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Diversity Statistics -- February 2014

Income Inequality: Background and Ideas for Action

by Margaret Manalo

Growth of income inequality

The end of World War II paved the way for decades of extreme economic growth in the United States with equally shared income distribution. Unfortunately, this era ended in the 1970s and distribution took a turn for the worse, favoring the top percent of households over the bottom. The main reasons for income inequality growth involves the rising inequality of labor and capital income, and how the increasing share of income goes to capital income rather than labor income.

Distribution of income gains in 1979-2007

Pay and productivity

Understanding the rise of income equality begins with understanding the divergence of pay and productivity. Pay is the hourly compensation of the typical worker, which unfortunately had modest growth in the past 10 years, also known as the “lost decade.” Productivity growth is the growth of output of goods and services per hour worked, which is the basis for the growth of living standards but only provides potential for rising living standards. Wage and compensation for the typical worker and income growth for the typical family have lagged behind the nation’s fast productivity growth.

The divergence

1948-1973: Hourly compensation grew with productivity
After 1973: Productivity grew strongly
After 1995: Productivity skyrocketed, but hourly compensation remained modest

Issue of capital gains

While market forces drive the rise of income inequality, the concept of tax policy upon capital gains has emerged the most prominent contributing factor. Capital gains, an increase in the value of a capital asset (investment or real estate) that gives it a higher worth than the purchase price, are what keep the top 1% of households ahead of the game. It seems that increasing the tax rates upon capital income could potentially reduce income inequality by dropping the Gini index, which measures deviation of income distribution from perfectly equal distribution.

Background of capital income (such as capital gains):

1979: 9.6% rise in total share of income to top 1% of households
2007: 20.0% rise in total share of income to top 1% of households

The 10.4% increase further concentrates capital income to top 1% that is taxed at a lower rate than wages and salaries,

Effect of a 1.0% percent increase in taxes:

1991: resulted in a 0.04% reduction in Gini index of income inequality
2006: resulted in a 0.5% reduction in Gini index of income inequality

A 0.46% increase towards reducing the Gini index greatly improves progress for equality.

Conclusion

Income inequality has now come to be viewed by some economists as the result of the skewed distribution of income towards the top 1%. From 1979-2007, the top 1% has been monopolizing the most market income with a 240% rise. The disproportionate, extreme climb of productivity in comparison to the weaker climb of pay poses the reason to such inequality. This divergence indicates that workers were not benefitting from productivity growth. In other words, “the economy could afford higher pay but was not providing it.” Based on this persistent issue and these statistics accumulated throughout the span of three decades, some are calling for the increase of tax rates on capital gains.

Sources:
Fieldhouse, Andrew (2013, June 14). “Rising Income Inequality and the Role of Shifting Market-Income Distribution, Tax Burdens, and Tax Rates.” Retrieved from
http://www.epi.org/publication/rising-income-inequality-role-shifting-market/

Mishel, Lawrence (2012, April 26). “The wedges between productivity and median compensation growth.” Retrieved from http://www.epi.org/publication/ib330-productivity-vs-compensation/http://www.investopedia.com/terms/c/capitalgain.asp

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