Income Inequality

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The pope deplored it. U.S. Federal Reserve Chair Janet Yellen said she’s “greatly concerned” about it. The World Economic Forum identified it at its 2014 Davos conclave of the wealthy and powerful as a menace to the global economy. President Barack Obama called it “the defining challenge of our time.” And a 700-page book about it by a French economist is the year’s surprise best seller. It is income inequality, a gap between rich and poor that has been widening in the U.S. and many other countries for a generation. The term is often used imprecisely as a catch-all description of various related ills including poverty, job stagnation, class division and social disorder. Yet there’s much debate among economists about the impact of inequality itself and its relationship to prosperity.

The Situation

The income gap narrowed in the U.S. between the Great Depression and the 1970s. Since then, it has widened. From 1979 to 2007, after-tax income for the top 1 percent of households grew 275 percent; for the bottom fifth it rose 18 percent. The top 1 percent of earners took home 95 percent of the gains in the first three years of the recovery from the 2008 recession. By 2013, the Fed found that the lower half of U.S. households by wealth held 1 percent of the total while the wealthiest 5 percent held 63 percent. (Economists quarrel about the data, though not about the direction of the trend.) The CIA World Fact Book ranks the U.S. 41st among 136 countries for family income distribution, with Sweden the most equal and Lesotho the least. Equality and prosperity can also diverge. While U.S. incomes were spreading out, poverty rates were falling. New York City has the biggest rich-poor gap in the country, but its poverty rate is roughly half of Detroit’s. China’s income gap has grown wider than America’s even as hundreds of millions of people were lifted out of poverty. The top 1 percent’s share of income has been falling in Spain and Norway as one struggles and the other prospers.

Source: Paris School of Economics, The World Top Incomes Database
Source: Paris School of Economics, The World Top Incomes Database

The Background

Many factors are thought to contribute to the growing rich-poor gap. The export of manufacturing jobs from rich countries to poorer ones has often been accompanied by widening inequality at both ends. In the U.S., the rise of the financial and tech sectors, the growing importance and cost of higher education, falling tax rates for the wealthy and reduced levies on capital gains may also play roles. The French author of the bestselling “Capital in the 21st Century,” Thomas Piketty, argued that unchecked capitalism concentrates wealth because the rate of return on capital generally exceeds the growth rate of labor income. The decades in the mid-20th Century in which inequality fell were the exception, not the rule, he concluded.

Source: U.S. Census Bureau
Source: U.S. Census Bureau

The Argument

Critics of inequality point to studies finding that more unequal societies suffer from higher unemployment, social instability and reduced investment. One linked households living in high-inequality areas with more financial distress, reflected by increased bankruptcy filings, higher divorce rates and longer commutes. The Great Gatsby Curve suggests that more inequality is linked to less mobility — the ease with which people move up and down the income ladder. Others contend there is scant proof these trends actually cause inequality to grow. Inequality acts as an incentive for people to produce and create wealth, innovate and take risks, they say. They point out that inequality isn’t a zero-sum game; when the recession shrank the stock portfolios of wealthy Americans, briefly reducing inequality, the poor did not get richer. Proposals to narrow inequality include increasing the minimum wage, taxing the affluent to pay for pre-kindergarten and raising levies on investments. In Switzerland, voters rejected both what would have been the world’s highest minimum wage, and a more radical measure to cap the salaries of CEOs. Piketty proposed a global tax on capital to combat social disarray that he considers a byproduct of inequality.

The Reference Shelf

  • The World Top Incomes Database has statistics on income distribution in 27 countries with more being added.
  • OECD data on income distribution and poverty.
  • The journalist Thomas Byrne Edsall argues that the wealthy have manipulated U.S. government policy to their benefit in his book, “The New Politics of Inequality.”
  • The Great Gatsby Curve: Bloomberg Visual Data chart showing links between higher inequality and lower mobility.
  • Thomas Piketty put the data sets underlying his “Capital in the 21st Century” online.

First Published Feb. 13, 2014

To contact the writer of this QuickTake:

Esmé E. Deprez in Santa Barbara at edeprez@bloomberg.net

To contact the editor responsible for this QuickTake:

Jonathan I. Landman at jlandman4@bloomberg.net