Income Inequality Predicted to Rise

Over the past three decades in the U.S., income from labor (wages, salaries, pensions, etc.) has been declining even as capital income (interest, dividends, investment returns, etc.) accounts for a greater share of total income. A new paper from the Federal Reserve Bank of Cleveland looks at the impact of the decline in the labor share of income and proposes a "likely future path of the labor share and its implications for inequality."

The study found that, depending on the data used for the calculation, labor income as a percentage of total national income has fallen by 3% to as much as 8% since 1980, "with the trend accelerating during the 2000s." The implications of this are spelled out:

Labor income is more evenly distributed across U.S. households than capital income, while a disproportionately large share of capital income accrues to the top income households. As the share that is more evenly distributed declined and the share that is more concentrated at the top rose, total income became less evenly distributed and more concentrated at the top. As a result, total income inequality rose.

The paper goes on to note that income inequality is a measure of outcomes, not of opportunities, and that most of the 30-year rise in income inequality has been attributed to "an increase in the returns to education and in the wage differential between high-skilled and low-skilled labor." The other part of the story, however, is that part of the rise in inequality may be attributed to a "shift from the more evenly distributed type of income [labor] to the more concentrated one [capital].

The study computes the widely-used Gini index to show that the impact of concentrating captial income suggests that the decline in labor income's share of total income raised by Gini index by 2.3%. Using their own model, the study's authors conclude that:

[T]he trend in the labor share declined 1.5 to 2 percentage points between 1980 and 2000, and then dropped an additional 2 to 3 percentage points, for a total of 4 to 4.5 percentage points.

The labor share of income will, over time, converge on its long-run average, according to the paper, by that does not mean that income inequality will decrease:

The concentration of capital income, however, is strongly procyclical, rising during recoveries (figure 5), and this suggests that capital income will become more concentrated at the top in the coming years of the recovery, helping to raise income inequality even further. This effect has dominated the dynamics of income inequality during the past two business cycles, so the future path of income inequality will likely be determined by the strength of the recovery and the associated pickup of the concentration of capital income.

The Cleveland Fed paper is available here.

Paul Ausick

Filed under: 24/7 Wall St. Wire, Economy, Labor
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