Monday, November 9, 2015

Causes of Income Inequality in the United States

There are many potential causes of income inequality in the United States.  They include market factors, tax and transfer policies, and other causes.

Market Factors:

  • Globalization - Low skilled American workers have been losing ground in the face of competition from low-wage workers in Asia and other "emerging" economies. While economists who have studied globalization agree imports have had an effect, the timing of import growth does not match the growth of income inequality.
  • Superstar Hypothesis - Modern technologies of communication often turn competition into a tournament in which the winner is richly rewarded, while the runners-up get far less than in the past.
  • Education - Income differences between the varying levels of educational attainment (usually measured by the highest degree of education an individual has completed) have increased. 
  • Skill-Biased Technological Change - The rapid pace of progress in information technology has increased the demand for the highly skilled and educated so that income distribution favored brains rather than brawn.
  • Race and Gender Disparities - Income levels vary by gender and race with median income levels considerably below the national median for females compared to men with certain racial demographics.  Despite considerable progress in pursuing gender and racial equality, some social scientists attribute these discrepancies in income partly to continued discrimination.  In terms of race, Asian Americans are far more likely to be in the highest earning 5 percent than the rest of Americans.  Studies have shown that African Americans are less likely to be hired than White Americans with the same qualifications.
  • Incentives - In the context of concern over income inequality, a number of economists, such as former Federal Reserve Chairman Ben Bernanke, have talked about the importance of incentives: "... without the possibility of unequal outcomes tied to differences in effort and skill, the economic incentive for productive behavior would be eliminated, and our market-based economy ... would function far less effectively."  Since abundant supply decreases market value, the possession of scarce skills considerably increases income.
  • Stock Buybacks - Writing in the Harvard Business Review in September 2014, William Lazonick blamed record corporate stock buybacks for reduced investment in the economy and a corresponding impact on prosperity and income inequality. Between 2003 and 2012, the 449 companies in the S&P 500 used 54% of their earnings ($2.4 trillion) to buy back their own stock. An additional 37% was paid to stockholders as dividends. Together, these were 91% of profits. This left little for investment in productive capabilities or higher income for employees, shifting more income to capital rather than labor. He blamed executive compensation arrangements, which are heavily based on stock options, stock awards and bonuses for meeting earnings per share (EPS) targets (EPS increases as the number of outstanding shares decreases). Restrictions on buybacks were greatly eased in the early 1980s. He advocates changing these incentives to limit buybacks

Tax and Transfer Policies:
  • Income Taxes - According to journalist Timothy Noah, "you can't really demonstrate that U.S. tax policy had a large impact on the three-decade income inequality trend one way or the other. The inequality trend for pre-tax income during this period was much more dramatic." Noah estimates tax changes account for 5% of the Great Divergence.  But many – such as economist Paul Krugman – emphasize the effect of changes in taxation – such as the 2001 and 2003 Bush administration tax cuts which cut taxes far more for high-income households than those below – on increased income inequality.  Part of the growth of income inequality under Republican administrations (described by Larry Bartels) has been attributed to tax policy. A study by Thomas Piketty and Emmanuel Saez found that "large reductions in tax progressivity since the 1960s took place primarily during two periods: the Reagan presidency in the 1980s and the Bush administration in the early 2000s.
  • Taxes on Capital - Taxes on income derived from capital (e.g., financial assets, property and businesses) primarily affect higher income groups, who own the vast majority of capital. For example, in 2010 approximately 81% of stocks were owned by the top 10% income group and 69% by the top 5%. Only about one-third of American households have stock holdings more than $7,000. Therefore, since higher-income taxpayers have a much higher share of their income represented by capital gains, lowering taxes on capital income and gains increases after-tax income inequality.  Capital gains taxes were reduced around the time income inequality began to rise again around 1980 and several times thereafter. During 1978 under President Carter, the top capital gains tax rate was reduced from 49% to 28%. President Ronald Reagan's 1981 cut in the top rate on unearned income reduced the maximum capital gains rate to only 20% – its lowest level since the Hoover administration, as part of an overall economic growth strategy. The capital gains tax rate was also reduced by President Bill Clinton in 1997, from 28% to 20%. President George W. Bush reduced the tax rate on capital gains and qualifying dividends from 20% to 15%, less than half the 35% top rate on ordinary income.  The Congressional Budget Office (CBO) reported in August 1990 that: "Of the 8 studies reviewed, five, including the two CBO studies, found that cutting taxes on capital gains is not likely to increase savings, investment, or GNP much if at all." Some of the studies indicated the loss in revenue from lowering the tax rate may be offset by higher economic growth, others did not.  Journalist Timothy Noah wrote in 2012 that: "Every one of these changes elevated the financial interests of business owners and stockholders above the well-being, financial or otherwise, or ordinary citizens."  So overall, while cutting capital gains taxes adversely affects income inequality, its economic benefits are debatable.
  • Transfer Payments - Transfer payments refer to payments to persons such as social security, unemployment compensation, or welfare. CBO reported in November 2014 that: "Government transfers reduce income inequality because the transfers received by lower-income households are larger relative to their market income than are the transfers received by higher-income households. Federal taxes also reduce income inequality, because the taxes paid by higher-income households are larger relative to their before-tax income than are the taxes paid by lower-income households. The equalizing effects of government transfers were significantly larger than the equalizing effects of federal taxes from 1979 to 2011.  CBO also reported that less progressive tax and transfer policies have contributed to greater after-tax income inequality:  "As a result of the diminishing effect of transfers and federal taxes, the Gini index for income after transfers and federal taxes grew by more than the index for market income. Between 1979 and 2007, the Gini index for market income increased by 23 percent, the index for market income after transfers increased by 29 percent, and the index for income measured after transfers and federal taxes increased by 33 percent."

