How the 1 Percent’s Savings Buried the Middle Class in Debt

Say a corporation issues equity to the wealthy, but instead of spending the proceeds on research or equipment, puts that money into a time deposit at a bank, which in turn uses it to fund a mortgage for a less-affluent household. This is how the rich become lenders, Sufi says. Because they are the most likely to own shares in public companies that may have their excess cash in banks, their money can indirectly fund mortgages and other consumer debt products, including auto loans.

The debt loads that nonrich households carry may rise as a result. Many people today are, as in previous generations, saving money through their homes, and a mortgage payment can be considered “forced savings,” as a percentage of it goes toward the principal of the loan. But consumers are collectively accumulating the same amount of real estate overall, or slightly less, while also taking on more debt—in the form of larger mortgages as a fraction of their house value, or cash-out refinancing and home-equity loans.

Some politicians, economists, and pundits say that people are borrowing (and consuming) irresponsibly. But banks with all that cash on hand work to expand the credit market and realize returns on the savings glut of the rich. “The bottom 90 percent are being convinced to borrow more and more, through lower interest rates, easier credit, and more advertising,” Sufi says.

From the 1980s through 2007, the net amount of household debt that the top 1 percent held as a financial asset rose by 15 percentage points of national income, while at the same time the amount of household debt that the bottom 90 percent owed as a liability rose by 40 percentage points. The so-called accumulated dissavings of the bottom 90 percent from 1983 to 2015, relative to the average level from 1973 to 1982, was over twice the national income, the researchers say.

The debt trap

Households on this trajectory can get stuck in debt, and so can entire economies, argue Mian, Straub, and Sufi. As the savings of the rich go toward the borrowing of the nonrich, there may be a GDP boost in the short run, as it does encourage consumption. But the debt becomes a drag on future demand, the researchers say.

To understand why, consider households in the bottom 90 percent that are repaying debt. People in these indebted households, usually poor or middle class, may spend less on other goods and services as they make their loan payments. A family repaying a home equity loan, for example, may have less money to spend on new clothes, vacations, or cable television. On a macro level, the decline in spending by people weighed down by debt will trim companies’ revenues and profitability, which could in turn affect the employees at those companies.

“During times when aggregate spending is weak already, this means more workers might lose their jobs, or not get that next promotion,” Straub says.

He makes a distinction between this kind of debt and its productive cousin. “Building a new road might also be debt financed, but because it increases productive capacity going forward, it typically also creates jobs, offsetting the negative externality,” he says. “So we are not arguing that it’s bad if people buy houses—just that unproductive lending has an externality that needs to be corrected.”

The cycle of unproductive debt makes it hard for consumer demand to support full employment in the economy, and it ultimately forces central banks to lower interest rates, argue Mian, Straub, and Sufi. While lower rates may strengthen demand for a time, consistently low rates may be problematic, particularly in a crisis, as they leave the Fed little room to move the benchmark rate to boost demand.

Persistent low demand can foster a high-debt liquidity trap—or debt trap—in which economies are stuck in long periods of sluggish growth, according to the researchers. The US, Japan, and the eurozone provide examples of depressed economic growth after interest rates hit bottom (or even went negative).

The COVID-19 effect

Do the theories that Mian, Straub, and Sufi lay out in research explain recent events? Anyone paying attention to monetary policy in the past decade has seen central banks trying to lift economies creatively, unable to cut interest rates further. When the pandemic spread around the globe in 2020, the US Fed could cut the policy rate by only 1.5 percentage points before effectively hitting zero. While the Fed can and does make other monetary-policy moves, such as large asset purchases, in times of crisis, rate cuts are a key part of the strategy to boost consumer demand.

In a September 2020 speech, Fed governor Lael Brainard warned of a “downward spiral” of elevated unemployment, muted inflation, and slow economic growth amid a reduced opportunity to further cut rates. Former New York Fed president William C. Dudley concurred at a summit in October, noting that “if the Fed did more, what would be the effect on the economic trajectory? It would be very, very modest.”

Several research projects are establishing that poorer households have been disproportionately affected by the COVID-19 recession, while wealthier households have spent less and been able to save. Both spending and saving initially rebounded faster for lower-income households during the pandemic in spring 2020, and some were even able to pay off debt. However, Sufi notes that the decline in household debt and the rise in savings in the middle and lower part of the income distribution can be attributed at least in part to massive government stimulus measures, and are likely temporary. Indeed, in August, the rise in saving by people who received unemployment checks began to reverse, according to research by University of Chicago Harris School’s Peter Ganong; JP Morgan Chase’s Fiona Greig, Max Liebeskind, and Daniel M. Sullivan; and Booth’s Pascal Noel and Joseph S. Vavra.

