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Income Inequality

By | Updated May 29, 2014

The pope deplored it. New York’s new mayor invoked it to get to City Hall. 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 tome by a French economist on it 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. (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.

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, used a wealth of historical data to argue that, left unchecked, capitalism inevitably produces wealth concentration 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.

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. For his part, Piketty proposed a global tax on capital to help stave off what he sees as the potentially dangerous social disarray that rising inequality threatens to spark.

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 New York at edprez@bloomberg.net

 

To contact the editor responsible for this QuickTake:

Jonathan I. Landman at jlandman4@bloomberg.net