Income inequality

Lane Kenworthy, The Good Society
August 2017

Income inequality is inevitable. There is no practical way to ensure that everyone’s income is the same. It’s also necessary. We need financial incentives in order to encourage hard work, investment, and entrepreneurship.

Yet too much inequality is unfair. Much of what determines a person’s earnings and income — intelligence, creativity, physical and social skills, motivation, persistence, confidence, connections, inherited wealth, discrimination — is a product of genetics, parents’ assets and traits, and the quality of one’s childhood neighborhood and schools. These aren’t chosen; they are a matter of luck. A nontrivial portion of income inequality is therefore, arguably, undeserved.

Since the 1970s, income inequality in the United States has increased. How much? What’s caused this rise? Has it happened in other rich countries too? How has government responded? Has the increase in income inequality been offset by mobility? Has consumption inequality also risen? What do Americans think about income inequality?

INCOME INEQUALITY HAS INCREASED, ESPECIALLY AT THE TOP

Income inequality has risen sharply in recent decades. Its key feature has been a growing separation between the incomes of the top 1% and those of everyone else.1 This is displayed in figure 1. Average income in the top 1% tripled from 1979 to 2013, while incomes in the bottom 60% grew only modestly.

Figure 1. Average income of households in the top 1% and the bottom 60%
Posttransfer-posttax income. The income measure includes earnings, capital gains, government transfers, other sources of cash income, in-kind income (employer-paid health insurance premiums, Medicare and Medicaid benefits, food stamps), employee contributions to 401(k) retirement plans, and employer-paid payroll taxes. Tax payments are subtracted. The incomes are in 2013 dollars; inflation adjustment is via the PCE. Data source: Congressional Budget Office, “The Distribution of Household Income and Federal Taxes, 2013,” Report 51361, 2016, supplemental data, worksheet 3.

Figure 2 shows the top 1%’s share of pretax income going all the way back to 1913. (These data are from IRS tax records, and the federal income tax began in 1913.) During the middle of the 20th century, that share decreased slowly but persistently. It’s since the late 1970s that we observe a big jump in inequality.

Figure 2. Top 1%’s share of income
Pretax income. Includes capital gains. Data source: World Wealth and Income Database.

Figure 3 shows the trends in the affluent nations for which we have data.2 (The appendix has a separate graph for each country.) The top 1%’s income share increased nearly as rapidly in Canada, Ireland, Korea, and the United Kingdom as in the US. It rose significantly but less rapidly in Australia, Finland, New Zealand, Norway, and Portugal. It increased only a little or not at all in Denmark, France, Germany, Italy, Japan, the Netherlands, Spain, Sweden, and Switzerland.

Figure 3. Top 1%’s share of income
Pretax income. Excludes capital gains. Data source: World Wealth and Income Database.

Figure 4 shows that the separation between the top and everyone else was mainly a story of the top 1%, rather than, say, the top 5% or 10%. The figure shows the income shares of three groups that comprise the top 10% — the top 1%, the next 4% (p95 to p99), and the next 5% (p90 to p95). The income share of the top 1% rose sharply, while the shares of the other two groups increased modestly or remained constant.

Figure 4. Income shares of three groups that comprise the top 10 percent
Pretax income. Excludes capital gains. Data source: World Wealth and Income Database.

Of income earners in the top 1%, about one in three are executives, managers, or supervisors, and one in ten are in financial professions. These two groups account for about half of the income share of the top 1% and nearly two-thirds of the increase in that share since the late 1970s.3 Unlike in the 1920s, most of their income comes from compensation — salaries, bonuses, fees, stock options, stock awards, golden parachutes — rather than from assets they own.4

A significant part of the surge in top-end inequality owes to a subset of the top 1%. There are about 120 million households in the US, so the top 1% are approximately 1.2 million. According to the World Wealth and Income Database, among the 600,000 or so that comprise the lower half of the top 1%, average pretax income roughly doubled between 1979 and 2014, from $275,000 to $500,000. Among the 12,000 households that comprise the top 0.01%, average income quadrupled during those years, from $7 million to $29 million.

The US Congressional Budget Office (CBO) has merged tax data with household survey data to create a more complete and accurate source of information on income inequality. It includes more sources of income, it subtracts tax payments (to the federal government), and it has good information on the incomes of those at the top of the distribution and those in the middle and bottom. Unlike most other sources, it counts the (estimated) value of employer- or government-provided health insurance as income.

Figure 5 shows two estimates of the top 1%’s income share in the United States. The pretax share from the WID (World Wealth and Income Database) data can be considered an upper bound. It rose from 10% in 1979 to 20% in 2013. The posttransfer-posttax share from the CBO can be considered a lower bound. It increased from 7% in 1979 to 12% in 2013.

