a critical analysis of income inequality in america

1Running head: A CRITICAL ANALYSIS OF INCOME INEQUALITY

A Critical Analysis of Income Inequality in America

Grant Gish

IUPUI

2A CRITICAL ANALYSIS OF INCOME INEQUALITY

Abstract

This paper seeks to determine an effective solution (or effective solutions) to income inequality. It

examines a variety of online sources, from online magazines to online research reports. It begins by

establishing the problem with a recent history and current data for income inequality. The paper then

works to understand the causes and effects of income inequality in order to know what issues need to be

addressed when evaluating four different solutions. The solutions were picked based on popularity, as

they are solutions often given by professionals or the general public. The paper approaches each solution

with a non-biased perspective and seeks to find the advantages and disadvantages of each as well as bring

to light details not often thought about when proposing these solutions.

Keywords: income inequality, taxes, minimum wage, education

Figure 1. Average after tax income. This figure graphs average after tax income for different percentiles (Gardner & Abraham, n.d.).


A Critical Analysis of Income Inequality in America

The United States has the highest income inequality of all democracies in the developed world

(Zuckerman, 2015). The issue is becoming increasingly more noticed by Americans, who are turning

toward the leaders of the country and the top one percent to assign blame. As Mortimer Zuckerman says,

“The public has moved beyond the plaintive cry of ‘feel our pain’ to the more angry pronouncement of

‘you are causing our pain.’” It is easy to blame the top one percent, but first, the issue must be thoroughly

examined to fully determine the history, causes, and effects of income inequality. Various solutions exist

for this issue, but each must be critically analyzed to determine the most effective one(s). After extensive

research in order to fully understand income inequality and its solutions, it is apparent the most effective

solution is educating low-skilled workers.

Recent History and Current Statistics

Income inequality is no new issue to America. Since 1979, the median of wages (adjusted for

inflation) have fallen or risen only slightly. As a result, real median earnings today are the same as in

1980. Inequality appears to be independent of what political party is in power, as incomes in 2014 are

twenty-one hundred dollars lower than in 2009 (when President Obama took office) and thirty-six

hundred dollars lower than in 2001 (when President Bush took office). Despite this, the average income

in America is rising (Zuckerman, 2015). To understand why, observe the following graph:

As the

graph shows,

the income

of the top one

percent is rising

at


exponentially higher rates than the rest of America’s income. Even the top five percent cannot keep pace

with the top one percent. Average income in America is not increasing because the poor are earning more,

but instead is increasing because of the rich getting richer (Gardner & Abraham, n.d.). As a result, the top

one percent are beginning to control America’s wealth. In 1944, the top one percent earned just eleven

percent of income. As of 2012, that number has risen to twenty three percent of income (Zuckerman,

2015). The gap between the rich and the poor in America is only increasing. What is causing this huge

gap between the top one percent and the other ninety-nine?

Causes of Income Inequality

Income inequality has a number of causes, including increasing imports, low productivity growth

resulting in a decrease in high paying jobs and an increase in low paying jobs, and CEOs cutting wages

expenses (laying off workers).

Cause One: Increasing Imports

In 1990, the automotive industry imported about thirty-two billion dollars in parts. Last year, it

imported one hundred and thirty-eight billion dollars, a four hundred and thirty-five percent increase over

less than twenty-five years. Increased imports result in less jobs for Americans, meaning less expenses for

businesses and higher unemployment which combine to result in greater income inequality in America.

Harvard Business School found that businesses outsource or use automation because of high corporate

taxes and high employee health care costs, both popular solutions to help eliminate income inequality.

These solutions appear, however, to only be increasing income inequality (Zuckerman, 2015).

Cause Two: Low Productivity Growth

Compared to the rest of the world, the U.S. has very low productivity growth at about one-point-

six percent each year. The consequence, according to Zuckerman, is “low-wage, part-time jobs replacing

high-wage, full-time jobs.” He then backs up his claim later by stating, “The number of full-time jobs last

year was two-point-three million below where it was back at its peak in 2007. Today’s jobs are twenty-

three percent lower in pay than the vanished jobs, according to the U.S. Conference of Mayors and HIS


Global Insight.” The Atlantic agrees with Zuckerman’s claim, presenting further evidence through their

graph:

While the exact cause of America’s low productivity growth is unknown, the results are

detrimental to the middle and lower class. As less high-wage jobs and more low-wage jobs become

available, the income of the majority decreases, consumer spending decreases, and the U.S. economy

suffers (The Atlantic, 2014).

