Introduction

In September of 2011, the Occupy Wall Street protests began in New York and quickly spread across the globe. Its "We are the 99 percent" slogan encapsulated popular angst over income inequality that had been rising steadily over the years. Today, inequality in the United States, measured by the standard Gini coefficient, is substantially higher than almost any other developed nation, and even some developing countries such as Russia and India.

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While income inequality can be summarized in a few words, its multiple potential causes are more complex. Globalization and technological change have simultaneously led to greater competition for lower-skilled workers--many of whom have also lost union membership--while giving well-educated, higher-skilled workers increased leverage. Changes to tax rates, including favorable treatment for capital gains, may also play a role.

Rising U.S. Income Inequality

Income inequality in the United States has been rising for decades, with the top echelon of earners rapidly outpacing the rest of the population. According to the Congressional Budget Office (PDF), the average real after-tax household income of the top 1 percent rose 275 percent from 1979 to 2007. Meanwhile, income for the remainder of the top quintile (81stto 99th percentile) grew 65 percent. Income for the majority of the population in the middle of the scale (21st through 80th percentiles) grew just 37 percent for the same period. And the bottom quintile experienced the least growth income at just 18 percent.

Furthermore, in 1965, a typical corporate CEO earned more than twenty times a typical worker; by 2011, the ratio was 383:1, according to the Economic Policy Institute.

While many of the suspected drivers of rising income inequality—globalization, technological change and the rising value of education—affect other nations as well, few have seen as stark a rise in inequality. From 1968 to 2010, the share of national income earned by the top 20 percent rose from 42.6 to 50.2 percent, with gains concentrated at the very top. Meanwhile, the "middle class," the middle 60 percent, saw its share decline from 53.2 to 46.5 percent. This increasing income inequality is captured by the steady rise in the U.S. Gini coefficient, from 0.316 in the mid-1970s to 0.378 in the late 2000s. Today, the U.S. income distribution is one of the most uneven among major developed nations (PDF).

Income Inequality in OECD countries

Source: OECD

Globalization and De-Unionization

Economic forces underlie the growth of income inequality. Highly skilled workers have greatly benefited from worldwide opportunities, from the star actor whose movies reach a global audience to the entrepreneur who can quickly and cheaply bring a new product to market through Chinese contract manufacturing (Forbes).

Meanwhile, globalization has brought tough competition to other American workers who have seen jobs move overseas, wages stagnate, and unions decline. The median union member earns roughly a quarter more than a non-union counterpart. Forty years ago, a quarter of private sector workers were represented by unions, but today it is only 6.9 percent. Despite a workforce one-fifth of the size, the public sector has more union members (PDF).

Immigration likely pays a role in stagnant wages, especially among workers without a high school degree, of which immigrants make up about half. One study found that a 10 percent increase in the local immigrant population correlated with a 1.3 percent decline in the price of labor-intensive services, but it is difficult to disentangle this competitive effect from others on the labor market (PDF).

A noted free trade advocate, Alan Blinder, said that while beneficial for the United States as a whole, the increased labor competition from globalization will be painful for many Americans. He advocated for helping displaced workers through a stronger safety net, reforming education, and encouraging innovation and entrepreneurship (WashPost). Fellow Princeton economist Paul Krugman believes that "we need to restore the bargaining power that labor has lost over the last thirty years, so that ordinary workers as well as superstars have the power to bargain for good wages" (NYT).

Education and Technological Change

Most high wages come from high-skill jobs that require a commensurate level of education. After decades of gradually narrowing, the college wage premium has grown dramatically since 1980, as the annual growth in the college educated workforce (2 percent) failed to keep pace with rising demand (3.27 to 3.66 percent) driven by technological change. In 2011, the median earnings of a worker with a bachelor's degree were 65 percent higher than a high school graduate's; holders of professional degrees (MD, JD, MBA) enjoyed a 161 percent premium. Higher educational attainment correlates both with higher earnings and lower unemployment.

However, college degrees do not guarantee good jobs. Falling communication and computer costs are leading to the offshoring and automation of some jobs that were once the purview of well-paid professionals, from scientists in pharmaceutical labs to finance and accounting jobs (Businessweek). There is a widening wage premium between those with advanced degrees and those with a bachelor's degree only. Since the 2000s, the wage premium for those with only a four-year degree has remained flat, while for those with advanced degrees it has continued to grow.

Gary S. Becker and Kevin M. Murphy of the University of Chicago see education as the major driver of rising income inequality. "In the United States, the rise in inequality accompanied a rise in the payoff to education and other skills. We believe that the rise in returns on investments in human capital is beneficial and desirable, and policies designed to deal with inequality must take account of its cause" (TheAmerican). To address income inequality, they argue for policies that would increase the percentages of American youth who complete high school and college, and against making the tax code more progressive.

In a recent survey, 80 percent of economic experts agreed that a leading reason for rising U.S. income inequality was that technological change has affected workers with some skill sets differently than others, but not all prominent economists agree. James K. Galbraith believes that "the skills bias argument--the notion that inequality is being driven by technological change and education and the supply of skills--is comprehensively rebutted by the evidence." He argues instead that the credit cycle has concentrated income in specific sectors, such as finance, tech and real estate (WashPost).