Meanwhile, people at the very top of the wealth distribution have grown richer through the pandemic, thanks in part to a poststimulus stock market surge. A March 2021 report by Americans for Tax Fairness and the Institute for Policy Studies finds that the collective wealth of America’s billionaires shot up by $1.3 trillion since the start of the pandemic, to a total of about $4.2 trillion. At the same time, more than one in four families with children are experiencing food insecurity, according to estimates from Northwestern’s Diane Schanzenbach. Mian, Straub, and Sufi see in the data a widening wealth gap and more saving by the rich, thus more money being turned into loans and lent out to consumers.

Is tax reform the answer?

To the researchers, the savings glut is a result of rising inequality, yet they also suggest that policy actions could encourage the rich to put their money toward more productive uses. Their proposed solutions involve taxation—either a more progressive tax system or a wealth tax—through which the government can finance spending and investment, or redistribution programs that benefit lower-income households.

Such suggestions are controversial. Among the critics, Booth’s Steve Kaplan argues that proposals such as a wealth tax seek to emulate what has already been tried and proven ineffective in Western Europe. As of 1990, there were 12 countries in Europe taxing net wealth, but now that is down to Norway, Spain, and Switzerland. When France did away with its version in 2018, the prime minister said it had caused many millionaires to flee.

Kaplan also notes that income inequality had actually been decreasing in the US in recent years, as the fortunes of the lower 90 percent improved. He points to the Gini index, which measures income inequality on a scale from 0 to 1 percent. From 2017 to 2019, the US Gini index fell 0.005 percentage points, from 0.489 to 0.484 percent, while the share of income held by the top 20 percent fell by 0.4 percent. Meanwhile, median household income rose to a record $68,700 in 2019, driven by an increase in the number of workers, particularly women.

“If you go back to December 2019, the economy was strong and the inequality data were improving while the country was following tax policies the opposite of what they [Mian, Straub, and Sufi] are recommending,” Kaplan says, although he acknowledges that the trajectory has “likely been upended by the pandemic.”

Implementing some of the more progressive tax policies, however, is “only likely to make things worse,” he says.

Data from the Fed’s Survey of Consumer Finances also indicate that between 2016 and 2019 both wealth and income inequality fell modestly. However, Sufi and others focus on the longer trajectory. The rate of inequality may have slowed or even fallen prior to the pandemic for some groups, but inequality remains at historically high levels, and economists are debating what the “right” level of inequality should be and how to achieve it.

“Any decline in inequality from 2017 to 2019 was tiny compared with the rise in inequality since the 1980s, and the COVID-19 crisis will almost assuredly amplify inequality going forward,” says Sufi. “Policies tried in the US to stem the rise in inequality have not worked.”

Research by Booth’s Eric Zwick and Princeton’s Owen Zidar suggests that reforms such as rolling back special deductions for pass-through businesses, which they say collectively generate more taxable income for the top 1 percent than do big C corporations, could be a key part of a tax plan that raises up to $5 trillion over the first decade of implementation. Pass-through businesses typically include medical and law practices and other types of consultancies.

When it comes to the billionaire class, a better-designed corporate income tax may be more effective than a wealth tax, Zwick says. A corporate tax that does a better job of aligning the rates on foreign versus domestic income, as the current system gives large companies many incentives to move income offshore, could also be part of the solution, he says.

Billionaires are “not a huge share of wealth—perhaps 3–5 percent of household wealth in the US,” Zwick says. “And if you look at them individually, their investments are incredibly concentrated. They’re invested in their companies. If you’re taxing Amazon, you’re taxing Jeff Bezos.”

Mian says the most important thing regarding policy is to have the end goal be a healthy economic balance. “We need both investments and a competitive landscape that makes the economy work for everyone so the economic output is more inclusively distributed,” he says.

This may be especially the case as the wealthiest in the US continue to grow their financial portfolios during a health and financial crisis that has intensified the gap between the 1 percent and the bottom 90 percent. If Mian, Straub, and Sufi are correct, as the savings of the rich grow, so do their investments in unproductive debt. This leads to more household debt and less household savings, and a savings gap that grows ever larger.