Laura Rowley Money & Happiness

Bill Gates lives in a house 20 times larger than mine. Frankly, that doesn't bother me. Robert H. Frank thinks it should.

Frank, a Cornell University economist, is the author of the new book "Falling Behind: How Rising Inequality Harms the Middle Class." In it, he examines how the rise of an uber-class, with its extreme earning and consuming patterns, is hurting middle-class Americans.

A Widening Gap

First, a look at the wealth gap: Between 1949 and 1979, U.S. incomes rose more or less across the board with economic growth, Frank writes. Incomes of the bottom 80 percent of wage-earners, in fact, grew faster than the top 1 percent. But since 1979, the top earners have dominated wealth gains.

For example, in 2005, the top 1 percent of Americans saw their incomes rise 14 percent to $1.1 million on average, while the incomes of people in the bottom 90 percent fell 0.6 percent, according to an analysis by Emmanuel Saez of the University of California, Berkeley, and Thomas Piketty of the Paris School of Economics.

The top 10 percent -- households earning more than $100,000 -- collected 48.5 percent of all reported income in 2005, up from 33 percent in the 1970s and the largest share since the historical peak just before the Great Depression. The top 1 percent garnered 22 percent of all reported income -- double the share they received in 1980.

Context Is Everything

The wealth gap is problematic, Frank argues, because the ultra-rich are shifting the frames of reference that govern spending by the rest of us. "The economist Richard Layard once wrote that in a poor society, a man can tell his wife he loves her by giving her a rose," Frank wrote me in an email. "But in a rich society he must give a dozen roses. People's spending patterns are always strongly influenced by local context."

Personally, one rose is just fine with me, and I truly don't want Bill Gates' five-acre compound unless it comes with free housekeeping (my kids would find a way to despoil all 40,000 square feet in about five minutes). And while I admit to occasional envy of the mansions in the next town, I also know what affording one requires: endless hours of toil on Wall Street or in the corporate skyscrapers that tower over midtown Manhattan's shadowy canyons. A bigger house means a bigger mortgage, taxes, utilities, maintenance -- and less control over my time.

While Frank acknowledges that many people similarly ignore the lifestyles of the rich and famous, "spending at the top nonetheless affects how much middle-class people have to spend to achieve basic life goals," he argues. This happens through a multi-stage process he calls "expenditure cascades."

The Mansion on the Hill

Consider housing. "Top earners have more money, so they build bigger mansions," Frank notes. "The middle-class doesn't care, but the new mansions shift the frame of reference that defines what people just below the top consider desirable or necessary. So people just below the top build bigger.

"Their spending, in turn, affects others just below them," he adds, "and so on, all the way down the income ladder. As a result, the median size of a newly built house in the U.S. is more than one-third larger now than in 1980, even though real median family earnings have scarcely risen since then."

Unfortunately, there's a clearly defined link between neighborhood housing prices and school quality. "And so most middle-class families work longer hours, save less, borrow more, and commute longer distances in order to meet community standards on housing expenditure," Frank points out.

Cascading Contagions

Expenditure cascades also occur in automobiles, clothing, and college tuition. "Tuitions have been growing in part because of the consumption amenities universities now feel they must offer to remain competitive for students with the best academic credentials," he suggests, citing state-of-the-art climbing walls, gourmet food courts, and luxury apartments.

Even the $10 million coming-of-age parties for children of the super-rich have launched an expenditure cascade, Frank argues. He may have a point. I find myself spending $150 on birthday extravaganzas at gymnastics facilities for 20 kids, when my own childhood parties consisted of a home-baked Betty Crocker cake and rousing games of musical chairs and "drop the clothespin in the milk bottle."

Decades of research underscore the power of social contagion. Peer effects have been found in a variety of settings, with both negative and positive consequences. Aside from the obvious -- overspending to keep up with the Joneses -- a recent study in the New England Journal of Medicine found that obesity spreads through social ties. If a friend becomes obese, you have a 60 percent higher chance of similar weight gain. The closer people are in a social network, the stronger the effect.

On the upside, a decision by one person to join his employer's retirement savings plan clearly influences coworkers' decisions to do so, according to a study by Saez and co-researcher Esther Duflo of MIT. In addition, people are more likely to invest in the stock market if there's a high participation rate by their neighbors, according to a study by Jeffrey Brown of the University of Illinois and three co-researchers.

Tax the Rich?

Birthday productions notwithstanding, Frank says conspicuous consumption isn't the main problem: "The middle class isn't struggling because they're trying to buy Gucci handbags and Prada shoes. They're struggling because they can't meet their mortgage payments on a house in a safe neighborhood with good schools. But the ultimate reason for that struggle is the expenditure cascade launched by higher incomes at the top."

Clearly, even if many Americans are discomfited by the wealth gap, they aren't protesting in the streets. Harvard business school professor Rafael Di Tella, who conducts research on the legitimacy of capitalism, says it's because most Americans believe the United States offers a level playing field of opportunity.

"People don't see income differences as the source of the problem," Di Tella says. "The CEO may be making a ton of money, but if he's super-sharp and intelligent, that's [seen as] merit-based. People are willing to undergo unbelievable differences in income as long as they think it's fair or legitimate."

Frank argues that rising inequality isn't legitimate, and he'd like to scrap the income tax system in favor of a progressive consumption tax, to discourage the rich from constantly upping the ante. "By exempting savings from tax, it would be a powerful incentive to save more," he argues. "High rates on the highest consumption levels would also attenuate the expenditure cascades that have been putting pressure on middle-income families."

Fueling Polarization

I'm not convinced that a tax-code change is in order. The first step is for people to recognize the power of social contagion and immunize themselves: Take responsibility for your consumption choices, and base them on your own values rather than what the people above you are doing.

On the other hand, there's little doubt that the cost of housing, real estate taxes, health care, and college educations are escalating much faster than middle-class incomes. And, as Alan Greenspan noted back in 2005, we ignore income inequality at our own peril.

"In a democratic society," he said, "a stark bifurcation of wealth and income trends among large segments of the population can fuel resentment and political polarization. These social developments can lead to political clashes and misguided economic policies that work to the detriment of the economy and society as a whole."