U.S. Income Inequality

April 26, 2012

Income inequality in the United States has emerged as a popular topic in the media as well as the upcoming presidential election. The Occupy Movement has garnered a great deal of media attention in the past six months, with its premise of protesting economic and social inequality. The upcoming presidential debates are certain to feature a fair amount of political rhetoric in an attempt to address the issue of income inequality.

The chart above depicts the percentage of total income¹ that the top 10% of earners (in 2010, families with a market income above $108k) are responsible for. As seen in the chart, the line forms a “U” shape where the top 10% accounted for approximately 45% of total income prior to WWII, declined to the low/mid 30’s until the late 1970’s and has risen to approximately 45% today.

In addition, we can use the GINI ratio (index of income concentration) to further scrutinize income disparity. The GINI ratio is a statistical measure of income equality ranging from 0-1. A measure of 1 indicates perfect inequality; i.e. one person has all the income and the rest have none. A measure of 0 indicates perfect equality; i.e. all people have equal shares of income. As also seen in the chart, the GINI ratio has also risen precipitously since its inception in 1967. Currently the GINI index stands at 0.47, which stands out as one of the highest when compared to other developed economies:

 

Germany	0.27
France	0.32
Italy	0.32
Canada	0.32
Japan	0.38
Uruguay	0.45
Russia	0.42
Singapore	0.47

There are many theories as to why we have seen such growth in income inequality since the late 1970’s. Potential explanations include:

• Immigration of unskilled workers has put downward wage pressure on native born workers.
• Advances in computers and automation may have replaced moderate to low skilled workers, thereby decreasing demand for these types of employees.
• Decline of private sector labor unions and their ability to maximize incomes of their members.
• Tax policy – corporate and individuals.
• Relatively small increases in the minimum wage.
• Corporate deregulation (in particular financials – 10% of corporate profits in 1970’s, 40% today – increase in executive compensation, prevalence of lobbyists).
• Education gap between rich and poor has grown substantially. Cost of tuition is prohibitive for low income families. This has led to a shortage of highly skilled workers; therefore, demand (compensation) goes up for these types of workers.

The upcoming presidential debates will surely contain a healthy dose of discussion regarding income inequality, with a bulk focusing on tax policy and education reform. It will be interesting to see how each candidate plans to address these issues and the effect these policies will have on the financial markets. Is income inequality a detriment to the greater economy, or an essential part of capitalism?

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¹ Income is defined as the sum of all income components reported on tax returns (wages and salaries, pensions received, profits from businesses, capital income such as dividends, interest, or rents, and realized capital gains) before individual income taxes. Government transfers such as Social Security retirement benefits or unemployment compensation benefits are excluded from the income definition. Non-taxable fringe benefits such as employer provided health insurance is also excluded from the income definition. Therefore, the income measure is defined as cash market income before individual income taxes.