Economic Inequality: Facts, Theory and Significance

Studies | Economy | Government | Social

No. 312
Tuesday, June 10, 2008
by David R. Henderson


Executive Summary

The well-documented rise in economic inequality in the United States over the last two decades is somewhat misleading.  Almost all Americans, whether considered “rich” or “poor,” are better off economically today than in previous times.  Furthermore, due to the high degree of income mobility in the United States, most people move between income groups throughout their life.

The gap between the top and bottom fifths of families measured by income (called quintiles) has increased substantially since about 1970.  The bottom quintile received 5.4 percent of all the money income in 1970, falling to 4 percent in 2005.  Meanwhile, the share of income going to the top quintile rose from 40.9 percent in 1970 to 48.1 percent in 2005.  However, total income grew over that time, and the real income of every income group rose.

Furthermore, household income varies substantially for several reasons that are often ignored, including: 1) differences in the number of family members who work, 2) differences in the amount of work and 3) differences in age.

  1. High-income households are not likely to consist of one person earning a very high income (as is often assumed); rather, they are likely to have two or more income earners:
    • In 2006, a whopping 81.4 percent of families in the top income quintile had two or more people working, and only 2.2 percent had no one working.
    • By contrast, only 12.6 percent of families in the bottom quintile had two or more people working; 39.2 percent had no one working.
    • The average number of earners per family for the top group was 2.16, almost three times the 0.76 average for the bottom.
  2. Census data show a large difference in full-time work and in the number of weeks worked in a year.
    • Less than one-third of families in the lowest quintile had a head of household working full-time; in the top quintile, more than three-fourths of families did.
    • Thus, average families in the top group have many more weeks of work than those in the bottom and, in the late 1970s, the 12-to-1 total income ratio shrunk to only 2-to-1 per week of work, according to one analysis.
  3. Workers tend to start out at a low income, increase their earnings with experience, and then have lower incomes late in their careers or in retirement.  For example, peak earnings typically occur in the 35-to-54 age group. However:
    • In the bottom income quintile, only one-third of households are headed by someone 35 to 54; whereas, in the top quintile, more than half of household heads are in that age range.
    • The bottom group also has a much larger proportion of household heads more than 75 years of age — 11.5 percent versus 2.3 percent for the top group.
    • The bottom also has more young heads of households ages 15 to 24 — 10 percent versus 1.1 percent for the top.

Many redistribution advocates fail to see that raising marginal tax rates on higher incomes would, in fact, increase measured inequality.  The reason is that an increase in the marginal tax rate would discourage work.  This reduction in the supply of labor would drive up the before-tax pay of the highest earners.  All other things equal, their after-tax pay would decrease and after-tax inequality would fall — but (before-tax) measured inequality would rise.

The income distribution should be judged not by how equal it is, but by how people obtained what they have. Inequality due to government-granted privileges, in the form of subsidies, quotas and so forth, is arbitrary and unfair, while inequality due to income earned through work and investment is just.


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