the Wealth of Nations, 1776, Book I, Chapter VII.

Rising inequality is the most dangerous social trend of our time. And yet the most visible signs of this trend have emerged, not on the factory floor, not in strikes as one might possibly expect, but in politics. It surfaces in bitter discussions of budgets, welfare and entitlement programs. And it has generally consisted of attacks by the rich on the poor and not by the poor on the rich.

A high degree of inequality causes the comfortable to disavow the needy. It increases the social and the psychological distance separating the haves from the have-nots. This makes it easier to imagine that defects of character or differences of culture, rather than an unpleasant turn in the larger schemes of economic history, are at the root of the separation. It is leading, as I argue in Created Unequal, toward the transformation of the United States from a middle-class democracy into something that more closely resembles an authoritarian quasi-democracy, with an overclass, an underclass, and a hidden politics driven by money.

To put the matter the other way around, economic equality blurs the distinctions between persons. It makes people feel similar to other people. In this way, equality casts a "veil of ignorance" over the comparative future of individual fortunes. As we know from the philosopher John Rawls, this ignorance, rather than equality itself, is the key to fairness in social choice. A just society, providing for the less fortunate in an equable way, is one that people would freely choose for themselves, without knowledge of their own position within it.

Inequality lifts the veil. Inequality is information; it is knowledge. With high inequality, of income and of wealth, it becomes easy to know whether one is likely in the long run to be a net gainer, or a net loser, from public programs of family assistance, pension security and health care. The more inequality there is in the present, the more definite is each person’s sense of their own position, both in the present and for the future. The rich feel more secure, the poor feel less hopeful. High inequality therefore weakens the willingness to share, at the same time that it concentrates resources in hands least inclined to be willing. In this way, and for this reason, inequality threatens the ability of society as a whole to provide for the weak, the ill and the old.

The rise in inequality is in this way the cause of our dreadful political condition. It is the cause of the bitter and unending struggle over the Transfer State, of the ugly battles over welfare, affirmative action, health care, social security, and the even more ugly preoccupation in some circles with the alleged relationship between race, intelligence and earnings. The "end of welfare as we knew it," to take a recent and, in my view, savage example, became possible only as rising inequality insured that those who ended welfare did not know it, that they were detached from the life experiences of those on the receiving end.

Crisis is a misused word, particularly by alarmists who have presented us in recent years with a budget crisis, a Medicare crisis and a Social Security crisis. None of those alleged crises really are. They all rest on specious claims about financial abstractions, on scare stories about bankruptcies that will not happen and public misunderstandings of the nature of public finance. They all serve the same underlying purpose, which is to legitimize the reduction of social welfare, to withdraw resources from the social to the private realm. And they all enjoy support from the same social quarter, namely the financial and commercial interests of the wealthy. The real crisis is the underlying attack on the elderly, the poor, and the ill, and the tragic willingness of many working people to join it.

The political position of the wealthy in these matters is easily understood. Safe in their gated suburbs, they do not wish to pay for urban police. With their children in private schools, they prefer low education taxes. They cannot imagine being reduced to Medicaid. With their own accumulations and pension plans, they have little interest in Social Security, apart perhaps from Medicare. And though in many cases the truly wealthy do not really work, they take a severe view of anyone who pursues leisure without independent means.

The reason working people sometimes join the attack also deserves a word. It is not that they are nasty, mean-spirited, ignorant, brutish. Rather, their position is a rational response to the situation into which they are placed. For rising inequality on one side increases the numbers and burden of the poor at the same time as it segregates the poor from the middle. And the social withdrawal of the wealthy on the other removes the major sources of funding for redistributive transfers, shifting a larger share of this higher burden onto to the middle. The middle groups in effect have little choice but to join in the attack on the poor.

We have, therefore a three-stage process: the rise in inequality itself, which increases the burden on the welfare state, the revolt of the rich, and the consequent uprising of the middle. It is a very general dynamic, and explains many features of our tax law, our benefits structures, and of our recent political history. Consider the cap on social security payroll taxation, the lower rate on capital gains, the continuing press to exempt savings from income taxes through IRAs and other devices. Though often couched in the rhetoric of economic incentives, the evidence that these measures have anything to do with saving or investment is essentially imaginary. The real reason for such breaks is far simpler: the lobbying power of the well-to-do.

Once the rich have insulated themselves, the middle is ripe for rebellion against the burdens of supporting the poor. The rebellion is rarely spontaneous; it is generally stoked by well-financed propaganda that now takes a fairly standard form. First, the beneficiaries, who are for the most part decent and hardworking people, are stereotyped and demonized, rendered as "other", presumed to be "trapped" in a "spider’s web of dependency." The program is declared a failure, so loudly and persistently that those who are inclined to argue otherwise simply recede from public view. It is not necessary to cite cases or names here; the story is completely familiar even to the most casual observers of the American political scene.

And then a drive begins, first to weaken the program politically, and then, when political interference duly creates insuperable problems, to abolish it altogether. Public housing suffered this fate in the early 1980s. Welfare went away in 1996. Today, the targets of the incendiary right are public schools, institutions that still enjoy wide support, which vouchers are intended to undermine, and Social Security, whose current base and even greater popularity would suffer from schemes for partial privatization. Whether these campaigns succeed entirely in the long run remains to be seen, but they have unquestionably gained major ground in recent years.

I lay out this sequence, not to attack or criticize any particular political tendency, but to make a fundamental point about the relationship between inequality and civil society. Rising inequality strengthens rabidly anti-communitarian forces in political life. It is a precondition for their success. I believe, moreover, that the most serious anti-communitarians, the most dedicated individualists, understand this. To that extent, they tend to favor and support policies of macroeconomic disruption, which produce rising inequality. And they have aligned themselves with tendentious economic doctrines, such as Milton Friedman’s natural rate of unemployment, that until recently obstructed progress toward full employment and the reduction of economic inequalities.