Cause Three: CEOs Cutting Wage Expenses

A large percentage of the top one percent is made up of CEOs, whose pay is rising at incredible

rates for alarming reasons. In 2009, CEO pay was double the average CEO pay for the 1990s, quadruple

the average in the 1980s, and eight times the average for mid-twentieth century decades. However, it

appears one of the main ways CEOs are increasing their pay is by cutting wage expenses. The top fifty

CEOs who cut wages the most earned forty-two percent more than the average S&P 500 Company CEO

(Gardner & Abraham, n.d.). Not only is the top one percent beginning to control the wealth, they appear

to be thriving at the expense of others.

Figure 2. Jobs lost and gained. This figure shows jobs lost and gained for varying wage levels (The Atlantic, 2014).


Effects of Income Inequality

Income inequality has detrimental effects to both the American people and the American

economy through stagnant wages and lower economic growth.

Effect One: Stagnant Wages

In a recent poll from the Pew Research Center, fifty percent of Americans say their incomes are

not keeping pace with the increases in the cost of living, while only five percent say their incomes are

increasing more quickly than the cost of living. In fact, according to the poll, “Forty-five percent of

Americans said they have lived through one serious financial hardship over the last year, an event such as

a job loss, falling behind in bills, or not being able to afford medical care” (Zuckerman, 2015). Wages are

becoming more and more stagnant, as shown in the following graph:

When Figure 3 is compared to Figure 4, it is interesting that the highest rates of wage growth

were during years when the top one percent was earning its smallest share of pre-tax income. There

appears to be a negative correlation between the growth of average American wages and the wages of the

Figure 3. Real average hourly wages. This graph shows the trends in real average hourly wages from 1947-2011 (Gardner & Abraham, n.d.).


top one percent (Gardner & Abraham, n.d.). If this is true, then while the incomes of the top one percent

increase, millions of Americans struggle to pay the bills as a result.

Effect Two: Lower Economic Growth

Income inequality has significant negative impacts on America’s economic growth, according to

both the International Monetary Fund and the Organization for Economic Co-Operation and Development

(OECD). Inequality also results in a shrinking middle class and, according to Washington University in

St. Louis, “A depleted middle class can lead to a downturn in demand for goods and services, a bad

outcome for businesses and the economy as a whole.” To see evidence of income inequality effecting

economic growth, one must simply look at history. Here is a graph of the top one percent’s share of total

pre-tax income from 1913-2012:

The graph shows a fascinating relationship between the state of the U.S. economy and the level of

income inequality. The highest level of income inequality in this graph was in 1928, the year the Great

Depression began. The second highest level was in 2007, the year the Great Recession began. Meanwhile,

income inequality was at its lowest during the 1950s-1970s, a time of great economic success in America.

Through Figure 5, it is easy to see the relationship between high income inequality and a low economic

growth in America (Gardner & Abraham, n.d.). Figure 4, of course, raises the question, “What does it

Figure 4. Share of Pre-Tax Income. This graph shows what percent of pre-tax income the top one percent have by year (Gardner & Abraham, n.d.).


mean that the top one percent’s share of pre-tax income is once again reaching levels where economic

collapse soon followed?” If this is an indicator of hard times to come for America, the effects of income

inequality must be alleviated.

Solutions for Income Inequality

A variety of solutions exist for income inequality, with the most popular being the rich spreading

their wealth, taxing the rich, raising the minimum wage, and educating low-skilled workers.

