The Challenge Of Inequality In The United States

Published Date: 02 Nov 2017

For they know that America moves forward only when we do so together, and that the responsibility of improving this union remains the task of us all.

-President Barack Obama. 2013 State of the Union Address [1] 

Income inequality has increased sharply in the United States since the late 1970s. The great economic recession and financial crisis that struck in 2008 and the continual high unemployment that has come with it have brought greater attention to the trend toward the substantial concentration of income at the top; the marginal or no progress for the middle; and knife edge of subsistence at the bottom of the income distribution. The problem was squarely at the center of the political debate during the 2012 US Presidential Election and continued with the December 2012 Fiscal Cliff and recent March 2013 Budget Sequester. Even amongst those who view inequality neutrally, or even positively, as the way in which markets reward performance, there is wide based agreement that some of the features that accompany it, such as lack of opportunity and reduced social mobility, increased encroachment of poverty, and the stagnation of average household income, are and unsustainable and undesirable. Those who traditionally are more concerned about high inequality worry that increased concentration of income is also leading to the concentration of political power, which impedes efforts to mitigate inequality and even may promote policies that exacerbate it. Meanwhile, a number of economists have argued recently (Krugman, 2007; Stiglitz, 2011) that the severe concentration of income at the top 1 percent may destabilize macroeconomic and financial stability by making it harder to sustainably maintain strong aggregate demand or by encouraging excessive borrowing.

The objective in this thesis review of the challenge of income inequality is to amass in one place a cohesive overview of the basic facts and the underlying issues that is available to both policymakers and a wider public. The focus is centered on the United States, but will draw on international comparisons and experience to shed light on the trends and help outline out some possible remedies. It is also quite clear that it is nearly impossible to separate the purely economic or technological drivers of inequality from the political processes that shape the policies influencing the distribution of income. But that merely reflects the realities that policymakers face; economics and politics are intertwined and understanding both will be necessary to understand why income inequality has arisen and how it might be alleviated. The hope is to present a comprehensive picture, bringing the different dimensions of the topic together but also with delving into technical details provided by the US government, institutions such as the OECD, and the academic economist findings. An informed discussion and practical application of policy needs an empirical synopsis of the realities and of the various available interpretations. That is what I aim to provide.

Whichever of the variety of measures one looks at, inequality in the United States has increased very substantially (OECD, 2008). The Great Recession exacerbated this issue of income inequality with the public face presented by the Occupy Wall Street protestors in the Fall of 2011. [2] Certainly this increase in inequality seems to be part of a global trend (OECD, 2008), yet among economically developed nations the United States is an outlier in almost every statistical sense. Although it is challenging to attribute the rise in inequality to any one precise cause, it is apparent that the growing role of the financial sector in the economy, technological change, international trade, changes in the labor market, the growth market sizes, and a reduction in the degree of progressivity of taxes all play some role. Additionally several of these factors have been particularly pronounced in the United States along with the divergence of wages and productivity (Sachdev, 2007). Also, the political environment, the decline in power of organized labor, and apparent changes in social norms affecting compensation at the top of companies and income bracket groups also seem to influence increased inequality. Though detailed policy recommendations lie beyond the scope of this thesis, and in reality policy recommendations are affected by numerous externalities as seen in the Fiscal Cliff and Sequester debates, a number of general policy suggestions that could help moderate some of the more damaging consequences of high and rising inequality, methods that are compatible with promoting an efficient and competitive economy, can be postulated.

This review is divided into 5 chapters with various subsections within the respective chapters. The first chapter is the introduction as seen. Chapter 2 will present the background for the rise in inequality in the United States and then followed up with a literature review of the arguments on income inequality. The third chapter will highlight the trends associated with rising inequality and the implications from the trends. Chapter 4 is a presentation of the causes of rising inequality and then another section on the policy and politics affecting inequality. Chapter 5 will bring what has been presented into a cohesive argument on strategies for narrowing the gap in the conclusion.

2 THE GROWTH OF INEQUALITY IN THE UNITED STATES

The country works better with a strong middle class, with real opportunities for poor folks to work their way into it with a relentless focus on the future, with business and government actually working together to promote growth and broadly share prosperity. You see, we believe that "we’re all in this together" is a far better philosophy than "you’re on your own."