Other Causes:

  • Decline of Unions - The era of inequality growth has coincided with a dramatic decline in labor union membership from 20% of the labor force in 1983 to about 12% in 2007.
  • Political Parties and Presidents - Liberal political scientist Larry Bartels has found a strong correlation between the party of the president and income inequality in America since 1948.  Examining average annual pre-tax income growth from 1948 to 2005 (which encompassed most of the egalitarian Great Compression and the entire inegalitarian Great Divergence) Bartels shows that under Democratic presidents (from Harry Truman forward), the greatest income gains have been at the bottom of the income scale and tapered off as income rose. Under Republican presidents, in contrast, gains were much less but what growth there was concentrated towards the top, tapering off as you went down the income scale.
  • Non-Party Political Action - According to political scientists Jacob Hacker and Paul Pierson writing in the book Winner-Take-All Politics, the important policy shifts were brought on not by the Republican Party but by the development of a modern, efficient political system, especially lobbying, by top earners – and particularly corporate executives and the financial services industry.  Change in the norms of corporate culture also may have played a factor.
  • Immigration - The Immigration and Nationality Act of 1965 increased immigration to America, especially of non-Europeans.  From 1970 to 2007, the foreign-born proportion of America's population grew from 5% to 11%, most of whom had lower education levels and incomes than native-born Americans. But the contribution of this increase in supply of low-skill labor seem to have been relatively modest. One estimate stated that immigration reduced the average annual income of native-born "high-school dropouts" ("who roughly correspond to the poorest tenth of the workforce") by 7.4% from 1980 to 2000. The decline in income of better educated workers was much less. Author Timothy Noah estimates that "immigration" is responsible for just 5% of the "Great Divergence" in income distribution, as does economist David Card.  While immigration was found to have slightly depressed the wages of the least skilled and least educated American workers, it doesn't explain rising inequality among high school and college graduates.
  • Wage Theft - Wage theft in the United States, is the illegal withholding of wages or the denial of benefits that are rightfully owed to an employee. Wage theft can be conducted through various means such as: failure to pay overtime, minimum wage violations, employee misclassification, illegal deductions in pay, working off the clock, or not being paid at all.  Wage theft, particularly from low wage legal or illegal immigrant workers, is common in the United States, according to some studies. A September 2014 report by the Economic Policy Institute suggests wage theft costs US workers billions of dollars a year and claims wage theft is also responsible for exacerbating income inequality.
  • Corporatism - Edmund Phelps, published an analysis in 2010 theorizing that the cause of income inequality is not free market capitalism, but instead is the result of the rise of corporatism.  Corporatism, in his view, is the antithesis of free market capitalism. It is characterized by semi-monopolistic organizations and banks, big employer confederations, often acting with complicit state institutions in ways that discourage (or block) the natural workings of a free economy. The primary effects of corporatism are the consolidation of economic power and wealth with end results being the attrition of entrepreneurial and free market dynamism
  • Neoliberalism - Some economists, sociologists and anthropologists argue that neoliberalism, or the resurgence of 19th century theories relating to laissez-faire economic liberalism in the late 1970s, has been the significant driver of inequality. Vicenç Navarro points to policies pertaining to the deregulation of labor markets, privatization of public institutions, union busting and reduction of public social expenditures as contributors to this widening disparity.  The privatization of public functions, for example, grows income inequality by depressing wages and eliminating benefits for middle class workers while increasing income for those at the top. The deregulation of the labor market undermined unions by allowing the real value of the minimum wage to plummet, resulting in employment insecurity and widening wage and income inequality. David M. Kotz, professor of economics at the University of Massachusetts Amherst, contends that neoliberalism "is based on the thorough domination of labor by capital." As such, the advent of the neoliberal era has seen a sharp increase in income inequality through the decline of unionization, stagnant wages for workers and the rise of CEO super salaries.


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