Rising inequality is a drag on growth

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The reasons are fairly simple, it shifts money from low savers to high savers, that is, from low income to high incomes, and from wages to profits. First, see the rise in inequality since the 1980s:



Then notice here how different quintiles of incomes display vastly different savings rates:



Combining the two charts you see stagnant incomes for most, whilst the gains of economic growth all went to the top. These also save much more, as you can see in the second figure, so this in and by itself should have reduced demand, and thereby economic growth. Here is one percenter Nick Hanauer explaining:

I earn 1000 times the median wage, but I do not buy 1000 times as much stuff. My family owns three cars, not 3,000. I buy a few pairs of pants and a few shirts a year, just like most American men. Like everyone else, we go out to eat with friends and family only occasionally. I can't buy enough of anything to make up for the fact that millions of unemployed and underemployed Americans can't buy any new clothes or cars or enjoy any meals out. Or to make up for the decreasing consumption of the vast majority of American families that are barely squeaking by, buried by spiraling costs and trapped by stagnant or declining wages. This is why the fast increasing inequality in our society is killing our economy. When most of the money in the economy ends up in just a few hands, it strangles consumption and creates a death spiral of falling demand.

However, there are some possible countervailing forces:

• The increase in savings could have funded a business investment boom
  
• Many more women entered the labor force, keeping family incomes from falling
  
• Families started to borrow heavily to keep up spending
  

The investment boom is the argument on the right. Increased savings are just assumed to be automatically reinvested, as markets always clear. However, the investment boom never really materialized, in fact, investment as a percentage of GDP went slowly down, not up. This is mostly a result of shareholder capitalism, which started to gather pace since the 1980s:

• Aims to maximize shareholder value which tend to cut investment with long time horizons and uncertain pay-off
  
• Focus the company more on cost cutting, which has a more immediate pay-off for shareholders
  
• Aligns the pay of management with the interests of shareholders, hence their pay exploded as much more of their pay was related to the share price. 
  
• Put pressure on companies to return more money to shareholders
  

Shareholder capitalism can set in motion some kind of vicious cycle:

• The pressure to boost the stock price in the short-term (next quarter) is strong as so much of executive compensation is tied into it, it puts pressure to cut cost, which partly go to the expense of employment and wages.
  
• Management increases income while wages are mostly stagnant, this makes growing the top line more difficult and companies are forced even more on cost cutting, creating a self-reinforcing feedback loop.
  
• Because of a lack in top-line growth, profits are mostly returned to shareholders (dividends and share buybacks routinely consume over 90% of profits), which causes a further shift from low to high savers, creating another self-reinforcing feedback loop. 
  

You'll also notice that savings for the bottom 90%(!) moved even negative in the past decade, such was the borrowing spree. Of course, this couldn't be kept up and since the financial crisis the compensation from an increase in family earners and borrowing cannot compensate the demand sapping effects of rising inequality anymore.

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Roughly 20 percent of U.S. children live in poverty. In the wealthiest country in the world, that’s not just a moral outrage — it’s a serious detriment to our economic future. For low-income children, Medicaid and SNAP are investments that significantly improve outcomes later in life.

For example, one study found that children who received SNAP were less likely to experience stunted growth, heart disease and obesity as adults — and had graduation rates that were 18 percentage points higher. We need to do more, not less, to help these children — by providing early family intervention, better schools and housing, safer neighborhoods and much else.

What’s more, these programs serve as “automatic stabilizers” during an economic downturn: In a weak economy, as more people lose income and become eligible for federal benefits, the programs expand, putting more money in more people’s pockets. People then spend that money, increasing demand and helping the economy recover.

Why hurting the poor will hurt the economy - The Washington Post