–President Bill Clinton. 2012 Democratic National Convention Speech [3] 

BACKGROUND

Gauging income inequality, even in the United States, where good data are available, is complicated. Attempting to compare US trends with those in other countries becomes remarkably complicated, although not insurmountable as seen by reports by the OECD, IMF, and others. Precisely defining income is a challenge in and of itself. Income can be quantified gross or net of taxes, including or excluding government benefits (welfare or redistribution for example), and including or excluding realized capital gains (profits made from selling assets). Units of measurement also vary: sometimes households with multiple earners (husband/wife, partners, etc) are the taxable unit and other times only individual income earners, regardless of whether or not they share a household. [4] Both official and private sources often provide data on an amalgamation of different income measures, based on different tax units, and these different sources rarely have identical definitions of income. This creates a challenge not only with comparisons across different measurements of inequality but also when looking at the same measurement of inequality calculated from different sources (see Table 2-1 for a summary of how various collectors of data measure and define income).

TABLE 2-1. Definitions Used to Measure Income, by Data-Collecting entity

Source: Compilation and CBO (2011)

There are a variety of ways to look at the distribution of income within a society, but this thesis will focus on the three most common measurements: the Gini index (the most comprehensive measure of inequality); the assessment of median income versus the nation's average (or mean), household income; and the portion of incomes at the very top and very bottom of the distribution relative to the rest of the distribution (often broken in segments of 20% or 10% depending in the data source). These indicators measure inequality at a space in time. Also social mobility: how those born at the lower end of the income distribution tend to fare over time versus those born in the middle or at the upper end of the distribution. A lack of social mobility can be an indicator that there is inequality of opportunity, thereby implying that the economy's human capital or talent (skills and knowledge) is not optimally deployed (EPI, 2012).

Comprehensive Inequality

The most widely used measure of general inequality is the Gini index, also called the Gini concentration ratio or the Gini coefficient, and is calculated to denote the relationship between shares of income and shares of the population. Gini values range from zero (perfect equality) to 1 (perfect inequality). [5] Therefore the larger the Gini coefficient, the greater is the concentration of income and therefore more unequal the distribution of income within that population.

The recent Congressional Budget Office (CBO) report on household income inequality found that the US Gini index rose from 0.48 in 1979 to 0.59 in 2007. [6] Support of this trend, and its continuation through 2010, is also found in data provided by the US Census Bureau and by the OECD. After remaining around 0.40 throughout the 1970s, the Gini index as reported by the Census Bureau rose from 0.46 in 2007 to 0.47 in 2010. [7] (Note that while smaller than those reported by the CBO, the differences arise in the definitions of income used to calculate the index; see table 2-1.) [8] Importantly, the CBO data are based on market income (income before taxes and transfers) whereas the census data do include some government transfers (which reduce inequality, ie redistribution). Income measures that do not include taxes and government transfers exaggerate inequality in terms of capacity to spend, since government taxes and transfers typically redistribute income downward. Indeed, historically, taxes and transfers have reduced the scale of inequality in the United States, though at a diminishing rate over time (OECD, 2012; UN HDR, 2011). These policies have done little, if anything, to slow the increase in inequality: the CBO report estimates that in 2007, federal transfers and taxes decreased the Gini coefficient by about 17 percent. In comparison, the redistributive effect in 1979 was larger, with a 23 percent reduction in the Gini as calculated by the CBO (CBO, 2011). Therefore, although taxes and transfers have a redistributive effect, the degree of redistribution has weakened over time, inferring that over the last three decades changes in government policies have worked in the same direction as market forces, toward greater inequality. The US Gini index for disposable income (income after federal transfers and taxes), as calculated by the CBO, has continued to rise, going from 0.37 to 0.49 between 1979 and 2007.

Rising inequality is by no means unique to the United States. Seventeen of the twenty-two OECD (Organization for Economic Cooperation and Development) countries for which data are available have seen inequality rise from the mid-1980s to the late 2000s, as calculated by the household Gini coefficient. In fact, only two countries, Turkey and Greece, have seen a decline in their Gini coefficients (see figure 2-1). [9] 

However, among developed countries the United States stands out. Comparative to the countries examined by the OECD, the US Gini index in the mid-1980s was second highest, behind Mexico, and this remained true through the mid-2000s. Mexico is classified as a developing country by the World Bank, which found income distribution in developing countries be more unequal than in advanced countries, so the statistical proximity of the United States to Mexico is startling, to say the least (WB, 2012).