Figure 5. Upper bound and lower bound estimates of the top 1%’s income share
Top 1%’s share of income. Includes capital gains. Data sources: World Wealth and Income Database (WID); Congressional Budget Office (CBO).

WHY THE SURGE IN TOP-END INCOME INEQUALITY?

What’s caused the sharp increase in income inequality between the top 1% and the rest of Americans since the late 1970s?

Explanations of rising income inequality often begin with education, but patterns of educational attainment can’t tell us much about why the top 1%’s incomes have separated from everyone else in recent decades, because Americans in the top 1% aren’t better educated than those just below them. That also holds for some other factors commonly invoked in explanations of rising income inequality. High earners more commonly couple with other high earners today than in former generations, but this doesn’t distinguish the top 1% from the rest of the top 10 or 20% of households. Manufacturing employment has declined, the statutory minimum wage has been flat, and unskilled immigration has risen sharply, but these are more likely to have contributed to rising inequality between the middle and the bottom than between the top and everyone else.

There appear to have been seven key causes of the rise in top-end income inequality5:

  • Increases in product market size
  • Changes in corporate governance and executive pay setting
  • Increases in the market power of large firms
  • Financialization
  • Soaring stock values
  • Union decline
  • Reductions in top tax rates

Product market size. By expanding the size of the product market, technological advance and globalization have produced large increases in firm revenues, and this translates into big payoffs for superstar athletes, entertainers, and CEOs.6 A related logic applies to the financial sector. Computerization and modern communications technology have enabled a big expansion in the volume of trades, as well as creation of new financial tools and instruments (leveraged buyouts, junk bonds, home equity loans, subprime mortgages, derivatives, collateralized debt obligations, credit default swaps). These in turn have increased the volume of fees earned by large financial firms, which has made it possible for these companies to handsomely reward their top creators, analysts, deal makers, and traders.

Yet beyond sports, entertainment, and finance, growth in product market size probably can’t account for much of the rise in top-end income inequality. Technological improvements — large shipping containers, lighter and stronger packaging materials, computerized logistics management, the internet, and more — have helped to globalize markets, boosting their size significantly. But they’ve also brought heightened competition. American companies now face foreign competitors not only abroad but also here in the domestic market. Barriers to entry by new competitors have fallen too, as venture capital firms ease access to financing and the information and communications revolution enhances the ability of start-ups to join and utilize global supply chains. Also problematic for the product market size explanation of rising top-end income inequality is the fact that many successful American companies enjoyed soaring revenues in the early post-World War II decades, before the technology-spurred globalization of product markets, yet compensation increases for CEOs (chief executive officers) and other high-level executives were modest during the former period, then huge during the latter.7

Changes in corporate governance and executive pay-setting. In the mid-to-late 1970s, higher-ups in large American firms began to change their perception of the core mission of the firm, of who its most valuable members are, and of how to compensate them. This shift had a number of elements.

During the “golden age” of post-World War II capitalism, boards of directors of large publicly-owned corporations saw the firm’s mission as increasing market share, revenues, and profits. Profits were invested in research or equipment, passed on to employees in the form of wage increases and new hires, or distributed to shareholders as dividends. Beginning in the late 1970s, this orientation was replaced by the notion that the principal aim should be to maximize “shareholder value” by increasing the firm’s stock price.

Wanting to maximize gains for shareholders doesn’t automatically entail offering large compensation to high-level executives, but it just so happened that around the same time corporate boards began to view top executives, and in particular the CEO, as the key to lifting the firm’s share price.

Prior to the 1980s it was common for large American firms to hire for top executive positions mainly from within. This meant budding executives had a financial incentive to stay put, and it meant they had limited ability to decamp if they wished to. In the 1980s that norm evaporated, probably pushed along by a similar development in sports (baseball free agency began in 1976) and entertainment. The ability of top executives to move among firms increased their leverage in negotiating salaries, bonuses, and stock options.

As firms increasingly hired CEOs and other high-level executives from a pool that included outsiders, and as large compensation packages became the norm, boards of directors turned to compensation consultants for information about whom to hire and how much to pay them. This has created a benchmarking and leapfrogging process whereby newly-hired executives insist on compensation slightly above most of their peers, some are granted this demand, and that shifts the norm steadily upward.8

An additional piece of the corporate governance story is the coziness between top executives and the board of directors who decide on their compensation packages. Many members of these boards are in effect handpicked by the CEO and then approved by shareholders who have little information and limited interest in the details of a company’s governance. Some board members are executives within the firm itself, and others are top executives at other publicly-owned companies. They thus have a direct interest in seeing executive compensation levels rise. In addition, some know each other personally and hence are more likely to vote for a generous pay package.

