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Politics & Society

What Is Income Inequality?

Written by MasterClass

Jan 17, 2019 • 9 min read

Over the last several decades a large portion of the economics gains in wealthy countries have gone to a small minority of the population. Many economists consider this income inequality to be one of the biggest economic challenges facing us today.

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What Is Income Inequality?

Income inequality (or income disparity) is the degree to which total income is distributed unevenly throughout a population.

In many cases of economic inequality, the greatest amount of wealth flows disproportionately towards a small number of already financially well-off individuals. People with the top income are often called the “one percent” in reference to the fact that they make up a minor fraction of the population but harbor a large percentage of the country’s wealth.

What Is the Difference Between Income Inequality and Wealth Inequality?

  • Income represents how much you earn in a given year both from work and from the yearly return on your investments.
  • Wealth is your total net worth.

The income inequality that existed prior to World War II was largely caused by wealth inequality. Some families had large fortunes which produced large returns every year.

7 Factors that Lead to Inequality

Income disparity is driven by a number of economic, structural, and demographic forces. Economists are still working to figure out exactly why inequality rose in over the last half century. It’s not that they don’t have any theories—on the contrary, they have lots of theories. Many of them are mathematically plausible. Some of them are almost certainly true. However, ascertaining what percentage of inequality was caused by each particular mechanism is an ongoing challenge.

Seven primary factors that influence income inequality are:

1. Tax policy: One of the most important variables is a country’s tax policy, with tax structures that raise economic growth in the short-term while supporting increased government revenue in the long-term connected to the lowest instances of income inequality.
2. Unemployment: Unemployment is a major variable which greatly increases the likelihood of income inequality, as does lower overall participation of the labor force. Some economists also argue that inequality actually stems from the rise in housing prices and the inability of workers to afford to move to cities with high job growth.
3. Globalization: In recent years, corporations in the United States have steadily increased their outsourcing of jobs overseas as a means of reducing bottom-line costs, in turn cutting jobs for working and middle-class Americans. International trade undoubtedly also plays a role. International trade has tended to favor highly educated workers at the expense of workers with lower educations.
4. Increased automation: In wealthier countries, automation has started to replace many (once high-paying) blue collar jobs, leading to layoffs. Recent technological advances have tended to favor educated workers over less educated workers, driving the wages of the former up while holding stagnant or even driving down the wages of the latter.
5. The decline of unions: Since 2000, 20 percent of factory jobs have disappeared in the United States, many of which were high-paying and union. Deregulation and the increase of “right to work” practices have similarly impacted the number of union jobs and increased income inequality across the country.
6. Race/gender disparities: Income inequality is most severe along race and gender lines, with women and people of color hit the hardest. Males earn, on average, 68 percent more than their female counterparts in the United States, with white males earning approximately twice as much as the country’s lowest earning demographic, Hispanic females.
7. Salary gaps: The income inequality that we have today mostly comes from wide differences in salaries. At the very extreme are C-suite executives who have seen their average compensation grow nearly tenfold between 1960 and 2010. College-educated workers in general have fared far better than average, seeing their wages nearly double over that same period. By comparison, workers with less than a high school diploma have seen no growth in real wages over that same period. That income inequality from salary differences is beginning to lead to income inequality from wealth differences. Few high income people spend all of what they make in a year. Over time, that built up savings produces vast wealth that will eventually pass onto their children.

graph illustrating the inequality in american society and economy

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The History of Inequality in the United States

In the 1950s and 1960s, the United States income was much more evenly distributed. During the 1970s and 1980s, that began to change. Income gains at the top especially the top 1 percent, outpaced the rest of the country. Meanwhile income for the middle class percent stagnated. This gap has created a society that is far more stratified by income than the one that existed 50 years ago. This increase in stratification is sometimes connected to the increase in economic anxiety that we have seen over the same period.

Before World War II, income inequality in the United States was roughly equivalent to where it is today. During and after World War II, income inequality fell rapidly and drastically. It stayed at this low level until about the 1970s, when inequality began rising again.

Since 2003, economists Emmanuel Saez and Thomas Piketty have been researching the rise in income inequality across the United States by tracking, among other things, tax records. The economists have found that, due in large part to tax policies which favored the richest Americans, the percentage of income distributed to the wealthiest one percent rose from 9.1 percent in 1979 to 15.7 percent in 2014. (Research from the Congressional Budget Office closely mirrors these statistics, finding that the top one percent’s share of after-tax income increased from 7.4 percent in 1979 to 15.1 percent in 2012.)