The Average American or Not so Average

The nation's average income (mean) is not an accurate representation of the standard US household. This is because the income distribution is not simply symmetrical: there are many more people who earn lower incomes than rich people who earn high incomes. The median income gives a clearer picture of the true typical household income in the United States; it is the income level at which half of all households earn more and half of all households earn less. The CBO calculates that the average, or mean, market income in 2007 was $64,500, whereas the median income was much lower, $41,700 (CBO, 2011). The real median household income after taxes and transfers (adjusted for inflation over the period) increased by 35 percent between 1979 and 2007, whereas the average household income saw a 62 percent increase in those years. This growing gap between the average and median incomes signifies a pattern in which income growth was heavily weighted toward households with income well above the median income levels (see figure 2-2).

Looking at the median and mean household income before federal transfers and taxes (which are redistributive influences) shows, as expected, an even wider gap (see figure 2-2): the average real household market income grew by 58 percent between 1979 and 2007, whereas the median real household income increased by a measly 19 percent over almost forty years (CBO, 2011). This reflects the fact that household market incomes have become more concentrated, and at an increasing rate (more accumulation of wealth at the top and more quickly).

FIGURE 2-1. Income Distribution in OECD Nations, the Gini Coefficient

Source: Organization for Economic Cooperation and Development (2011a).

Importantly, the figure also shows that the median household saw a decline in real income during the early 2000s and there has been little growth over the whole last decade. Alan Krueger, the chairman of the White House Council of Economic Advisers, recently estimated that if, in the early 2000s, real median household market income had grown at the same rate as it did in the 1990s, middle-class households would have about $8,900 more to spend per year than they currently do. [10] 

FIGURE 2-2. Growth in Average and Median Household Income

Source: Congressional Budget Office (2011, p. 2). After Taxes and Transfers

The Gini coefficient, the mean household income, and the median household income are all beneficial measures for displaying an overall trend in the income distribution in the US, and they also show that income is becoming more concentrated. It is important to note that these measurements are somewhat insensitive to variations within segments of the income distribution. For example, a relatively small absolute decline (such as wage reductions during a recession) in the incomes of those at the lower end of the income distribution may have a big impact on their living standards but will only be reflected in a small change in the Gini (Radelet, Perkins, Snodgrass, Gillis, & Romer, 2001). It is useful to look more directly at how particular segments of income within the distribution have performed.

FIGURE 2-3. Growth in Mean and Median Household Market Income

Source: Congressional Budget Office (2011, p. 6).

The Vast Differences in Income

The ratios of top-quintile [11] incomes to bottom-quintile incomes expose that overall inequality not only has increased in the United States but also has become exceptionally noticeable at the extremes. The growing gap between the rich and the poor is the result of extraordinary gains at the very top of the income distribution and little advance at the bottom. Within the top quintile (the top 20 percent of earners) the income of the top 1 percent of earners has rocketed. The CBO finds that market income share of the top 1 percent of households doubled, from around 10 percent of the total market income in the 1970s to more than 20 percent in 2012. In the meantime, incomes of the 80th-through 99th-percentile households remaining in the top quintile saw their portion of income fall. This upsurge at the very top has had a strong effect on both the level and growth of overall income inequality, particularly since 1980. According to CBO estimates, from 1979 to 2007, excluding the top 1 percent would have resulted in a 13.8 percent increase in market income inequality as measured by the Gini coefficient, compared to the actual overall increase of 23.2 percent. [12] 

Historical studies estimate that this scale of income concentration has not been seen since the days before the Great Depression (Noah, 2012). According to the World Top Incomes Database, which is created using income tax records for twenty-two countries, the top 1 percent of US tax filers, individuals or couples filing one return, earned 20 percent of US market income in 2010. [13] This share was down from 23.5 percent in 2007, revealing the losses from the financial crisis, but was still a portion not seen since 1928. The top 0.01 percent of tax units (about 15,000 units of over 150 million) earned 5 percent of the total income in the US. Before the financial crisis this group's share exceeded 6 percent, the highest on record. If the income distribution were perfectly equal, the income of these 15,000 tax units would have equaled that of over 9 million tax units. This showcases the vast accumulation of wealth in a small cluster.