In 1993, the Clinton administration and Congress ruled that a publicly-traded corporation can deduct executive compensation from its taxable income only if that compensation is tied to the firm’s performance. As a result, more and more of executive compensation began to come in the form of stock options — shares in the firm that can be sold after a specified number of years. As the stock market soared, the payoff from stock options turned out to be enormous.9

Executives also discovered a way to help temporarily boost their company’s stock price when it came time to cash in their stock options: stock buybacks. Purchasing shares of the firm’s own stock drives up the price of the stock. It also increases the firm’s earnings per share (by reducing the denominator), a metric investment analysts use in judging a firm’s performance. Between 2003 and 2012, firms listed on the Standard & Poor’s (S&P) 500 index used, on average, 54% of their earnings to buy back their own stock.10

Because the corporate governance explanation has a number of components, it is difficult to quantify in a way that allows statistical testing. The explanation works well in terms of timing in the US case; most of its components are coincident with the rise in executive compensation and of the top 1%’s income share. It also seemingly works well in helping us understand country differences. In other rich nations, the shareholder value revolution, CEO free agency, and compensation via stock options either didn’t occur at all or happened later than in the United States. And a number of European countries have institutions — strong unions and employee election of some members of the board of directors — that are likely to obstruct sentiment among corporate boards in favor of huge executive compensation packages.

On the other hand, compensation at the top has risen sharply in a number of occupations — not just among executives in publicly-traded firms but also among their counterparts in privately-owned companies and among financial professionals, partners in large law firms, and top physicians, athletes, and entertainers.11 So corporate governance shifts can take us only part of the way in explaining the rising income share of America’s top 1%.

Large-firm market power. Two recent books — Joseph Stiglitz’s Rewriting the Rules of the American Economy and Robert Reich’s Saving Capitalism — argue that the market power of large firms accounts for a significant share of the growth in top-end income inequality in the United States. Firms with a dominant position in their product market can deter potential entrants, weaken existing competitors, and extract more revenue from customers. They then pass on the resulting above-market profits, or “rents,” to their top executives.

In Stiglitz’s telling, this process began with government deregulation of key industries such as airlines and railroads in the 1970s, eventually extending to telecommunications, finance, and other industries. Economists and policy makers embraced the notion that ensuring competition via government oversight and regulation was unnecessary, even counterproductive. Markets, according to the new perspective, would ensure ample competition if left alone, particularly in an age of rapid technological advance and globalization.

Instead, in industry after industry, we’ve gotten the opposite — weaker competition, more firms with a monopoly or quasi-monopoly position, less pressure for productivity improvement, more rent-seeking. Patent and copyright protections give pharmaceutical firms and software developers exclusive access to revenues from a new innovation. Tech titans benefit when their service or platform becomes an industry standard — think Microsoft, Apple, Google, Facebook, and Amazon. According to Reich, America’s large banks and other Wall Street firms have colluded to enlarge their profits by driving down the price of corporate takeover targets, influencing the setting of interest rates, engaging in insider trading, and more. Large firms also use their resources to lobby for regulations that further advantage them vis-à-vis competitors, with cable providers securing local monopoly rights only the most visible example.

Yet while market dominance matters for some firms, this explanation too has limits. We observe sharp increases in the compensation of CEOs and other high-level executives across a wide range of industries. In how many of them is the power of the largest firms greater now than in the 1950s and 1960s, when there was less domestic competition and little globalization?

Financialization. Over the past century, the financial sector’s share of America’s GDP has correlated fairly strongly with the top 1%’s share of income; it was high in the 1920s, then lower for about 50 years, then high again since the late 1970s. Financial firms’ revenues have grown in recent decades, and the salaries and bonuses of top financial managers, traders, and analysts have risen sharply. The amounts for some, particularly hedge fund managers, are staggering. Moreover, many large nonfinancial companies have added financial operations such as loans and credit cards on top of their core business.

The expansion of finance has multiple causes. Globalization, the emergence of large institutional investors, advances in computing and telecommunications, the creation of new financial instruments, and reductions in regulatory constraints have allowed financial companies to draw on larger pools of funds and to channel those funds into a wider array of investments. The growing size of large financial firms has allowed them to seek more risky investments. This has been accentuated by the expectation of a government bailout should too many of those bets go sour, on the grounds that a bankruptcy by one or more such firms would create too much uncertainty in global financial markets. Nonfinancial companies, struggling in a more competitive global economy and facing investor demands for strong short-term profit performance, have turned to financial operations to shore up revenues and profits.