By the very same token, the sustained reduction of economic inequality is utterly necessary, as a precondition, if progress toward broader and more broadly supported communitarian policies is to be possible. Traditional liberal economists have argued that markets should be left alone to allocate incomes -- wages and prices -- as they see fit, and that governments should restrict themselves to post factum redistributions -- income and wealth taxation and social security schemes -- to reduce the inequities of the market. My argument demonstrates, I believe, that this is political untenable. High inequality obstructs the progressive taxation and redistributions that would make right what the market does wrong; the only solution therefore is to go to the root of the difficulty and insist on more equal market outcomes.

Amitai Etzioni writes of "encapsulated competition." The regulation of the shape of the income distribution is -- by far -- the most important sphere in which encapsulation is required. And it is an entirely legitimate object of normal political activity. Income and wealth distributions do not simply happen. They are entirely created, by structures of public policy. They should be chosen carefully, with a view to the social consequences of each choice.

The great example of created equality occurs during World War Two. I mention this with some family pride, for my father was in charge of prices and wages in those years and took deliberate action to promote equalization -- such as capping all wages save those at the bottom -- actions that succeeded brilliantly and that helped produce the middle class society that emerged from the war. The critical point is that though the postwar wage and incomes structure was entirely artificial, it endured a full quarter century, until about 1970. And it generated the longest sustained period of prosperity and social improvement in national history, a time of economic progress that led inexorably to civil rights, women’s rights, and other major improvements.

One may doubt, very legitimately, that any peacetime economic expansion can replicate the rapid accomplishment of the war years. But Lyndon Johnson’s Great Society also reduced inequalities quite substantially, within living memory. And even the weak expansion of the 1990s is beginning, if only just beginning, to chip away at earnings inequality as unemployment rates fall toward four percent. The difficulties of economic policy lie in finding ways to keep the expansion going long enough to make a difference -- say for another ten years -- in the face of financial instability and external turmoil. The difficulties of a corresponding politics lie in finding ways to accelerate an improvement in the equality of wage and pay structures and in locking in communitarian policies while the support for them permits.

What then can be done? First, raise the minimum wage, and index it to the average wage. The minimum wage has an important effect particularly on female, part-time and contingent workers. Indexing it to the average wage -- and not to the price level -- would assure that in the future workers at the bottom of the pay structure enjoy at least the average rate of real wage growth. It is probably the single most important guarantee of future social stability one might plausibly achieve in the next year or so.

Second, I would index all other social benefits: Social Security, federal civil and military pensions, and benefits not currently indexed, such as food stamps, to the average wage rather than to the price level. Again, the purpose and the effect would be to improve social solidarity. Presently a rise in the cost of living that is not generated by rising wages -- say an oil shock -- is entirely offset for retirees, and absorbed by working people. This could be justified in 1973, when most retirees are poor but working people generally were not (the minimum wage back in 1969 was over $6.50 per hour in current terms). But in 1999 the poverty rate among the elderly has fallen to ten percent, below that of the population on average. What is required is not to erode the gains of the elderly, but to make sure that no segment of the population makes capricious gains, or suffers capricious losses, as the result of circumstances.

Third, one must strengthen, not weaken, the core protections of Social Security for those who will be elderly twenty and thirty years from now. A funded supplementary scheme, though in economic terms undeniably a gimmick, is not a bad idea so long as both contributions and returns are managed so as to be equal across persons. But the crucial thing is to protect the system that we have. There is no case for creating "private" savings accounts under public auspices -- one might as well, if that is the objective, simply hand out cash to taxpayers.

Fourth, if tax reform is contemplated, then folding the payroll tax and perhaps the corporate income tax into a single progressive income tax, without savings deductions and other loopholes, is the most reasonable way forward. Proposals to move to value-added or consumption taxation are the most radically anti-communitarian tax ideas presently in circulation, for they would essentially bifurcate the population into the taxed and the untaxed, those who have means vastly above their outlays and those who do not. Once again, the economic arguments for these self-serving schemes lack substantiality and need not detain us.

One might menton many other economic ideas, but I will restrict myself to one: low and stable interest rates. It is a favorite proposition of Galbraith pere that those who have money to lend have more money, as a rule, than those who do not have money to lend. Rising interest rates in the early 1980s redistributed income and wealth with exceptional ferocity, through many mechanisms, from the middle classes to the rich. Low interest rates slowly erode the bondholder’s excessive holdings, and slowly strengthen the equity of the homeowner, backbone of a communitarian social class. Everything can and should be done to lock down a long-term regime of low and stable interest rates, including the creation of additional safeguards against rising inflation so that the Federal Reserve is removed from its role as first line of defense against that economic problem.

Let me end on a word of caution. Those who favor embarking on the large task of reducing inequality will need to accept, and acknowledge, a measure of discipline. Solidarity means, by its nature, self-restraint. If we wish to move to a new and more balanced equilibrium in the distribution of income and wealth, if we wish to restore the predominance of the middle class, we have to accept, as a nation and as individuals, that certain prizes will be unavailable, certain opportunities foregone. We will have to accept a certain social discipline on our individual chances, to better increase the prospects of rising as a group. We shall have, also, to recognize the irreversible interdependence of nations within our trading region, and act to stabilize growth and equality not only inside the United States, but across international frontiers. We shall have, in other words, to sober up and act responsibly. This, and not the alleged trade-off between equality and efficiency, is the true sacrifice that a more equal society requires.

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James K. Galbraith is Professor at the LBJ School of Public Affairs and Senior Scholar of the Levy Institute. His book is Created Unequal: The Crisis in American Pay.