The ratios discussed prior include income from realized capital gains (stocks, bonds, or real estate), which is the most unequally distributed source of income (discussed later "Channels of Income Inequality"). Even excluding capital gains, however, the World Top Incomes Database shows that the current level of income concentration at the top has not been reached since 1929 (see figure 2-4).

This swift expansion of incomes at the top is in contrast with little or negative growth at the bottom of the distribution. The Census Bureau estimates that from 1979 to 2010, the real household income of the bottom 10 percent grew by only 3.6 percent over three decades— a negligible amount (especially factoring in per annum inflation which slowly erodes the value of the income of the bottom 10 percent). [14] Though details differ between studies, depending on how income and tax units are defined, the conclusion is inescapable: income growth at the bottom of the distribution has been slow and has been far outpaced by that at the top.

FIGURE 2-4. Top 1 Percent Income Share, 1913-2010

Source: Alvaredo and others, "World Top Incomes Data Base."

International comparisons corroborate that these occurrences have been particularly pronounced in the United States. Of all countries in the World Top Incomes Database, the United States is home to the highest income shares for the top 1, top 0.1 and top 0.01 percent of earners. Only South Africa and Argentina, two developing countries marked by long histories of deep inequality and social divisions, even come close to the US figures.

Within major developed countries, the United States stands out in another regard: over the four decades since 1970, the remarkable fact is that there has been almost no increase in average incomes among the bottom 90 percent of earners. From 1970 to 2007 (pre-crisis), average real incomes, excluding capital gains, only increased by about 5 percent, yet for the years 1970 through 2010 (post-crisis), the average actually decreased by 6 percent. In comparison, in Australia, Canada, France, Italy, New Zealand, Norway, and Sweden, the average income of the bottom 90 percent of earners grew on average by more than 60 percent over approximately the same time (see figure 2-5). Note that this data from the World Top Income Database seems to challenge the minimal but positive growth of median incomes reported by the CBO. There are several reasonable explanations for this disagreement. As seen in table 2-1, the definitions of income vary by source. It is vital to restate that the World Top Incomes Database reports data by tax unit, not by household. A single tax unit includes couples filing jointly, with dependents, or individuals filing separately, with dependents. For this reason information assembled by tax unit should not be expected to match data collected by household, as is the case for data collected by the CBO and OECD and for many census studies. [15] 

FIGURE 2-5. Growth in the Bottom 90 Percent of Earners, 1970-2005a

Source: Alvaredo and others, "World Top Incomes Data Base." Countries with data at least through 2000 but varies due to data availability; capital gains excluded due to lack of data. Average real income.

Not surprisingly, the vapid growth at the bottom and rapid growth at the top have polarized the edges of the income distribution more in the United States than in any other advanced country. Notwithstanding some breaks in the data, it can be confidently stated that the US ratios of top-quintile and top-decile [16] incomes versus bottom-quintile and bottom-decile incomes are the highest in the OECD. That is, the ratio of the top 20 percent to the bottom 20 percent is higher in the US than in any other OECD country. The same is true for the top 10 percent and the bottom 10 percent. All gauges of income inequality in the United States point to the same verdict: inequality is rising and reaching levels not seen since before the Great Depression of the 1930s, and it is the very large concentrations at the top of the income distribution that are goading this increase. The income disparity between the top and the rest began to broaden at the start of the late 1970s, and this trend has continued, after a brief pause following the income gap between the top and the rest began to widen at the beginning of the late 1970s, and this trend has continued, after a brief hiatus following the 2008 financial crisis. Data for 2011 and 2012 are not yet available, but with the current trend the best guess is that the facts will show that inequality in 2011 and 2012, measured by the assorted definitions used, will have enlarged again and will be close to or higher than the level it had reached in 2007. This is because capital and business income and income derived from capital gains will have increased, while real wages will hardly have increased and in many cases will have decreased. [17] About two decades ago, the country's very highest earners began to considerably outpace the rest in the rate of their income increases. Many other developed countries have seen the income distribution become more unequal, but the deviation in the United States has been the most vivid, especially in the extent to which the divergence stems from the concentration of income at the top.