Finance clearly has contributed to America’s top-heavy increase in income inequality.12 It too, however, is only part of the story. Financial professionals get one-seventh of the top 1%’s income, and they account for about one-quarter of the rise in its income share.13 The financial sector’s share of income has been rising since the 1950s, whereas the top 1%’s income share only began to increase around 1980. And if we look across countries, we find a number of anomalies. For instance, the Netherlands and Japan look similar to the United States in over-time trends in financial regulation, in finance’s share of income or value-added, and in financial-sector wages relative to wages in nonfinancial sectors, yet they are among the rich countries in which the top 1%’s share of income has risen the least over the past generation.14

The stock market. An important part of the story of rising top-end income inequality in the United States is the rise in stock prices. The Standard and Poor’s (S&P) 500 is a common measure of stock-market values. Over the six decades since the mid-1950s, the correlation between the inflation-adjusted value of the S&P 500 and the top 1%’s income share is +0.92. As figure 6 shows, both were flat through the late 1970s and then shot up.

Figure 6. S&P 500 index and top 1%’s share of income
Stock values are adjusted for inflation, via the CPI-U-RS. Incomes are pretax, including capital gains. Data sources: Federal Reserve Bank of St. Louis, FRED Economic Data, series sp500; World Wealth and Income Database, series top 1% income share including capital gains.

As I noted earlier, most of the income gains for America’s top 1% have come from increases in compensation rather than in capital income. Yet a lot of the movement in compensation over time is tied to the stock market. A large portion of the mammoth compensation increases for high-level executives in big firms has come in the form of stock options, which hinge on increases in the share price of the executive’s firm. A key part of the rise in pay for financial professionals is linked to trading in stocks and related financial instruments, which tends to increase when stock values rise.

The growth of incomes among the top 1% also fuels rising stock values. The rich tend to save and invest a larger portion of their income than do middle-class and poor households, so as the incomes of those at the top soar, more money will go toward purchase of stocks, increasing the demand for them and hence their price.

When we turn to other rich nations, stock values aren’t always helpful in accounting for changes in top-end income inequality. In a handful of countries, the over-time correlation is as strong as in the US. In others, though, it is weak or nonexistent.

Unions. Where unions exist and are sufficiently strong, they can force firms to distribute more of the profits to ordinary workers and less to top executives. Computers, robots, the ability to move to another state or country, immigration, high unemployment rates, and other developments have increased employers’ leverage vis-à-vis workers, and in this context union strength is likely to be especially critical. Unions also can affect income inequality via a political channel, by pressuring policy makers and influencing election outcomes.

The unionization rate in the United States has declined sharply during the period of rising top-end income inequality, falling from 23% in 1979 to 10% in 2014. Then again, the drop in unionization began in the 1950s, and the decrease in the 1950s, 1960s, and 1970s was comparable to what has happened since.

Cross-county comparison suggests that union strength has mattered for income inequality. The contrast between the US and Canada is illustrative. Canada’s unionization rate has remained fairly constant over the past generation, and the top 1%’s income share in Canada has risen only half as much as in the US. Several recent quantitative studies that examine developments over the past generation in the United States alone or in the US along with other affluent democracies have found unionization to be one of the best predictors of variation in the top-end income inequality.15

In this instance, however, the best predictor isn’t an especially good predictor. The only one of these studies that provides information needed to gauge the magnitude of unions’ impact has it predicting a rise in the top 1%’s income share in the US of 0.5 percentage points. The actual rise was 10 percentage points.

Taxes. Analyses of the impact of taxes on income inequality typically focus on how a progressive tax system reduces the share of income that goes to the rich, and accounts of the rise of top-end inequality in the United States often point to the tax cuts of presidents Reagan and (George W.) Bush as key contributors. However, the best estimates we have of the top 1%’s posttax income share, from the Congressional Budget Office, suggest that those tax cuts didn’t change the picture very much.16 As figure 7 shows, in 1979 the top 1%’s after-tax income share was about 83% as large as its pre-tax income share. In 2007, following the Reagan and Bush tax cuts, it had risen, but only to 89%. In 2013 it was back to 83%. Indeed, changes during the Obama presidency brought the effective federal tax rate (taxes paid as a share of pretax income) on the top 1% back up to the level it was at in 1979.

Figure 7. Top 1%’s income share before and after taxes
Includes capital gains. Federal taxes only; does not include state and local tax payments. Data source: Congressional Budget Office, “The Distribution of Household Income and Federal Taxes, 2013,” Report 51361, 2016, supplemental data, worksheet 3.

Taxes may have a larger influence on the pretax distribution of income.17 When top statutory income tax rates are lower, people and households at the top have greater incentive to try to maximize their income. They may do so by working harder or smarter, or perhaps by grabbing more “rent.”

In the United States, the top statutory federal income tax rate and the top 1%’s share of pretax income have indeed tended to move in opposite directions over time. In the 1920s the top tax rate decreased and the top 1%’s income share shot up. The top tax rate rose sharply between 1929 and 1945, and the top 1%’s income share fell sharply. From 1979 to 2007, the top tax rate decreased a good bit and the top 1%’s income share jumped.

