A product of the early industrial era, the second American middle class was largely limited to the industrial states of the Northeast and the Midwest. Unlike the factory workers in those states, the rural majority in the South and the West did not share in the income gains from industrialization; tariffs were, in effect, a tax imposed on them to subsidize urban workers and capitalists. The protectionist system also hurt the professional elite, because it raised prices on high-end consumer goods. Economics goes a long way toward explaining why elite progressives from the North teamed up with southern and western populists in the New Deal coalition that lasted from 1932 until the 1960s. The New Dealers created the third American middle class.
Whereas the second American middle class was founded on high wages for workers in the industrial sector, the third American middle class was founded on the supplementation of wage income by government benefits that collectively constituted a "social wage." The social wage included not only private-sector benefits encouraged by the tax code, such as employer-provided health insurance, but also subsidies such as the home-mortgage-interest deduction and government entitlements such as Social Security and Medicare (which freed many middle-class families from the bankrupting burden of caring for elderly parents), the GI Bill for higher education, and student loans. As the Yale political scientist Jacob Hacker has pointed out, when the hidden welfare state is counted along with the visible welfare state, the United States has a system of social provision as generous as those in Western Europe -- though in this country much of that system extends only to the middle class and the professional elite.
The social-wage system had many flaws -- for example, it failed to provide health insurance for tens of millions of Americans. Nevertheless, the third American middle class, the product of Franklin Roosevelt's New Deal, Harry Truman's Fair Deal, and Lyndon Johnson's Great Society, was larger and more inclusive than the earlier two. From the 1930s to the 1970s income inequality in America shrank dramatically
, producing what the economic historians Claudia Goldin and Robert Margo have called the Great Compression.