Inequality and the Sources of Income

Assessing the sources of income (labor and capital) sheds some light on the immediate causes of spreading inequality. Various individuals obtain more of their income from labor while others receive more of their income from returns on capital. Income can become more unequal either because labor or capital incomes become more focused or because capital income, which tends to be more concentrated, becomes a more important source of total income. As it turns out, both of these factors were at play in the United States: the CBO estimates that changes in concentration by source account for nearly 80 percent of the increase in the Gini coefficient for market income between 1979 and 2007, and shifts from less-to more-concentrated sources account for the remaining 20 percent. The CBO computed concentration indices for each major income source (see figure 2-6), where greater concentration values, measured on the vertical axis, indicate larger income inequality. The graph shows that although labor income has become more unequal (concentrated) since 1979, it is still much less concentrated than the other sources of income, most notably capital gains. To qualify this, in 1979 the bottom 80 percent of the population obtained 60 percent of total labor income and 41 percent of total capital income. By 2007, the bottom 80 percent received just under 50 percent of labor income and only 25 percent of capital income. [18] Therefore the bottom four quintiles of the income distribution saw a decrease in their portion of both labor and capital income.

FIGURE 2-6. Income Concentration

Source: Congressional Budget Office (2011).

That all sources of income have grown more unequal explains (partly) the increase in income inequality in the United States. Also the second element (the makeup of total income) also helps to explain growing inequality. The pie charts in figure 2-7 display that the piece of labor income in total market income has decreased by roughly eight percentage points over the past twenty-eight years, whereas the portion of income from capital gains, capital income, and business income have jointly increased by five percentage points. Additional income, which includes income collected in retirement, makes up the remaining three percentage points. This shift is important because the numbers show that over time the income channels that are less equal are making up a larger part of total market income.

The American Dream: Social Mobility

The majority Americans have long trusted that they have equal opportunity to realize and prosper by the surety of their own labors. A Pew Charitable Trust survey published in 2011 testifies that 68 percent of Americans still believe they are in control of their own economic situation and that they have realized or will realize the American Dream. [19] A 2011 Gallup poll discovered that 70 percent of Americans believe that growing equality of opportunity should be a significant or vital duty for the federal government. The poll also reports that the percentage who felt that there was a lack of opportunity has gone up from 17 percent in 1998 to 41 percent in 2011. [20] Income inequality has certainly increased over the last four decades by any measure, but has opportunity in America changed as well?

FIGURE 2-7. Share of Pre-Tax Market Income, Comparison of 1979 and 2007

Source: Congressional Budget Office (2011).

Determining income mobility is more complex than measuring income inequality. Income mobility has a time dimension; mobility can transpire over a short period of time, over a lifetime, or between generations. The following questions are usually asked to try to evaluate income mobility and opportunity (EPI, 2012):

Do children achieve higher living standards than their parents?

Do children of poor families catch up with children of rich families?

Is there intergenerational mobility or do poor families remain poor and rich families, rich?

These types of question are important. As a upshot of economic growth, all children may be better off than their parents, but children born in poor families may remain relatively poor.

The Economic Mobility Project, a 2007 study, undertaken jointly by the Pew Charitable Trust and the Brookings Institution, estimates that 40 percent of children born to parents in the bottom quintile of the income distribution will remain there and 60 percent of children will move up. [21] Initially this may seem like a reasonable number, but the data also hint that this 60 percent may not shift far above the lowest quintile. The report estimates that 23 percent of children born into the bottom quintile will move up to the lower-middle quintile and 19 percent will move up to the middle quintile. A 2006 Center for American Progress (CAP) report estimates that children born into families with income in the bottom 20 percent of the income distribution have just a 1 percent chance of reaching the top 5 percent of the income distribution, whereas a child born into a rich family (defined as the top 5 percent of the family income distribution) has a 22 percent chance of remaining in the top 5 percent as an adult. This is further supported by recent analysis of family inter-generational mobility studies conducted in advanced nations and reported in The Economist. [22] In short, a child’s economic opportunity is highly influenced by his or her parents’ economic position. [23] Moreover, separating US mobility by race shows that big variances persist. A study by the Economic Policy Institute estimates that white workers are ten times as likely as African American workers to make it into the top 25 percent of the income distribution (EPI, 2012).