However, there are notable exceptions. The 1963 Kennedy tax reform reduced the top statutory tax rate from 90% to 70%, yet the top 1%’s pretax income share continued its slow, steady post-World War II decline. In the early 1990s the (first) Bush administration and the Clinton administration increased the top statutory tax rate from 28% to 40%, yet the top 1%’s income share continued its sharp post-1979 rise. Carola Frydman and Raven Molloy have looked closely at whether compensation for top executives in large US firms changes in response to shifts in top statutory tax rates. Drawing on data going back to the 1940s, they find no noteworthy correlation between top tax rates and executive compensation.18

What does the experience of other countries suggest? Data are available for most of the rich longstanding democracies since the mid-1970s. In some of them — Australia, Canada, Ireland, New Zealand, Norway, Portugal, and the United Kingdom, along with the US — we observe the predicted increase in the top 1%’s income share when the top statutory tax rate decreases. But in others — Denmark, France, Italy, Japan, the Netherlands, Spain, and Sweden — we don’t.

All of these countries reduced top income tax rates during this period, but they differed significantly in the degree of reduction. Did the nations with larger decreases in top tax rates experience larger increases in their top 1%’s income share? Yes, but the correlation isn’t especially strong.19 Particularly noteworthy is that four English-speaking countries — the US, the UK, Canada, and Australia — are among those with largest increase in the top 1%’s income share even though only one of them, the United States, enacted very large tax rate reductions.

Why isn’t the association stronger? Part of the reason is that hiding behind statutory tax rates are an assortment of loopholes, deductions, and “tax expenditures.” These reduce the effective tax rate on persons or households with high incomes by shielding some, potentially much, of their pretax income from taxation. Warren Buffett’s famous discovery that he pays a lower effective federal income tax rate than his office staff illustrates the point. Moreover, different parts of high incomes — salary, business income, capital gains — may be taxed at different rates.

A multicausal story. Analysts of rising top-end income inequality frequently focus on one or another hypothesized cause and conclude that it is the key contributor. I don’t think any such conclusion is justified.20 The rise in the top 1%’s income share since the late 1970s is a product of multiple developments, no one or two or even three of which look to have been dominant.

Nor does it appear that political causes mattered more than economic ones, or vice versa. Deregulation, tax cuts at the top, the 1993 cap on deductibility of non-performance-related executive compensation, lack of support for labor unions, and other policy actions and inactions have played an important role. But so too have technological advances, the expansion of markets, changes in corporate culture, and other economic developments. And even where policy has mattered, it hasn’t necessarily been decisive. Deregulation of finance is a prominent culprit in many accounts of rising income inequality, yet nearly all affluent nations had deregulated their financial sectors as much as the United States by the early 1990s, with many experiencing nothing like our surge in top-end income inequality.21 And unions have weakened not only here in the US, but in many other affluent countries, some of which have a much less hostile legal climate.

INCOME INEQUALITY WITHIN THE BOTTOM 99%

The United States has a high level of income inequality within the lower 99% of households compared to other rich democratic nations, as figure 8 shows. The level increased significantly in the 1980s and the early 1990s. Since then, however, it has risen only a little. (This chart uses the Gini coefficient, the most commonly-used measure of inequality — equal to 0 if everyone’s income is the same and 1 if a single household gets all the income.22)

Figure 8. Income inequality in the bottom 99%
Gini coefficient. Posttransfer-posttax income, adjusted for household size. The lines are loess curves. The vertical axis doesn’t begin at zero. Data sources: Luxembourg Income Study; OECD.

Figures 9 and 10 show that much of this rise in bottom-99% income inequality occurred above the median. The income ratio of households at the 90th percentile to households at the median (p50) increased steadily and to a greater extent than the median-to-p10 ratio.

Figure 9. Income inequality in the upper half
Ratio of income at the 90th percentile to income at the 50th percentile. Posttransfer-posttax income, adjusted for household size. The lines are loess curves. Data sources: Luxembourg Income Study; OECD.

Figure 10. Income inequality in the lower half
Ratio of income at the 50th percentile to income at the 10th percentile. Posttransfer-posttax income, adjusted for household size. The lines are loess curves. Data sources: Luxembourg Income Study; OECD.

There are two principal sources of rising inequality within the bottom 99%.23 The first is increased wage inequality. Since the late 1970s, wages for Americans above the middle have risen fairly steadily, whereas in the middle and below they have increased only minimally. There are multiple causes of this development, including shifts in educational attainment, globalization, technological change, and union decline.24

The second source is changes in household structure and employment. Employment trends in the 1980s and 1990s tended to reduce the increase in income inequality by reducing the share of households with zero earners or a single earner. Since 2000, though, the US employment rate has declined, so employment trends have accentuated the rise in inequality.25 The share of households with just one adult has been rising, which increases household income inequality by increasing the share of households with only one earner or no earners. Rising marital homogamy is another contributor to rising inequality; more Americans are coupling with a person whose employment and wages are similar, so high earners are becoming more likely to be paired with other high earners, moderate earners with moderates, and low earners with lows.

