The middle class, long the bastion of the American Dream, is losing ground — and the housing market is taking notice.

The middle class saw a reduction in the vast majority of U.S. metro areas from 2000 to 2014, according to the Pew Research Center. Former members of the middle class either filtered into the upper or lower class, accentuating the divide between the two.

But what exactly is meant by the mercurial term “middle class”? The report defines middle class as households in the range of two-thirds the median income to double the median income. This of course varies by state. In California, a middle class household typically earns between $44,700 and $135,500, according to data from the U.S. Census. The exact dollar figure varies by metro area. Note that “class” in this context is used purely to denote income level and has no other socioeconomic qualifiers attached to it.

This vanishing of the middle class and corresponding swell in the lower and upper income classes is reflective of a broader economic issue: income inequality.

California’s growing income gap

Pew researchers contend areas with large tech industries have higher upper class populations. In California, look no further than the glittering Silicon Valley and the Bay area. Alternatively, a greater number of lower income populations are most often found in agricultural communities, as exist in the Central Valley.

California is home to both large upper class and lower class communities. For instance, about 20% of the population nationwide is classified as being in the upper class income strata. In California, the upper class is most numerous in and around the Bay Area, including:

  • 31% of households in San Jose-Santa Clara; and
  • 28% of households in San Francisco.

At the same time, about 29% of the population nationwide is classified as being in the lower class income strata. In California, members of the lower class are most numerous in far inland communities, including:

  • 46% in Visalia-Porterville;
  • 43% in Fresno; and
  • 43% in Merced.

The widening rift

The divide between upper and lower income classes is widening with each passing year. In California, 50.1% of the population was considered middle class in 2000. In 2014, 47.8% were middle class, a loss of 2.3%, or about 900,000 people.

The difference is split between households growing their income and matriculating into the upper class — and households who have lost income and have descended into the lower income category.

This distribution has played out differently in California’s largest cities, with fewer middle class households everywhere you look. The metro areas with the biggest losses in middle class households from 2000 to 2014 were:

  • Sacramento, with a 6.1% loss, most of which filtered to the lower class;
  • Napa, with a 5.2% loss, most filtering to the upper class;
  • San Francisco, with a 5% loss, most filtering to the upper class;
  • Santa Rosa, with a 4.8% loss, with households filtering equally between lower and upper class; and
  • Modesto, with a 4.7% loss, most filtering to the lower class.

Clearly, a smaller middle class means different things for each locale.

Areas with growing upper classes are seeing a surge in home prices and a growing economy. At the same time, home inventory shortages are worse in these areas of the state experiencing rapid growth.

Places where the lower class is growing are experiencing slower economic growth, and some places are even stuck in the lingering recession that most of the state has already recovered from. Housing markets in these areas are still moving along, but turnover is down and home sales volume is weak.

Housing in areas with a growing lower class

Areas in California with a growing lower income class are prone to a few issues that hinder the housing market. These include:

  • less income to support saving for a down payment, needed to become a homeowner;
  • lower homeownership rates;
  • a focus in low-tier home sales, despite a lack of inventory in this price tier;
  • fewer home sales as inventory is extremely limited in the tier where most potential homebuyers are located; and
  • a vicious cycle of less participation in the economy, which holds down wages and further contributes to the problem of income inequality.

Related article:

Income inequality harms California’s housing market

Housing in areas with a growing upper class

Areas with a growing upper income class also have experienced issues with their housing markets. For examples, look no further than San Jose and San Francisco, which have seen their upper classes grow:

These metros are poster children of what happens when a rapidly gentrifying population outpaces and overtakes their local housing markets.

Here, economic growth fueled by the tech industry created massive wealth for the residents. But these same residents are constrained by restrictive zoning and land use ordinances, which prevent new construction. This has caused residential construction to lag far behind population growth, pushing up the price of existing homes catastrophically.

Related article:

Population growth exceeds new housing – by a lot

The result is an unbalanced region of the state, where teachers and service employees cannot afford to live where they work. Fewer home sales occur and real estate professionals rely on a shrinking number of high-priced transactions to make a living each year.

The solution is within reach

To find the solution to reenergizing the middle class, you need to first look to the cause of the problem.

The causes are many, and most fall within recent changes to the tax code.

The aim of the U.S. tax system is to equitably shift wealth around to fund the foundations of our society. These structures include schools, law enforcement, infrastructure, the judicial system, health services, the military… and so many other necessities.

Everyone with a job pays taxes, but most of these taxes come from a select few who earn their money passively, through the assets they hold — the rentier class. Some call this class of people “the 1%,” a term which entered the public lexicon during the Occupy Wall Street movement. The tax code is meant to shift wealth from the rentier class to these foundational structures in order to maintain a stable and functioning society.

For the purposes of understanding why the middle class has shrunk in recent years, consider this — the U.S. tax code has changed significantly in recent decades.

Following World War II, the ceiling for the top tax bracket was 94% — a limit set to reduce the national debt which ballooned following the Great Depression and curative New Deal.

By 1982, the ceiling was down to 50%. In 2016, the top tax bracket was 39.6%. At the time of this writing, the current tax proposal lowers taxes further on the wealthy.

Those who advocate for lower taxes on the wealthy may point to some notion of trickle down economic theory, which posits that when wealthy individuals are able to keep more of their money, they will spend it. By spending the money, these wealthy individuals therefore become drivers of the economy, spreading their wealth to the masses.

But the problem is, this generally doesn’t happen. In real life, wealthy recipients of tax breaks tend to hold on to their money, building their nest eggs and keeping their money out of direct circulation in the markets.

In the meantime, the rest of the population is relegated to relying on substandard government services in order to stay afloat, which reduces everyone’s quality of life.

The solution to the dwindling middle class —requiring the wealthy to pay more taxes — is right in front of us, but no one is likely to take any action. Instead, our current course is set to widen the rift further between lower and upper classes.