Another important element of economic mobility in the United States is relative intra-generational mobility: How does an individual’s income adjust within his or her generation comparative to his or her peers’ income changes? A 2007 report by the US Treasury Department discovered that there is "considerable" short-term mobility. The study evaluated a sample of individuals’ taxpayer data between 1996 and 205 and found that "close to half of all taxpayers moved from the bottom quintile to a higher income quintile during the period." [24] But as with inter-generational mobility, one must be conscious of the trend that those who begin at the bottom of the distribution are more probable to stay near the bottom. Progressing up one quintile from the bottom does not necessarily signify the level of upward mobility that serves as the foundation for the American Dream; but one need not travel far up the income distribution for the movement to be interpreted that way. It is also crucial to keep in mind that degrees of mobility are particularly sensitive to the population measured. For example, counting sixteen-year-olds may paint a very singular picture than starting at the age of twenty-two, because sixteen-year-olds typically earn small part-time wages, so the rise to a full-time job (particularly after college) artificially inflates wage increases, and therefore mobility.

The 2007 Treasury Department report on mobility also found that only 25 percent of the earners who in 1996 were in the top .01 percent remained in that income group in 2005. This reinforced other studies’ conclusions that implied that in a given year, income among the very rich reflects windfalls. These reports show that there is high mobility at the very top of the income distribution; in the bottom fifth, however, earners lack mobility.

Differentiating between absolute mobility (how children progress relative to their parents in terms of absolute real income) and relative mobility (how children born into poor and wealthy families fare relative to one another) is essential when thinking about the suitable policy response. Intensifying absolute mobility requires policies that advance economic growth, whereas affective relative mobility requires policies that affect the distribution of opportunities across income classes.

How does America’s mobility compete with that of other countries? Figure 2-8 compares earnings mobility of several developed countries. On the horizontal axis the earnings capacity is expressed from the inter-generational earnings elasticity between fathers and sons as calculated by the OECD. [25] The vertical axis measures income inequality as expressed by the Gini coefficient. Earnings mobility of zero percent means that sons earn the same as their fathers; 100 percent would denote that there is no relationship between the earnings of fathers and their sons. At 50 percent, the United States’ earnings mobility is on the low end compared to European countries; some of which have earnings mobility as high as 80 percent. In other words, compared to international data, a parent’s income in the United States is relatively more predictive of incomes for his or her children than in other developed countries. The figure also implies that countries with greater inequality tend to have lower inter-generational mobility.

FIGURE 2-8. Earnings Mobility (2007) and Income Inequality, About 2005a

Source: OECD (2011a). Countries with data through 2000 but varies due to data availability

Is high inequality itself a major cause of low mobility? In their persuasive book, The Spirit Level: Why More Equal Societies Almost Always Do Better, Richard G. Wilkinson and Kate Pickett contend that inequality in developed countries is the root of troublesome trends across a range of social indicators, including crime, physical and mental health, teenage pregnancies, and trust. [26] They find a negative correlation between inequality and education outcomes (OECD data are similar; see figure 2-9), implying that high inequality can become self-reinforcing. Wilkinson and Pickett’s arguments are grounded on a survey of indicators and studies rather than on a statistical analysis that controls meticulously for multiple factors, and they by no means close the debate on the social effects of income inequality, but they still present a highly suggestive case that high inequality has various undesirable costs, including those that affect the hopes for upward mobility.

FIGURE 2-9. Inequality and Education Outcomes: Average of PISA Scores in OECD 2009

Source: OECD (2009)

The CBO report, along with others from the OECD, World Bank, IMF, UN, and academics have all begun to shed new light on the need for government policy and understanding of equality and sustainability. The OECD Economic Survey of the US in 2012 reported that income inequality and relative poverty are among the highest in the OECD (OECD, 2012). Furthermore income inequality in the US has risen continuously over the last forty years and the Gini coefficient for disposable income is the fourth highest in the OECD (behind Chile, Mexico, and Turkey). Such a dramatic rise in inequality can impose a number of unforeseen or politically undesirable outcomes. High inequality is associated with low intergenerational mobility (Jantti et al. 2006; Krueger, 2012); potential causes of the financial crisis (UN, 2009; IMF, 2011) as it might have encouraged subprime borrowing to replace income disparity (Rajan, 2010); has been argued as a factor in economic well-being (OECD 2008, Hopkins 2008) and also affecting health, innovation, and education (Wilkinson & Pickett, 2009; Torre & Myrskyla, 2011). Rising consumption inequality is also reflected in income inequality in the US (Attanasio et al., 2012). There is also some attention on how inequality can result in a population supporting anti-market, protectionist measures, or voicing concerns against lack of opportunities (Stiglitz, 2012). Inequality in wealth could also lead to a small group having political influence disproportionate to their size. The OECD continuous work on inequality has found no conclusive link or consensus that reducing inequality is harmful for developed economy growth (OECD 2008, 2011, 2012). The following will present a literature review on the United States and the rise of inequality and how that affects equity, growth, sustainability, and more (often times with cross-country comparative analysis with OECD member nations).