Shifts in taxation and/or government transfers could have contributed to the rise in income inequality between upper-middle-income and middle-income households, but there is little evidence to suggest that they did.

HOW HAS GOVERNMENT RESPONDED?

Have government taxes and transfers become more redistributive in order to offset the rise in inequality of market incomes?26 Figure 11 shows the Gini coefficient for market income, for income after government transfers are added, and for income with transfers added and federal taxes subtracted. Transfers increased, so inequality of posttransfer-pretax income (the middle line) didn’t rise as much as inequality of pretransfer-pretax income (the top line). This happened mainly in the 1990s and in the 2000s, with the latter consisting largely of increases in spending on Medicare and Medicaid, which in these data are counted as transfers. Federal taxes became less redistributive, though only slightly so (figure 7 above), so we see little change in the distance between inequality of posttransfer-pretax income (middle line) and inequality of posttransfer-posttax income (bottom line).

On the whole, changes in taxes and transfers didn’t add to the rise in market inequality, but nor did they reduce it by much.

Figure 11. Gini coefficient for pretransfer-pretax income, posttransfer-pretax income, and posttransfer-posttax income
The lines are loess curves. The vertical axis doesn’t begin at zero. Data source: Congressional Budget Office, “The Distribution of Household Income and Federal Taxes, 2013,” Report 51361, 2016, supplemental data, worksheet 8.

OFFSET BY RISING MOBILITY?

Our inequality statistics — Gini coefficient, share of income going to the top 1%, and others — are calculated based on households’ income in a single year. This misses the fact that people move up and down over time.27 Our incomes in any given year may be more dispersed now than several decades ago, but if many of us are switching places from year to year, why the fuss?

Two claims need to be distinguished here. One says there is enough movement up and down in the income distribution over time (in technical lingo, relative intragenerational income mobility28) that we needn’t worry about single-year inequality at all. It doesn’t matter whether inequality is high or low; it doesn’t matter whether it’s rising or falling. Single-year income inequality is simply irrelevant, on this view, because there is a lot of mobility. Since “a lot” and “enough” are in the eye of the beholder, evidence can’t confirm or refute this claim.

A second claim says that the rise in income inequality has been offset by a rise in mobility. Here we can look to the data for a verdict. Has income mobility increased?

For the bulk of the population — everyone but the richest — we have multiple sources of mobility data, including the Panel Study of Income Dynamics (PSID), the Survey of Income and Program Participation (SIPP), and earnings and income records from the Social Security Administration and the IRS. Studies using these data find that there has been no increase in income mobility in recent decades.29

What about at the top? A good bit of the past generation’s rise in inequality consists of growing separation between the rich, especially the top 1%, and the rest of America. Has this been accompanied by increased churn among those at the top? In 2007 the Treasury Department released a study based on analysis of tax records. It included data on movement out of the top 1% over two nine-year periods: 1987-1996 and 1996-2005. Single-year income inequality rose sharply during these two periods; the share of income going to the top 1% going to the top 1% of households jumped from 11% in 1987 to 14% in 1996 to 18% in 2005. But according to the Treasury study, mobility was unchanged. Of households in 1987’s top 1%, 62% were not in 1996’s top 1%. Of households in 1996’s top 1%, 60% were not in 2005’s top 1%. The large increase in income inequality has not been offset by a rise in mobility at the top.30

HAS CONSUMPTION INEQUALITY INCREASED TOO?

Yes, as best we can tell. Recent studies have used the Consumer Expenditure Survey (CEX) to compare trends in income inequality and consumption inequality since the late 1970s. The CEX isn’t designed to effectively capture spending among the top 1%, so it may overestimate or underestimate the degree to which consumption inequality has increased. The data suggest that consumption inequality has increased, though studies have reached varying conclusions about whether it has risen as much as income inequality.31

DOES INCORPORATING WEALTH ALTER THE INCOME INEQUALITY TREND?

Some believe we should incorporate wealth into the measure of income. Specifically, we should add an estimated income stream of, say, 5% of the value of each household’s net worth. Would doing so change our conclusion about the trend in income inequality in recent decades?

Not much. Tim Smeeding and Jeffrey Thompson use data from the Survey of Consumer Finances (SCF) to calculate an income measure that combines standard income flows with imputed income to assets. Compared to the CBO income data (figure 11), this measure suggests a higher level of inequality and a somewhat smaller but still sizable rise in inequality.32

WHAT DO AMERICANS THINK?

