19.1: Income Inequality

Learning Objectives

1. Explain how the Lorenz curve and the Gini coefficient provide information on a country’s distribution of income.
2. Discuss and evaluate the factors that have been looked at to explain changes in the distribution of income in the United States.

Income inequality in the United States has soared in the last half century. Since 1967, real median household income has risen 30%. For the top 1%, incomes shot up by over 200%. Consider recent experience. Median household-size-adjusted disposable income rose 13% between 1988 and 2004. At the 75th percentile it rose 16%, at the 90th percentile 21%, and at the 95th percentile 27% (Burtless, G., 2007).

Increasingly, education is the key to a better material life. The gap between the average annual incomes of high school graduates and those with a bachelor’s degree increased by nearly a factor of five between 1975 and 2006. Read that sentence again. The gap went from under $5,000 to over$23,000 per year. That is a phenomenal change in such a short period of time. A special study by the U.S. Census Bureau estimated that compared to the full-time year-around work-life earnings of a high school graduate, a person with a bachelors degree would earn 75% more, while a person with a professional degree would earn almost four times more over their working lifetime1. Moreover, education is not an equal opportunity employer. A student from a family in the top quarter of the income distribution is six times more likely to get a college degree than a student whose family is in the bottom quarter of the income distribution.

That inequality perpetuates itself. College graduates marry other college graduates and earn higher incomes. Those who do not go to college earn lower incomes. Some may have children out of wedlock—an almost sure route to poverty. That does not, of course, mean that young people who go to college are assured high incomes while those who do not are certain to experience poverty, but the odds certainly push in that direction.

We shall learn in this section how the degree of inequality can be measured. We shall examine the sources of rising inequality and consider what policy measures, if any, are suggested. In this section on inequality we are essentially focusing the way the economic pie is shared, while setting aside the important fact that the size of the economic pie has certainly grown over time.

A Changing Distribution of Income

We have seen that the income distribution has become more unequal. This section describes a graphical approach to measuring the equality, or inequality, of the distribution of income.

Measuring Inequality

The primary evidence of growing inequality is provided by census data. Households are asked to report their income, and they are ranked from the household with the lowest income to the household with the highest income. The Census Bureau then reports the percentage of total income earned by those households ranked among the bottom 20%, the next 20%, and so on, up to the top 20%. Each 20% of households is called a quintile. The bureau also reports the share of income going to the top 5% of households.

Income distribution data can be presented graphically using a Lorenz curveA curve that shows cumulative shares of income received by individuals or groups., a curve that shows cumulative shares of income received by individuals or groups. It was developed by economist Max O. Lorenz in 1905. To plot the curve, we begin with the lowest quintile and mark a point to show the percentage of total income those households received. We then add the next quintile and its share and mark a point to show the share of the lowest 40% of households. Then, we add the third quintile, and then the fourth. Since the share of income received by all the quintiles will be 100%, the last point on the curve always shows that 100% of households receive 100% of the income.

If every household in the United States received the same income, the Lorenz curve would coincide with the 45-degree line drawn in Figure 19.1 “The Distribution of U.S. Income, 1968 and 2006”. The bottom 20% of households would receive 20% of income; the bottom 40% would receive 40%, and so on. If the distribution of income were completely unequal, with one household receiving all the income and the rest zero, then the Lorenz curve would be shaped like a backward L, with a horizontal line across the bottom of the graph at 0% of income and a vertical line up the right-hand side. The vertical line would show, as always, that 100% of families still receive 100% of income. Actual Lorenz curves lie between these extremes. The closer a Lorenz curve lies to the 45-degree line, the more equal the distribution. The more bowed out the curve, the less equal the distribution. We see in Figure 19.1 “The Distribution of U.S. Income, 1968 and 2006” that the Lorenz curve for the United States became more bowed out between 1968 and 2006.

Figure 19.1 The Distribution of U.S. Income, 1968 and 2006

The distribution of income among households in the United States became more unequal from 1968 to 2006. The shares of income received by each of the first four quintiles fell, while the share received by the top 20% rose sharply. The Lorenz curve for 2006 was more bowed out than was the curve for 1968. (Mean income adjusted for inflation and reported in 2006 dollars; percentages do not sum to 100% due to rounding.)

Sources: Carmen DeNavas-Walt, Bernadette D. Proctor, and Cheryl Hill Lee, U.S. Census Bureau, Current Population Reports, P60-229, Income, Poverty, and Health Insurance Coverage in the United States: 2004, U.S. Government Printing Office, Washington, DC, 2005, Table A-3; U.S. Census Bureau, Current Population Survey, 2005 Annual Social and Economic Supplement, Table HINC-05.

The degree of inequality is often measured with a Gini coefficientA measure of inequality expressed as the ratio of the area between the Lorenz curve and a 45° line and the total area under the 45° line., the ratio between the Lorenz curve and the 45° line and the total area under the 45° line. The smaller the Gini coefficient, the more equal the income distribution. Larger Gini coefficients mean more unequal distributions. The Census Bureau reported that the Gini coefficient was 0.397 in 1968 and 0.470 in 2006—the highest ever recorded for the United States (U.S. Census Bureau, 2006).

Mobility and Income Distribution

When we speak of the bottom 20% or the middle 20% of families, we are not speaking of a static group. Some families who are in the bottom quintile one year move up to higher quintiles in subsequent years; some families move down. Because people move up and down the distribution, we get a quite different picture of income change when we look at the incomes of a fixed set of persons over time rather than comparing average incomes for a particular quintile at a particular point in time, as was done in Figure 19.1 “The Distribution of U.S. Income, 1968 and 2006”.

Addressing the question of mobility requires that researchers follow a specific group of families over a long period of time. Since 1968, the Panel Survey of Income Dynamics (PSID) at the University of Michigan has followed more than 5,000 families and their descendents. The effort has produced a much deeper understanding of changes in income inequality than it is possible to obtain from census data, which simply take a snapshot of incomes at a particular time.

Based on the University of Michigan’s data, Federal Reserve Bank of Boston economists Katharine Bradbury and Jane Katz compared mobility in the 1970s, 1980s, and 1990s. In the 1970s, just under half the families in the poorest quintile at the start of that decade were still in that quintile at the end of that decade and overall about 32% of families moved up one quintile or more. The mobility figures for the 1980s were about the same as for the 1970s. In the 1990s, however, mobility declined. About 30% of families moved up one quintile or more and 53% of families that started the 1990s in the poorest quintile were still in that quintile at the end of the 1990s. In every decade, some of the movement to higher quintiles results simply from gaining age and experience. The researchers further comment that, for the 1990s, moving across quintiles has become harder to achieve precisely because of the increased income inequality (Bradbury, K. and Jane Katz, 2002).