Income Tax Rates

One tool for addressing income inequality is a more progressive tax code (PDF). While some argue that shifting some money from the rich to the poor means that money can be used to create more social utility—the economic concept of declining marginal utility—other see this shift as unfair and unwise because it reduces the ability of more productive citizens to re-invest in the skills and businesses responsible for their higher relative income, thus retarding overall growth. While economic models and theories can attempt to quantify the relationship between inequality and growth, the optimum balance cannot be empirically determined.

The United States has generally cut top income tax rates over the past half century. When John F. Kennedy entered the White House in 1961, the top ordinary income tax bracket--applied to wages and savings interest--was more than 90 percent. Ronald Reagan slashed the top rate from 70 percent in 1981 to 28 percent after 1986. Tax increases under the first President Bush and President Clinton brought the top rate to 39.6 percent, but tax cuts signed by President George W. Bush and reauthorized by President Obama set it to 35 percent.

Tax rates on investment income in the form of capital gains taxes and dividends have also declined, with the current rate of 15 percent the lowest since 1933. Investment income ultimately is derived from the after-tax profits of corporations, whose tax rate has also declined since the Eisenhower-era, from more than 50 percent to today's marginal rate of 35 percent. Corporate income tax has declined steadily as a share both of corporate profits and as a percentage of GDP over the past half century.

The Social Security payroll tax, which funds both old age pensions and Medicare, is regressive because it is a flat rate that only applies to the first $110,100 of wages, in 2012. On the other hand, roughly half of U.S. taxpayers pay no additional federal income tax.

A Tax Policy Center analysis of all federal taxes found overall progressive taxation, with each quartile paying a successively higher rate and the top 0.1 percent paying an effective rate of 30.4 percent. While higher than the 14.1 percent borne by the middle quartile, 30.4 percent is lower than the historical rates paid by this small group, which is earning its largest share of national income since the Great Depression.

Social Program Support

The poverty rate tends to generally follow the economic cycle (PDF). As the economy reached new heights in 2000, the poverty rate fell to 11.1 percent--a rate not seen since 1973—but in 2010 the poverty rate had jumped back up to 15.1 percent.

Under President Lyndon Johnson's Great Society, most assistance was in the form of cash benefits to needy families. Through the 1970s and 1980s, non-cash benefit programs were created or accelerated, including college grants, food stamps, and housing assistance. The 1990s ushered in welfare reform, replacing federal cash assistance with TANF block grant to states (PDF), with work requirements and time limits. The refundable earned income tax credit, (created in 1975) was greatly expanded at this time, providing extra cash to workers in an effort to "make work pay."

Today, record numbers receive food stamps, though one in five Americans struggle to afford food (Stateline). The number of Social Security Disability Insurance recipients has surged by more than 22 percent since the recession began, as that program effectively acts as a long-term unemployment benefit for some (Bloomberg).

From Medicaid to unemployment benefits, many social support programs are driven by decisions at the state level. States have less flexibility to run deficits and many have cut programs to needy citizens. Pennsylvania recently joined other states in eliminating its general assistance program (Stateline). One caseworker observed: "My clients have lost an important source of funds for life's necessities, while they face longer waitlists for job training programs."

Bred for Success?

A longer-term source of income disparity is strengthening: It is increasingly difficult to reach a higher economic status than your parents. Many Americans take pride in the belief that everyone has a chance to "make it big" and rags-to-riches stories are almost legends. But today, more than 40 percent of those born into the lowest income quintile will stay there, and less than 30 percent will make an above-average income.

Among developed countries, only the United Kingdom has less class mobility; in 2006, the Brookings Institution found that 47 percent of U.S. parents' income advantages are passed to their children, greater than in France (41 percent), Germany (32 percent) or Sweden (27 percent). The countries with the highest mobility were Canada, Norway, Finland and Denmark, where less than 20 percent of economic advantages are passed to children (PDF).

Political Impact

The growing gap between the rich and poor may exacerbate political disunity. Economist Joseph E. Stiglitz of Columbia University examined this in his recent book, The Price of Inequality, and argued that no one has an interest in stark inequality. "The rich do not exist in a vacuum. They need a functioning society around them to sustain their position. Widely unequal societies do not function efficiently and their economies are neither stable nor sustainable" (Vanity Fair).

The Pew Research Center found increasing anxiety among America's middle class, with 85 percent expressing greater difficulty in maintaining their standard of living. While a majority of Americans see income inequality as a big problem (TheHill), polls also show more desire for economic growth and greater equality of opportunity (Gallup).

During the debate in late 2010 over whether to extend the Bush-era tax rates, influential behavioral economist Richard H. Thaler asked "whether we want a society in which the rich take an ever-increasing share of the pie, or prefer to return to conditions that allow all classes to anticipate an increasing standard of living" (NYT). The former chairman of Bush's Council of Economic Advisers, N. Gregory Mankiw, argued that raising his marginal tax rate would lead him--and many others--to work less (NYT). This tension between equality and growth is likely to remain unresolved for the foreseeable future.

Finally, an August 2012 paper by the Hoover Institution of Stanford argued that income inequality is not rising. Their analysis considered after tax income and added in non-cash benefits from employers and government programs, and calculated a decline in the U.S. Gini coefficient from 1993 to 2009. The authors argued that reducing income inequality would not improve economic well-being, and policymakers should instead target opportunity inequality.