The steep increase has had large scale implications for working class Americans, who Saez and Piketty say have been all but shut out of income growth over the past 40 years. The working class and one percent have almost completely flip-flopped their shares of the national income. Four decades ago, the top one percent of earners took home 10.5 percent of the total national income, and now they earn 20 percent of it. The bottom half of Americans, on the other hand, earned 20 percent of the total national income four decades ago, and now they take home only 12.5 percent of it.

over time, the american economy has become more unequal

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Inequality in the United States Today

In 2014, the Pew Center found that income inequality in the United States was the widest ever recorded, with the median net worth of the nation’s upper-income families 6.6 times that of middle-income families, and nearly 70 times that of lower-income families. The research also indicated that almost all gains made by families in the United States have gone to those in the upper echelons since the early 1980s thanks to the adoption of tax policy which favor those who already possess immense wealth. Findings like this have led economists to refer to our modern era as “The New Gilded Age.”

Since the 1970s, the United States has experienced higher rates of income inequality than most other developed nations, which continues to grow at an ever-quickening pace. By 2015, average household income for the bottom 90 percent of Americans averaged $34,074 per year, while average household income for the top one percent hovered around $6.7 million. This cavernous income gap between the one percent and the vast majority of Americans is easily exemplified by comparing the salaries earned by CEOs of major corporations versus an average worker at the same company. The CEO of Whirlpool, for example, made $7.1 million in 2015: 356 times that of an average employee, who makes only $19,906.

Many economists believe that income inequality will remain unimpeded in the coming decades without significant tax policy shifts, with the top one percent of Americans gaining a quarter or more of the national income by 2030.

The Gini Coefficient and Global Inequality

The leading measure of income inequality globally is a system called the Gini coefficient, or the Gini index, which was developed by Italian sociologist Corrado Gini in 1912. The Gini coefficient assigns each country a number between zero and one, with a score of zero indicating perfect equality—everyone has the same income—and a score of one indicating perfect inequality, where one person has all the income and everyone else has none.

Among the 34 OECD (Organisation for Economic Cooperation and Development) countries, the United States has the fourth worst Gini coefficient at .42, ranking higher than only Turkey, Mexico and Chile.

The United States’ wealth inequality—which takes into consideration property and investments, not just income—is even more pronounced than its income inequality. The United States currently holds 41.6 percent of the world’s personal wealth, making it the richest nation in the world, but has a Gini coefficient (.42) that is the worst of any OECD nation vis a vis wealth inequality.

What Are the Effects of Inequality?

The economic effects of income inequality are far reaching—most noticeably for those outside of a country’s wealthiest class. They include:

  • Political Polarization. There has been an enormous rise in political polarization. This trend occurred over roughly the same time period as the rise in inequality and followed the same pattern.
  • Stymied Economic Growth: Income inequality depresses economic growth since more people are making less money, and therefore have less to spend.
  • Decreased Social Mobility: Income inequality also means a serious decrease in the viability of social mobility for those in lower income brackets. According to a report by OECD, “The main mechanism through which inequality affects growth is by undermining education opportunities for children from poor socioeconomic backgrounds, lowering social mobility and hampering skills development.”

Income Inequality and Economic Crises

The Great Recession of 2008 is a pivotal example of how dramatically income inequality can impact a country. Working and middle-class incomes became stagnant in the early 2000s, which resulted in an increased demand for credit, and in turn, an unsustainable credit bubble for the majority of Americans. This, coupled with bank deregulation which fueled the growth of the wealthiest one percent, created an unstable economy that came crashing down in late 2007 and launched America into the Great Recession.

Most economic crises tend to drive down income inequality. This happens because stock market collapses not only bring down the wealth of the richest Americans but because CEOs of public corporations and financial executives are often paid based on the performance of the market. The Great Recession, however, was concentrated in the housing market. The most valuable asset that most middle class people own is their home. Therefore, the crisis hit the middle class much harder than previous crises. It has also meant that many middle class families have not yet recovered from their loss in wealth.

as the economy becomes less equal, politics get polarized

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5 Ways to Create More Equality

Finding solutions to income inequality begins with the recognition that income inequality is detrimental to the economic and social health of a nation.

  • The market itself can’t create more equitable outcomes. That will require government intervention.
  • Policies like universal health care and nutrition assistance are important. They can do an enormous amount to reduce inequality by improving the long term prospects of poor children.
  • Fiscal policies can help. Policies that prevent wages from getting unequal in the first place can lead to long-term equality.

Political and economic leaders have promoted several potential solutions to systematically addressing income inequality from multiple angles. These include:

  1. Fair pay. Raising the minimum wage will raise the national average income.
  2. Better state and federal programs. Strengthening social safety net programs like Medicaid relieves cost burdens for many.
  3. Restructure taxes. Redistributing taxes can create greater benefits for the working and middle class.
  4. Accessible education. Increased educational opportunities, such as universal preschool or college, democratize learning and provide the same opportunities for advancement across socioeconomic classes.
  5. Unions. Economists have long recognized that unions reduce inequality within a company by lowering wages for their higher paid members and raising wages for their lower paid members, a process known as wage compression. Many economists also believe that unions reduce inequality nationally.

The general consensus is that a multipronged approach—educational, economic, social and political—must be taken over many years in order to undo the current income imbalance and, in turn, increase access to opportunity for all within the United States.