declining inequality until the mid-1930s or even later: When FDR delivered his second inaugural address in 1937, the one that spoke of one-third of a nation still in poverty, there was little evidence that the rich had any less dominant an economic position than they had had before World War I. But a mere decade later the rich had clearly been demoted: The sharp decline in incomes at the top, which we have documented for the 1950s, had already happened by 1946 or 1947. The relative impoverishment of the economic elite didn’t happen gradually—it happened quite suddenly,
This sudden decline in the fortunes of the wealthy can be explained in large part with just one word: taxes.
Here’s how to think about what happened. In prewar America the sources of high incomes were different from what they are now. Where today’s wealthy receive much of their income from employment (think of CEOs and their stock-option grants), in the twenties matters were simpler: The rich were rich because of the returns on the capital they owned. And since most income from capital went to a small fraction of the population—in 1929, 70 percent of stock dividends went to only 1 percent of Americans—the division of income between the rich and everyone else was largely determined by the division of national income between wages and returns to capital.
So you might think that the sharp fall in the share of the wealthy in American national income must have reflected a big shift in the distribution of income away from capital and toward labor. But it turns out that this didn’t happen. In 1955 labor received 69 percent of the pretax income earned in the corporate sector, versus 31 percent for capital; this was barely different from the 67–33 split in 1929.
But while the division of
In the twenties, taxes had been a minor factor for the rich. The top income tax rate was only 24 percent, and because the inheritence tax on even the largest estates was only 20 percent, wealthy dynasties had little difficulty maintaining themselves. But with the coming of the New Deal, the rich started to face taxes that were not only vastly higher than those of the twenties, but high by today’s standards. The top income tax rate (currently only 35 percent) rose to 63 percent during the first Roosevelt administration, and 79 percent in the second. By the mid- fifties, as the United States faced the expenses of the Cold War, it had risen to 91 percent.
Moreover, these higher personal taxes came on capital income that had been significantly reduced not by a fall in the profits corporations earned but in the profits they were allowed to keep: The average federal tax on corporate profits rose from less than 14 percent in 1929 to more than 45 percent in 1955.
And one more thing: Not only did those who depended on income from capital find much of that income taxed away, they found it increasingly difficult to pass their wealth on to their children. The top estate tax rate rose from 20 percent to 45, then 60, then 70, and finally 77 percent. Partly as a result the ownership of wealth became significantly less concentrated: The richest 0.1 percent of Americans owned more than 20 percent of the nation’s wealth in 1929, but only around 10 percent in the mid-1950s.
So what happened to the rich? Basically the New Deal taxed away much, perhaps most, of their income. No wonder FDR was viewed as a traitor to his class.
While the rich were the biggest victims of the Great Compression, blue-collar workers—above all, industrial workers—were the biggest beneficiaries. The three decades that followed the Great Compression, from the mid- forties to the mid-seventies, were the golden age of manual labor.
In fact, by the end of the 1950s American men with a high school degree but no college were earning about as much, adjusted for inflation, as workers with similar qualifications make today. And their relative status was, of course, much higher: Blue-collar workers with especially good jobs often made as much or more than many college-educated professionals.
Why were times so good for blue-collar workers? To some extent they were helped by the state of the world economy: U.S. manufacturing companies were able to pay high wages in part because they faced little foreign competition. They were also helped by a scarcity of labor created by the severe immigration restrictions imposed by the Immigration Act of 1924.
But if there’s a single reason blue-collar workers did so much better in the fifties than they had in the twenties, it was the rise of unions.
At the end of the twenties, the American union movement was in retreat. Major organizing attempts failed, partly because employers successfully broke strikes, partly because the government consistently came down on the side of employers, arresting union organizers and deporting them if, as was often the case, they were foreign born. Union membership, which had surged during World War I, fell sharply thereafter. By 1930 only a bit more than 10 percent of nonagricultural workers were unionized, a number roughly comparable to the unionized share of private- sector workers today. Union membership continued to decline for the first few years of the depression, reaching a low point in 1933.
But under the New Deal unions surged in both membership and power. Union membership tripled from 1933 to 1938, then nearly doubled again by 1947. At the end of World War II more than a third of nonfarm workers were members of unions—and many others were paid wages that, explicitly or implicitly, were set either to match union wages or to keep workers happy enough to forestall union organizers.
Why did union membership surge? That’s the subject of a serious debate among economists and historians.
One story about the surge in union membership gives most of the credit (or blame, depending on your perspective) to the New Deal. Until the New Deal the federal government was a reliable ally of employers seeking to suppress union organizers or crush existing unions. Under FDR it became, instead, a protector of workers’ right to organize. Roosevelt’s statement on signing the Fair Labor Relations Act in 1935, which established the National Labor Relations Board, couldn’t have been clearer: “This act defines, as a part of our substantive law, the right of self-organization of employees in industry for the purpose of collective bargaining, and provides methods by which the government can safeguard that legal right.” Not surprisingly many historians argue that this reversal in public policy toward unions caused the great union surge.
An alternative story, however, places less emphasis on the role of government policy and more on the internal dynamic of the union movement itself. Richard Freeman, a prominent labor economist at Harvard, points out that the surge in unionization in the thirties mirrored an earlier surge between 1910 and 1920, and that there were similar surges in other Western countries in the thirties; this suggests that FDR and the New Deal may not have played a crucial role. Freeman argues that what really happened in the thirties was a two-stage process that was largely independent of government action. First the Great Depression, which led many employers to reduce wages, gave new strength to the union movement as angry workers organized to fight pay cuts. Then the rising strength of the union movement became self-reinforcing, as workers who had already joined unions provided crucial support in the form of financial aid, picketers, and so on to other workers seeking to organize.
It’s not clear that we have to decide between these stories. The same factors that mobilized workers also helped provide the New Deal with the political power it needed to change federal policy. Meanwhile, even if FDR didn’t single-handedly create the conditions for a powerful union movement, the government’s shift from agent of the bosses to protector of the workers surely must have helped the union drive.
Whatever the relative weight of politics, the depression, and the dynamics of organizing in the union surge, everything we know about unions says that their new power was a major factor in the creation of a middle-class society. According to a wide range of scholarly research, unions have two main effects relevant to the Great Compression. First, unions raise average wages for their membership; they also, indirectly and to a lesser extent, raise wages for similar workers, even if they aren’t represented by unions, as nonunionized employers try to diminish the appeal of union drives to their workers. As a result unions tend to reduce the gap in earnings between blue-collar workers and higher-paid occupations, such as managers. Second, unions tend to narrow income gaps among blue-collar workers, by negotiating bigger wage increases for their worst-paid members than for their best- paid members. And nonunion employers, seeking to forestall union organizers, tend to echo this effect. In other words the known effects of unions on wages are exactly what we see in the Great Compression: a rise in the wages of blue-collar workers compared with managers and professionals, and a narrowing of wage differentials among blue-collar workers themselves.
Still, unionization by itself wasn’t enough to bring about the full extent of the compression. The full
