The obvious one is that it allows the rich to deceive others (and themselves) into believing that they are ordinary people, and victims of “NuLabour attacks on the middle class” rather than what they really are - a privileged elite; a salary of £50,000 puts one in the top 10% of earners.
However, I suspect the tendency to over-estimate “middle England” incomes has (at least) four adverse effects upon those on truly middle incomes, namely:
1. Lower self-esteem. Our estimates of self-worth are connected to our income - they call them “earnings” for a reason. And we measure this worth relative to other people; it’s for this reason that income is a positional (pdf) good (pdf). This means that if we over-estimate median incomes, we’ll under-estimate how well we are doing, and so feel worth less.
2. Over-ambition. If workers feel they are earning less than others, they’ll make more effort to climb the greasy pole. This isn’t just aesthetically unpleasant; as Mill said, “I am not charmed with the ideal of life held out by those who think that the normal state of human beings is that of struggling to get on.” It could also be counter-productive in aggregate. This paper shows that workers who seek promotion naturally invest in those skills which their managers can more easily evaluate. This can lead to over-investment in general managerial or salesmanship skills, and under-investment in technical geeky skills which bosses can’t understand. The upshot can be lower aggregate productivity.
3. Excessive debt and consumption. Robert H. Frank has written extensively about how perceptions of others’ wealth cause people to spend more on conspicuous consumption - bigger cars and houses - and so get into bigger debt. Spending is contagious. The more we over-estimate the Jones’ incomes, the more we’ll struggle to keep up with them.
4. Crime. When people think there’s money around, they become more selfish. So if they over-estimate others’ incomes they might become more mean-spirited and even prone to crime. Those MPs who fiddled their expenses did so in part because they thought (wrongly) that an income of £60,000 wasn’t much.
Now, I’m not saying these are large effects - just that they might be non-zero. If so, the persistent over-estimate of “middle England” incomes might be nastier than generally supposed.