Inequality - Different Economic Perspectives

Inequality is on the rise. In America, the top 0.1%’s share of wealth has risen from 7% in 1978 to 22% in 2012, [1], and the top 1%’s share of after-tax income rose from 9% in 1960 to 15% in 2019[2]. Meanwhile, the share of income of the bottom 90% has steadily declined. Yet, the issue of inequality is incredibly divisive among economists. This article explores two distinct perspectives held by economists regarding the significance of inequality and the actions that should be taken to address it.

Some, like French economist Thomas Piketty, sound the alarm over the escalating income and wealth inequality in America. Piketty shows in his 2013 book Capital in the Twenty-First Century that wealth inequality allows firms to use accumulated wealth to engage in rent-seeking for personal benefit. Common examples of rent-seeking include monopolies or regulatory capture—firms or individuals wielding political connections to benefit themselves.

The OECD furthers find that inequality has reduced growth by up to 9%. [3] Their reasoning for the stalling growth stems from the bottom 40% of earners investing less in education, resulting in lower economic outcomes. In a similar light, the IMF found that greater income inequality hurts consumption and drives excessive borrowing by low and middle-income households, resulting in lower economic growth [4] and higher volatility [5], respectively. As such, these economists advocate for higher taxes on wealth, capital gains, or income to redistribute wealth top-down. 

However, many economists are skeptical. Piketty's methodology has fallen under criticism for ignoring diminishing returns on capital [6], and MIT's Kristin Forbes [7] and Harvard's Robert Barro [8] [9], contradicting the OECD study, show that an increase in a country’s level of income inequality is positively correlated with growth. They posit that this is due to inequality's effect incentivizing innovation. These economists contend that inequality is merely an inevitable consequence of capital investment and argue that as the standard of living continues to improve, the effects of inequality are ultimately inconsequential. For instance, middle-class wealth has surged by 82.1% since 1990, and between 2017 and 2018, [10] the real median earnings of all workers grew by 3.4%. [11]

This skepticism carries into a distrust of redistributive taxation aimed at curtailing inequality for fears that these policies will only cause capital flight whilst failing at redistributing wealth. Mankiw wrote, responding to Piketty, “if closing the gap between rich and poor lowers everyone’s standard of living, as I believe Piketty’s global tax on capital would do, I see little appeal to the proposal.” [12]

References

1: Saez, E., & Zucman, G. (2016). Wealth Inequality in the United States since 1913: Evidence from Capitalized Income Tax Data. The Quarterly Journal of Economics, 131(2), 519–578. https://doi.org/10.1093/qje/qjw004

2: Piketty, T., Saez, E., & Zucman, G. (2017). Distributional National Accounts: Methods and Estimates for the United States. The Quarterly Journal of Economics, 133(2), 553–609. https://doi.org/10.1093/qje/qjx043

3: Cingano, F. (2014). Trends in Income Inequality and its Impact on Economic Growth. In OECD Social, Employment and Migration Working Papers. OECD Publishing. https://doi.org/10.1787/5jxrjncwxv6j-en

4: Alichi, A. Rising Income Polarization in the United States. (2016, June 28). IMF. https://www.imf.org/en/Blogs/Articles/2016/06/28/rising-income-polarization-in-the-united-states

5: Kumhof, M., Rancière, R. G., & Winant, P. (2013). Inequality, Leverage and Crises: The Case of Endogenous Default. SSRN Electronic Journal. https://doi.org/10.2139/ssrn.2376683

6: Rognlie, M. (2014). A note on Piketty and diminishing returns to capital. http://mattrognlie.com/piketty_diminishing_returns.pdf

7: Forbes, K. J. (2000). A Reassessment of the Relationship Between Inequality and Growth. American Economic Review, 90(4), 869–887. https://doi.org/10.1257/aer.90.4.869

8: Barro, R. (1999). Inequality and Growth in a Panel of Countries*. https://scholar.harvard.edu/files/barro/files/p_inequalitygrw.pdf

9: Barro, R. (1999). Inequality, Growth, and Investment. Library Union Catalog of Bavaria, Berlin and Brandenburg (B3Kat Repository). https://doi.org/10.3386/w7038

10: McCloskey, D. How Piketty Misses the Point. (2015, July 27). Cato Institute. https://www.cato.org/policy-report/july/august-2015/how-piketty-misses-point#:~:text=SUPPLY%2C%20DEMAND%2C%20AND%20CREATIVE%20DESTRUCTION&text=The%20fundamental%20problem%20is%20that,supply%20responds%20to%20higher%20prices.

11: Current. (2024). USAFacts. USAFacts. https://usafacts.org/state-of-the-union/standard-living/#middle-class-wealth-has-increased-821-since-1990-however-middle-class-families-went-from-owning-122-of-wealth-in-1990-to-72-in-2021

12: Bureau, U. C. (2019, December 4). Income, Poverty and Health Insurance Coverage in the United States: 2018. Census.gov. https://www.census.gov/newsroom/press-releases/2019/income-poverty.html#:~:text=not%20statistically%20significant.-,Earnings,respectively%2C%20between%202017%20and%202018.