Americans do appear to have noticed that income inequality has been rising, even before the Occupy Wall Street movement brought the issue to the forefront in 2011. But this has produced little or no increase in support for programs that directly address income inequality, for instance by increasing taxes on the well-off or by increasing transfers to the poor. Instead, the rise in inequality seems to have increased Americans’ support for programs perceived as boosting opportunity and economic security, such as education and health care.33

APPENDIX

The appendix has additional data.


  1. Congressional Budget Office, “Trends in the Distribution of Household Income Between 1979 and 2007,” Report 42729, 2011; Timothy M. Smeeding and Jeffrey P. Thompson, “Recent Trends in Income Inequality,” Research in Labor Economics, 2011; Richard V. Burkhauser, Shuaizhang Feng, Stephen P. Jenkins, and Jeff Larrimore, “Recent Trends in Top Income Shares in the United States: Reconciling Estimates from March CPS and IRS Tax Return Data,” Review of Economics and Statistics, 2012; Emmanuel Saez, “Striking It Richer: The Evolution of Top Incomes in the United States,” 2015. 
  2. See Anthony Atkinson, Thomas Piketty, and Emmanuel Saez, “Top Incomes in the Long Run of History,” Journal of Economic Literature, 2011. 
  3. Bakija et al, “Jobs and Income Growth of Top Earners and the Causes of Changing Income Inequality.” 
  4. Saez, “Striking It Richer.” 
  5. The following draws from Lane Kenworthy, “Why the Surge in Income Inequality?,” Contemporary Sociology, 2017. 
  6. Robert H. Frank and Philip J. Cook, The Winner-Take-All Society, Penguin, 1995. 
  7. Carola Frydman and Raven E. Saks, “Executive Compensation: A New View from a Long-Term Perspective, 1936-2005,” Review of Financial Statistics, 2010. 
  8. Thomas A. DiPrete, Gregory M. Eirich, and Matthew Pittinsky, “Compensation Benchmarking, Leapfrogs, and the Surge in Executive Pay,” American Journal of Sociology, 2010. 
  9. Kevin J. Murphy, “Executive Compensation: Where We Are, and How We Got There,” in Handbook of the Economics of Finance, volume 2, part A, Elsevier, 2013. 
  10. William Lazonick, “Profits without Prosperity,” Harvard Business Review, 2014. 
  11. Steven N. Kaplan and Joshua Rauh, “It’s the Market: The Broad-Based Rise in the Return to Top Talent,” Journal of Economic Perspectives, 2013. 
  12. Thomas Philippon and Ariell Reshef, “An International Look at the Growth of Modern Finance,” Journal of Economic Perspectives, 2013; Donald Tomaskovic-Devey and Ken-Hou Lin, “Financialization: Causes, Inequality Consequences, and Policy Implications,” North Carolina Banking Institute Journal, 2013; Eoin Flaherty, “Top Incomes Under Finance-Driven Capitalism, 1990–2010: Power Resources and Regulatory Orders,” Socio-Economic Review, 2015. 
  13. Jon Bakija, Adam Cole, and Bradley T. Heim, “Jobs and Income Growth of Top Earners and the Causes of Changing Income Inequality: Evidence from U.S. Tax Return Data,” 2012. 
  14. Philippon and Reshef, “An International Look at the Growth of Modern Finance.” 
  15. Thomas W. Volscho and Nathan J. Kelley, “The Rise of the Super-Rich: Power Resources, Taxes, Financial Markets, and the Dynamics of the Top 1 Percent, 1949 to 2008,” American Sociological Review, 2012; Florence Jaumotte and Carolina Osorio Buitron, “Inequality and Labor Market Institutions,” Staff Discussion Note 15/14, International Monetary Fund, 2015; Evelyne Huber, Jingling Huo, and John D. Stephens, “Power, Markets, and Top Income Shares,” Working Paper 404, Kellogg Institute for International Studies, University of Notre Dame, 2015. 
  16. Congressional Budget Office, “The Distribution of Household Income and Federal Taxes, 2013,” Report 51361, 2016. 
  17. Thomas Piketty, Emmanuel Saez, and Stefanie Stantcheva, “Optimal Taxation of Top Incomes: A Tale of Three Elasticities,” American Economic Journal: Economic Policy, 2014; Jesper Roine and Daniel Waldenström, “Long-Run Trends in the Distribution of Income and Wealth,” Uppsala Center for Fiscal Studies, Uppsala University, 2014. 
  18. Carola Frydman and Raven S. Molloy, “Does Tax Policy Affect Executive Compensation? Evidence from Postwar Tax Reforms,” Journal of Public Economics, 2011. 
  19. Lane Kenworthy, “Taxes,” The Good Society. 
  20. Lane Kenworthy, “Business Political Capacity and the Top-Heavy Rise in Income Inequality: How Large an Impact?” Politics and Society, 2010. 