Solution One: The Rich Should Spread Their Wealth

Many people look at the rich and say, “Why don’t they donate more? They have so much and

others have so little.” According to The Atlantic, “The wealth of the world’s one thousand six hundred

forty-six billionaires combined is five-point-four trillion dollars– a third of U.S. yearly GDP – while there

are eight hundred and seventy million people living in extreme poverty. Oxfam calculated that the

revenues from a one-point-five percent tax on the wealth of the world’s billionaires could save twenty-

three million lives if put into healthcare, or put every child in the world into school if used for education”

(The Atlantic, 2014). Upon hearing this, it is especially hard to accept that the rich hold on to so much of

their money. After all, if they would all just donate one-point-five percent of their wealth it could forever

change the world. However, wealth distribution is not a technique that has worked in the past. It must be

remembered that the top one percent earned their money and often invest more time than the average

person to get to where they are. In fact, one percenters are three times as likely to work over fifty hours a

week as the other ninety-nine percent (Dewan & Gebeloff, 2012). Also, the top one percent is already

responsible for thirty percent of philanthropic giving (Conover, 2012). Additionally, many of the top one

percent are business owners, meaning they employ hundreds or thousands of workers. The top one

percent already spread their wealth in various ways, so it is difficult to encourage them to get rid of their

hard-earned money. Adam Katz, a one percenter who creates jobs and gives to charitable causes, said it

best: “[The ninety-nine vs. one battle] shouldn’t be relevant. I’m not hurting anyone. I’m helping a lot of

people” (Dewan & Gebeloff, 2012).


Solution Two: Tax the Rich

So, if the rich won’t donate more of their money, why doesn’t America just take it from them?

Forty-nine percent of Americans believe raising taxes could help reduce income inequality, according to

the Pew Research Center. Professional organizations like the Economic Policy Institute claim taxing the

rich would reduce income inequality (The Atlantic, 2014). Even almost all of the one percenters

interviewed for Dewan and Gabeloff’s article in the New York Times said, “The wealthy could and

should shoulder more of the country’s financial burden, and almost all said they viewed the current

system as unfair.” With this overwhelming support, why not tax the rich?

Because it won’t work. Thomas Piketty wrote Capital in the Twenty-First Century, where one

solution he presents to solve income inequality in the U.S. is an eighty percent tax rate on incomes above

five hundred thousand or one million dollars or a fifty-to-sixty percent tax rate on incomes above two

hundred thousand dollars (while this may seem outrageous, France actually recently instituted a seventy-

five percent income tax rate for top earners, although it was reversed about a year later). Tax

Foundation’s Taxes and Growth model calculated the economic effects of these tax brackets through

changes in costs of labor and costs of capital (taxfoundation.org, n.d.)

Piketty’s proposed tax rates would decrease GDP by almost six hundred billion dollars, decrease

the wage by over one-point-five percent, and cause the economy to lose over two million jobs. This

calculation assumes no change to capital gains and dividends. If they were to also be taxed, GDP would

drop almost three trillion dollars, wage rate would drop almost fifteen percent, and the economy would

lose almost five million jobs (Schuyler, 2014). Obviously, this is not a route we should pursue.

Chris Conover, in his article in Forbes magazine, approached this solution a little more logically.

In 2009, the top one percent earned thirteen-point-four percent of U.S. income but covered thirty-eight-

point-seven percent of federal income taxes. Compared to the average American household, the top one

percent made just less than sixteen times as much income but paid “more than forty times as much in

federal income taxes.” With all other taxes factored in, the top one percent pays twenty-two-point-three

percent of federal taxes. Each one percenter pays twenty three times as much as the average American


household, which is about three hundred and thirty thousand dollars. Now, if the U.S. were to increase

taxes further, the top one percent can move out of the country and renounce their citizenship (which

happened in France). As a result, the bottom ninety-nine percent would have to pay at least sixty-three

percent higher federal income taxes to make up for the lost tax revenue. Raising the taxes of the rich is

not a good solution.

Solution 3: Raise the Minimum Wage

Over sixty percent of America is in favor of raising the minimum wage (Zuckerman, 2015).

