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Social Sci LibreTexts

14.3: Income Distribution

How Income is Allocated

Recent growth in overall income inequality has been driven mostly by increasing inequality in wages and salaries.

learning objectives

  • Discuss factors that contribute to income inequality

Recent growth in overall income inequality has been driven mostly by increasing inequality in wages and salaries. Globalization has contributed to some portion of rising inequality as jobs have moved to lower wage geographies, placing downward pressure on wages of higher cost of living countries. However, economists view the impact of technological progress to outweigh the effect of globalization, as technology has effectively been substituted for more expensive wage labor. Policy reforms and regressive taxation have promoted disparity but are relatively minor contributors to existing inequality. Discrimination and favoritism in the workplace has continued to limit advancement of minority groups and women, but evidence reveals that wage related impacts to marginalized groups diminish with the increase in educational attainment.

Common factors thought to impact domestic economic inequality include:

  • Labor market outcomes
  • Globalization
  • Technological changes
  • Policy reforms
  • More regressive taxation
  • Discrimination

Globally, income inequality has increased over the last few decades. In the U.S., recent studies have stated that the wealthiest 400 Americans control nearly 50% of domestic wealth. Given that economic theory points to a decline in income inequality over time, the recent increase has led many researchers to conclude that we may be starting a new inequality cycle.

320px-kuznets-curve.png 

Kuznets curve: The Kuznets curve depicts the relationship between inequality and income; after hitting a market peak, inequality will decrease as income increases. Recent economic trends have caused researchers to believe that the economy may have started on a new Kuznet’s curve given the heightening economic inequality.

 

Role of Government

The market for labor is not completely transparent, competition is imperfect, information unevenly distributed, opportunities to acquire education and skills unequal, and since many such imperfect conditions exist in virtually every market, there is in fact little presumption that markets are in general efficient. This means that there is an enormous potential role for government to correct these market failures.

Governments have a number of tools with which they can affect income distribution. One way in which governments attempt to decrease income inequality is through progressive taxation. Wealthier people pay proportionally more of their income in taxes, which are then used to pay for services for the poor. Government can also place regulations of hiring and firing practices to address issues such as discrimination.

 

Current Topics in Income Distribution

Income inequality in the United States has grown significantly since the early 1970s.

learning objectives

  • Describe trends in income inequality in the U.S.

While income inequality has risen among most developed countries, and especially English-speaking ones, it is highest in the United States. Income inequality in the United States has grown significantly since the early 1970s and has been the subject of study of many scholars and institutions.

Most of the income growth has been between the middle class and top earners, with the disparity becoming more extreme the further one goes up in the income distribution. A 2011 study by the Congressional Budget Office (CBO) found that the top earning 1% of households increased their income by about 275% after federal taxes and income transfers over a period between 1979 and 2007, compared to a gain of just under 40% for the 60% in the middle of America’s income distribution. Scholars and others differ as to the causes, solutions, and the significance of the trend, which in 2011 helped ignite the “Occupy” protest movement. As a result, inequality has been described both as irrelevant in the face of economic opportunity (or social mobility) in America, and as a cause of the decline in that opportunity.

Yale professor and economist Robert J. Shiller, who was among three Americans who won the Nobel prize for economics in 2013, believes that rising economic inequality in the United States and other countries is “the most important problem that we are facing now today.”

Brief History of Income Disparity in America

The first era of inequality lasted roughly from the post-civil war era (“the Gilded Age”) to sometime around 1937. But from about 1937 to 1947, a period that has been dubbed the “Great Compression,” income inequality in America fell dramatically. Highly progressive New Deal taxation, the strengthening of unions, and regulation of the National War Labor Board during World War II raised the income of the poor and working class and lowered that of top earners. This “middle class society” characterized by a relatively low level of inequality remained fairly steady for about three decades ending in early 1970s. The return to high inequality or what has been referred as the “Great Divergence,” began in the 1970s. It was caused mainly due to the widening gap between middle and top earners.

Recent History: Inequality on the Rise

The income growth of the average American family closely matched that of economic productivity until some time in the 1970s. However, while income began to stagnate, productivity continued to climb.

ly-income-growth-1947-2009.png 

U.S. Income over time: Though productivity gains were primarily the basis for the increase in U.S. income, in more recent times, productivity increases have not been captured in income increases for the majority of U.S. families as noted in the graph.

In 2013, the Economic Policy Institute noted that even though corporate profits are at historic highs, the wage and benefit growth of the vast majority has stagnated. The fruits of overall growth have accrued disproportionately to the top 1%. According to PolitiFact and others, 400 Americans now own more than 50% of the net wealth of the United States.

 

Key Points

  • There is a potential role for government to correct the market failures that have propelled the rise in income inequality.
  • Common factors thought to impact domestic economic inequality include labor market outcomes, globalization, technological changes, policy reforms, more regressive taxation, and discrimination.
  • Some government tools for affecting income distribution are policies, hiring regulations, and progressive taxation.
  • While inequality has risen among most developed countries, and especially English-speaking ones, it is highest in the United States.
  • The fruits of overall growth have accrued disproportionately to the top 1%.
  • According to PolitiFact and others, 400 Americans now own more than 50% of the net wealth of the United States.

Key Terms

  • regressive: Whose rate decreases as the amount increases.
  • progressive: Gradually advancing in extent; increasing.
  • globalization: The process of international integration arising from the interchange of world views, products, ideas, and other aspects of culture.
  • inequality: An unfair, not equal, state.

 

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