  21. Philippon and Reshef, “An International Look at the Growth of Modern Finance,” appendix data set 
  22. A good introduction to inequality measures and data is Chad Stone, Hannah Shaw, Danilo Trisi, and Arloc Sherman, “A Guide to Statistics on Historical Trends in Income Inequality,” Center on Budget and Policy Priorities, 2011. 
  23. Gary Burtless, “Effects of Growing Wage Disparities and Changing Family Composition on the U.S. Income Distribution,” European Economic Review, 1999; Peter Gottschalk and Sheldon Danziger, “Inequality of Wage Rates, Earnings, and Family Income in the United States, 1975-2002,” Review of Income and Wealth, 2005; Lane Kenworthy, Egalitarian Capitalism, 2004; Lane Kenworthy, Jobs with Equality, 2008; OECD, Growing Unequal?, 2008. 
  24. Claudia Goldin and Lawrence F. Katz, The Race between Education and Technology, Harvard University Press, 2008; Bruce Western and Jake Rosenfeld, “Unions, Norms, and the Rise in U.S. Wage Inequality,” American Sociological Review, 2011; Lawrence Mishel, Josh Bivens, Elise Gould, and Heidi Shierholz, The State of Working America, 12th edition, Economic Policy Institute, 2012; David H. Autor, “Skills, Education, and the Rise of Earnings Inequality among the ‘Other 99 Percent’,” Scientific American, 2014. 
  25. Lane Kenworthy, “Employment,” The Good Society. 
  26. The expectation that government would respond in this way is based on the median-voter theorem. See Allan H. Meltzer and Scott F. Richard, “A Rational Theory of the Size of Government,” Journal of Political Economy, 1981. 
  27. Mark Rank, Thomas Hirschl, and Kirk Foster, Chasing the American Dream, Oxford University Press, 2014. 
  28. Lane Kenworthy, “Types of Mobility,” Consider the Evidence, 2008. 
  29. Lane Kenworthy, “Rising Inequality Has Not Been Offset by Mobility,” Consider the Evidence, 2008; Richard V. Burkhauser and Kenneth A. Couch, “Intragenerational Inequality and Intertemporal Mobility,” in The Oxford Handbook of Economic Inequality, edited by Wiemer Salverda, Brian Nolan, and Timothy M. Smeeding, Oxford University Press, 2009; Michael D. Carr and Emily E. Wiemers, “The Decline in Lifetime Earnings Mobility in the U.S.: Evidence from Survey-Linked Administrative Data,” Working Paper, Washington Center for Equitable Growth, 2016. 
  30. Department of the Treasury, “Income Mobility in the U.S. from 1996 to 2005,” 2007. 
  31. Jonathan Fisher, David Johnson, and Tim Smeeding, “Inequality of Income and Consumption: Measuring the Trends in Inequality from 1985-2010 for the Same Individuals,” Russell Sage Foundation, 2012; Mark Aguiar and Mark Bils, “Has Consumption Inequality Mirrored Income Inequality?,” American Economic Review, 2015; Bruce D. Meyer and James X. Sullivan, “Consumption and Income Inequality in the U.S. Since the 1960s,” Working Paper 23655, National Bureau of Economic Research, 2017. 
  32. Smeeding and Thompson, “Recent Trends in Income Inequality.” These data are available only from 1989 and they are pretax. Philip Armour, Richard V. Burkhauser, and Jeff Larrimore pursue a related approach (“Levels and Trends in United States Income and Its Distribution: A Crosswalk from Market Income Towards a Comprehensive Haig-Simons Income Approach,” Working Paper 19110, National Bureau of Economic Research, 2013). They count as income the (real or paper) change in a person’s net worth during the year. This yields the surprising conclusion that the top 1%’s income share in the US decreased between 1989 and 2007. However, this measure is likely to be very sensitive to fluctuations in stock values, which are the chief asset held by those in the top 1%. Hence the conclusion may be an artifact of the large increase in stock prices from 1988 to 1989 compared to that from 2006 to 2007. For more discussion, see Thomas B. Edsall, “What if We’re Looking at Inequality the Wrong Way?”, New York Times, June 26, 2013. 
  33. Larry M. Bartels, Unequal Democracy, Princeton University Press, 2008, ch. 5; Leslie McCall and Lane Kenworthy, “Americans’ Social Policy Preferences in the Era of Rising Inequality,” Perspectives on Politics, 2009; Benjamin Page and Lawrence Jacobs, Class War? What Americans Really Think about Economic Inequality, University of Chicago Press, 2009; Leslie McCall, The Undeserving Rich, Cambridge University Press, 2013.