Economic inequality is present in all economies, societies, countries regardless of what type of economic system - communism, capitalism, socialism, etc.  Substituting politics and central planning for markets does not eliminate income inequality.  Remember, significant income inequality even exists within a family, almost as much as society at large!!  Inequality of outcome seems inevitable.

NBA, NFL, BASEBALL
Nobel Prizes
Olympics
Sales
Grade Points, etc.

How much inequality exists in a market economy like the U.S.?  What can/should be done about it?

Market economy does not have a central distributing agency carving up the economic pie and allocating slices to individuals.  Distribution of income is determined by the quantity and value (quality) of resources supplied by various individuals.
 

INCOME INEQUALITY IN THE U.S.

See page 416.  Quintile analysis of household income (pre-tax) distribution.  Slight increase (decrease) in the top (bottom) quintile's share of income.

One adjustment is for: a) income taxes paid and b) transfer payments since high income households pay a greater share of taxes (progressive income tax) than low income households.  After adjusting for taxes and transfers (food stamps, general assistance, AFDC, subsidized housing, etc.), there is less inequality.  For 1992, bottom quintile household income goes UP from 4.3 to 5.5%, and top quintile household income goes DOWN from 44.7 to 42%.

What about differences in households that might contribute to earnings differences?  If all households were identical, the use of aggregate data to measure income inequality would be justified, however many differences exist such as:

1) Large household vs small households
2) Prime-age earners vs elderly retirees
3) Multi-earner households vs households with no current earners
4) Husband-wife families vs single parent households.

We are violating ceteris paribus condition by comparing aggregate, unadjusted household income.  For example, consider the effect of age on household income and typical life-cycle earnings:

Many young people are not earning a lot of money, either because they have just started a career or because they are still in medical school, law school, getting a graduate degree, etc.  Current income would be very low, but we wouldnt really consider them poor.  Future (lifetime) income could be very high, e.g. future surgeon in med school.  In prime-age years (35-55) income would be very high.  During retirement, income would be very low again even for very wealthy people who own their house, have lots of money in the bank, pension funds, etc.

Point: Most individuals would start in the bottom quintile when they are young, then be in a much higher quintile during prime-age years, and then fall back into the lowest quintile again.  Life-cycle earnings.  Lumping all households together distorts the assessment of inequality.  Even if all individuals made the same lifetime income, income inequality would still exist when we looked at the aggregate data.

Consider other differences between high and low income households, page 418.  Comparing the lowest quintile to the highest quintile, we can see that:
1. High income households have more education
2. High income households are more likely to be between 35-64 years of age.
3. Low income households are more likely to be YOUNG (Under 35) or OLD  (Over 65).
4. Almost all (95%) of high income families are married couple families.
5. Over half (51%) of low income households are single-parent families.
6. High income household actually have more people on average per household (might make a difference in income when children start working and still live at home).
7. High income families have more income earners (2.3) per household than low income families (.74).
8. Top (bottom) 20% of income earners contributed 32% (7%) of the total numbers of weeks worked per year, indicating that work effort contributes to income inequality.  Low income households are either working part time or out of the labor force (retired, full-time parent, etc.).
9. High income households made about 10x as much as low income households (46% versus 4.2% of total income), but worked about 5x as much, indicating that earnings per week of top income earners was only 2x that of low income workers.
 

WHY HAS INCOME INEQUALITY INCREASED?

Page 416, Share of Top 20% was 9.48x the bottom 20% in 1950 compared to 11.11 times in 1994.  Why?

1. The number of single parent families has doubled, at the same time that there are more double-earner families (labor force participation rate has increased for women), leading to an increase in income inequality.

2. Earnings differential between skilled and less-skilled workers have increased.  There has been an increasing premium for highly skilled, highly educated workers in an increasingly technical Information Age economy.  In the 1950s it was much easier to make a decent living, doing something physical, with limited education.  Now it is much harder to do that.

3. As marginal tax rates fell in the 1980s, there was increased incentive and payoff for productive activity, greater work effort, expanded tax base for high income households.  Less tax-shelter activity, more work activity, more dual-earner households, more compensation in the form of wages, income become more visible (and taxable), leading to income inequality, as high income households increased income.
 

INCOME MOBILITY

Is it the same households who are poor over time, or is there income mobility over time.  If the poverty rate is 12%, is it the same 12% of the people over time or not?  Most of the statistics don't track people over time, it is just a static "snapshot" of a given point in time of aggregate data.  See page 423 for a dynamic analysis, looking at a large group of households in 1979 and then looking at those SAME households 9 years later in 1988.

Read across the top row.  Of the top 20%, about 65% stayed in the top quintile and 35% moved down one or more quintiles 9 years later.  Indicates that once a person achieves high income status, they tend to stay there, but there is some mobility as people retire, lose or change jobs, go back to school, etc.

Read across the bottom row.  Of the people in the bottom quintile in 1979, almost 86% had moved up at least one quintile and only 14% of the lowest income group were still in the lowest quintile in 1988.  About 21% moved up one quintile, 25% moved up 2 quintiles, 25% moved up 3 quintiles, and almost 15% moved from the bottom to the top, e.g. people who were med or law students in 1979 and were making high salaries by 1988, or people who were starting businesses in 1979 and they became successful by 1988 (Bill Gates).

Point: There IS income mobility, almost 86% of taxpayers moved out of the bottom quintiles over a 9 year period.  Households with low incomes are not permanently poor.  Younger, temporarily poorer workers gain experience, education, training and move into higher income groups.  Life-cycle earnings.

Since there is significant income mobility, it might be better to look at differences in household expenditures (consumption) as a more accurate indicator of economic status than income.  Example: person in college or grad school living on scholarships, loans, grants, etc. would have consumption expenditures greater than low or no current income.  Or retired people with very low current income, living on savings - their current consumption would be greater than current income.

See page 416.  There is less inequality in household expenditures than in family income.  Bottom (top) quintile consumes 7% (39.7%)of total compared to 4.2% (46.7%) of income.