LITERATURE REVIEW

In many OECD countries, income inequality has increased in past decades. In some countries, top earners have captured a large share of the overall income gains, while for others income has raised only a little. There is growing consensus that assessments of economic performance should not focus solely on overall income growth, but also take into account income distribution. Some see poverty as the relevant concern while others are concerned with income inequality more generally.

In the early 1990s, there was a wide consensus in the US literature that (Lemieux, 2008):

there had been a pronounced growth in inequality in the 1980s;

the main determinant behind widening inequality was an increase in the relative demand for skills driven by skill-biased technological change;

the relative demand for skills was pervasive or ubiquitous in the sense that all dimensions of inequality were growing (linked to returns to education, experience, unobserved ability, etc.); and

alternative explanations related to international trade or globalization were not the main source of the increase in the relative demand for skills.

This consensus proved to be difficult to reconcile with the stylized facts of the 1990s and early 2000s, however. This includes in particular:

the diverging patterns in inequality across advanced countries with, for instance, large and sustained increases in the United States and Germany and a narrowing distribution in France; and

an increasingly heterogeneous pattern of wage inequality at different points of the distribution over time. For example, in the case of the United States, inequality at the top end of the distribution has grown steadily since the 1980s, while at the low end it only widened in the 1980s and remained constant or declined during the 1970s, 1990s and 2000s. These new stylized facts led to a renewed interest in the drivers of labor income inequality and in particular the role of institutional and policy factors.

The 2007 Global Financial Crisis and the economic turmoil that ensued brought inequality and growth to the forefront on economic analysis, scholarship, and policy making. The 2008 OECD report Growing Unequal? highlighted that inequality in the distribution of market incomes – gross wages, income from self-employment, capital income, and returns from savings taken together – increased in almost all OECD countries between the mid-1980s and mid-2000s. Changes in the structure of households due to factors such as population ageing or the trend towards smaller household sizes played an important role in several countries. Finally, income taxes and cash transfers became less effective in reducing high levels of market income inequality in half of OECD countries, particularly during the late 1990s and early 2000s.

Building on the 2008 OECD report, the 2008 World Bank, the 2008 IMF, the 2009 UN/EU Stiglitz report, and others the OECD released an update on inequality; the 2011 OECD report Divided We Stand. The 2011 OECD report took the drivers that had been developed and analyzed them more in depth and are now better understood, while previously they have typically been studied in isolation the report looked at them in an inequality ecosystem. Moreover, while growing dispersion of market income inequality – particularly changes in earnings inequality – has been identified as one of the key drivers, the question remains open as to the major underlying, indirect causes of changes in inequality. Is globalization the main culprit? To what degree were changes in labor and product market policies and regulations responsible? Do changes in household structure matter? Finally, what can governments do to address rising inequality? These and other questions were addressed in detail in the report which identifies key drivers and possible policy measures for tackling inequality trends among the working-age population.

New research from the IMF, the UN HDI, the WEF, the World Bank, and popular scholarship (Krugman, Stiglitz, and Noah released books) in 2012 provided new material for a 2012 OECD Economic Policy Reform report chapter – Going for Growth. This chapter encompassed the newly available datasets and scholarship to bridge the divide between sustainable and equitable growth policies. It first highlights differences in income inequality across the OECD and the factors driving them, such as cross-country differences in wage and non-wage income inequality, as well as in hours worked and inactivity. The chapter then provides new analysis of the policy and non-policy determinants of overall income inequality, assessing separately the drivers of labor income inequality and the redistributive role of tax and transfer systems. In each case, the analysis identifies "win-win" policies that can both reduce inequality and promote economic growth, and also highlights policies that may entail trade-offs between the two policy goals. This presents new empirical analysis which shows that although technological change and globalization have played a role in widening the distribution of labor income, the marked cross-country variation is likely due to differences in policies and institutions. This leads us to the following assimilation on inequality and sustainable growth:

Main Literature Components of Inequality and Sustainable Growth

Subjects

Findings