While in theory this provides more money to low-income families, the reality is not so. Only about two

percent of American workers earn minimum wage or below (Patton, 2014). Over seventy-five percent of

these minimum wage workers above twenty-five years old are above the poverty line, and just sixteen-

point-five percent of minimum wage earners are single parents. According to the American Legislative

Exchange Council, studies have shown an absence of a relationship between raising the minimum wage

and decreasing poverty. Some low-skilled workers benefit, but some lose work hours or their jobs. In fact,

increased minimum wage can decline the GDP lower-skilled workers generate. If employers have to pay

more for employees, they want to make sure they have higher quality employees. This would cause more

lower-skilled workers to be unemployed. The Council states, “Raising the minimum wage favors those

who already have jobs at the expense of the unemployed.” Also, when minimum wage has increased in

the past, the businesses affected most (in a negative way) by the increase were businesses that hired low-

income workers and businesses that had a large percentile of low-income customers (Council, 2014).

Mike Patton, in his article in Forbes, calculates that an increase in the minimum wage from seven dollars

and twenty-five cents an hour to fifteen dollars an hour results in a total increase in U.S. GDP of only just

over one percent, assuming all extra income is spent (which it won’t be). He also agrees that raising the

minimum wage will not help low-skilled workers, as it could result in job cuts and increased automation

to help reduce expenses (Patton, 2014). After an increase in minimum wage, there are more unemployed

low-skilled workers. As the American Legislative Exchange Council says, “Increasing the minimum

wage will hurt the exact people it is meant to help.”


Solution Four: Educate Low-Skilled Workers

Education is the most effective solution to income inequality. Brad Hershbein, Melissa Kearney,

and Lawrence Summers of Brookings Institution calculated what would happen if there were a ten

percent increase in B.A. attainment among males aged twenty-five to sixty-four. They found that if this

were to happen, it “would almost entirely wipe out the reduction in median wages that has been

experienced from 1979 to 2013.” While education will not decrease the wages of the top, it will increase

the wages at the bottom (White, 2015), and Hershbein et al. found that increased education will benefit

the twenty-fifth percentile the greatest. The following tables show their findings:

As the tables show, a ten percent increase in B.A. attainment would increase the twenty-fifth

percentile’s wages by over thirty-three percent and also lower the wage ratios between all percentiles.

Hershbein et al. conclude, “Our nation should aim to increase the educational attainment and, more

generally, the skills of less-educated and lower-income individuals because in the long run, this is almost

surely the most effective and direct way to increase their economic security, reduce poverty, and expand

upward mobility."

Conclusion

Figure 5. Increased earnings. This table shows the increase in earnings resulting from increased education (Hershbein, Kearney, & Summers,2015).

Figure 6. Wage percentile ratios. This table shows the changes in wage percentile ratios from increased education (Hershbein, Kearney, & Summers, 2015).


Income inequality has been an issue in the United States for decades. However, it is more

complex than it first appears. With causes such as increasing imports, low productivity growth resulting

in a decrease in high paying jobs and an increase in low paying jobs, and CEOs cutting wages expenses

(laying off workers) and effects such as stagnant wages and lower economic growth, income inequality is

an incredibly difficult issue to solve. Although some inequality may always be present, there are different

popular solutions that exist to alleviate its effects and lower the level of inequality. While the rich

spreading their wealth, taxing the rich, and raising the minimum wage all have possible upsides, the risk

of each is too great. The most effective solution is the education of low-skilled workers. Not only will this

significantly raise the bottom twenty-fifth percentile’s incomes, it will lower wage ratios between all

percentiles. This is a solution America needs to take seriously, whether through providing funds for low-

income, low-skilled workers to receive an education or through marketing the benefits of higher

education to the entire country. U.S. President Barack Obama in regards to this issue stated: “We have an

obligation and a responsibility to be investing in our students… We must make sure that people who have

the grades, the desire and the will, but not the money, can still get the best education possible.”

References

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millionaires-reasons-to-give-thanks-for-one-percent-taxes/


Council, A. L. (2014, March). The State Factor. Retrieved from alec.org: http://www.alec.org/wp-

content/uploads/Raising_Minimum_wage.pdf

Dewan, S., & Gebeloff, R. (2012, January 14). Among the Wealthiest 1 Percent, Many Variations.

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http://inequality.org/income-inequality/

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hershbein_kearney_summers.pdf

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mockery-of-the-american-dream/ar-AAa63Rj?ocid=mailsignout

a critical analysis of income inequality in america

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