Monday, February 17, 2014

Income Inequality

“Income inequality” has become the current theme and in years to come it will influence our debates on many social and policy issues. President Barack Obama has income inequality as one of his major themes during the remaining term of his presidency and has talked a lot recently about reducing income inequality. He proposes to raise minimum wage as a potential solution to reduce income inequality.

Income inequality in its basic form is the wealth and income gap between the wealthy and those who earn considerably less than the wealthy. Economists track an index called Gini coefficient that measures the variance of income which ranges between 0 and 1. A score of 0 means that everyone in the society earns the same income and a score of 1 means all but one person in the society earn nothing. The Gini coefficient of the U.S., in 2011 was 0.477, in 2010 it was 0.469, and in 1967 it was 0.397. Each country is different and comparing the Gini coefficients among countries might not be fruitful. To give another perspective, according to a report published in 2012 by CNN senior writer Jennifer Liberto, CEO’s earned 380 times more than the typical American worker.

There are multiple causes cited for rising income inequality. First, the fundamental shift from manufacturing jobs to service sector jobs. Manufacturing jobs were high paying jobs and these jobs have migrated to low cost centers such as emerging nations. Those emerging nations are witnessing a rise in income as they become more competitive in the global marketplace. Second, corporations are expected to keep a tight leash on costs, which puts a downward pressure on wages. Finally, technology also has helped eliminate many jobs.

According to studies published independently by the Congressional Budget Office and the Tax Foundation, the government is already redistributing money and the federal-tax-and-spending system is extremely progressive and redistributive. The system redistributes $1.5 trillion from the top 40% of the Americans to the rest 60%. Is this redistribution enough to bridge the gap? Perhaps not. What then is the solution?

Besides raising minimum wages there could be other policy measures to address the situation. Supply side incentives such as change in tax policies, access to education and employment training are touted as potential long term solutions for income inequality. Some might even be tempted to think - should we even try to reduce income inequality? On the lighter side of things, analysis performed by Beverly Lahaye Institute found that among families headed by two married parents only 7.5% lived in poverty. Get a good education, get a job and get hitched. 

Sources: This report was prepared from the following -
1. “Income Inequality in America – Causes of Income Inequality” by Kimberly Amadeo
2. “CEO pay is 380 Times Average Worker’s – AFL-CIO” Jennifer Liberto, CNNMoney, April 19, 2012.
3. “How do you measure Income Inequality?”, Damian Paletta, WSJ, Dec 5, 2013.
4. “Here’s what ‘Income Equality’ would look like”, Scott Hodge, WSJ, Feb 13, 2014.
5. “How to fight Income Inequality: Get Married”, Ari Fleischer, WSJ, Jan 12, 2014.

Dr. Subramanian “Subbu” Rama Iyer is an assistant professor of Finance at UNM Anderson School of Management.  Click here to contact Dr. Iyer.

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