U.S. Income Inequality Has Reached Pre-War Europe Levels

If we could attach a scale to inequality -- like Homeland Security's phased-out system of colors and vague words to indicate the potential for terrorism -- America's level of income inequality could be labeled "Pre-War Europe." And that seems a precarious level.

But where does this fall on the total scale? Does this mean we're headed for a 21st-century Archduke Ferdinand powder-keg scenario? Or will inequality eventually level off without dramatic upheaval?

The inequality scale
Here's the data on what the top 10% of earners take as a share of total income:

Source: The World Top Incomes Database.

The important things to note here are that income inequality historically hasn't trended higher than its current level. The last time this measure of inequality was this high was in the 1930s, before a quick and major readjustment in the 1940s. But will these trends continue into the future?

The future of inequality
Thomas Piketty, a French economist who studies inequality, believes wealth concentration equals net-of-tax rates of return minus growth rates. That means:

  • Inequality will increase as tax rates decrease
  • Growth helps lessen inequality
  • Low, zero, or negative growth increases inequality

As Piketty writes in a recent presentation (link opens PDF), given increased tax competition between countries that can lower tax rates and worldwide growth still hungover from the Great Recession, inequality could continue to increase past historical levels.

We can also look at what has caused previous drops in inequality, like that of the 1940s. One research paper (link opens PDF) attributes that lessening of inequality to an increased power of labor unions, changes in taxation, and increased corporate governance. There are signs that these same factors are coming back to rein in inequalities' rise.

Labor unions
While labor union membership has declined substantially over the past 30 years from 24% of employed workers to 11% today, there have been stands by historically unorganized industries. For example, fast-food workers are striking across the country.

On the other hand, as another example of labor losing the fight, Boeing's (NYSE: BA  ) machinist union voted against a contract that would have secured work on its future 777X aircraft in Washington State -- but with changes to the workers' pension program. Now Boeing is looking at 22 other states in which to create an estimated 8,500 jobs. And, while Boeing is looking to save on labor costs, its recent decision to increase its dividend by 50% and authorize $10 billion in buybacks demonstrates how those with wealth can capture increased capital gains.

Taxes
Tyler Cowen, an economist at George Mason University, writes, "The next major struggle ... will be over whether taxes on personal wealth should rise -- and by how much." He continues:

Higher wealth in a nation means that there is more to take, and growing inequality means there are more problems that its government might seek to remedy. At the same time, however, this new economic configuration will mean greater political influence for the holders of that wealth, and that will make higher wealth taxes harder to achieve.

The modern fight over income distribution has already started with Occupy protests, but it has yet to take center stage on the political agenda.

The top of inequality
Piketty notes that the history of inequality is "political, chaotic, and unpredictable." With the increased attention inequality has been given, though, it seems society does have a limit on just how unequal things can get. The U.S. recently passed its historic high, and while it seems unlikely a World War-type event will occur, dramatic changes in policy might halt further inequality increases.

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Read/Post Comments (10) | Recommend This Article (11)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 18, 2013, at 10:34 PM, MartyTheCanuck wrote:

    Inequality was at its lowest in the 40's, 50's and 60's. Ask you parents or grandparents who grew up in that era what they had for presents at Christmas, and ask yourself if your kids will be better of next week.

    Greater inequality isn't greater poverty, the USA being richer than the more "equal" France. It's at best a distraction from a government failure ( Obamacare ) or at worst a political selling point that will lead to bad policy.

  • Report this Comment On December 19, 2013, at 8:38 AM, DonkeyJunk wrote:

    During the 40s, 50s, and 60s it took one person working full time to maintain a standard of living similar to what we have now. That doesn't seem like an improvement by comparison.

  • Report this Comment On December 19, 2013, at 10:03 AM, Mwhy wrote:

    I disagree Donkey(Shrek voice).

    Our standard of living today is much better then our grandparents/parents. In general, we have bigger houses, more than 1 car, and oodles of toys(computers, xbox, smart phone).

  • Report this Comment On December 19, 2013, at 10:15 AM, Mathman6577 wrote:

    Income inequality is the latest distraction from Obamacare by the left-wing. It is disappointing that TMF is part of the crowd.

  • Report this Comment On December 19, 2013, at 11:01 AM, TXObjectivist75 wrote:

    What business is it of anyone's especially the government, who has what? Unless he stole it, it's nobody's business that Donald Trump has billions of dollars, and Joe Smith down the street only has a $50K IRA to his name. Income inequality BS is just another way to distract the masses and implement more control over the economy. Motley Fool needs to move it's headquarters out of VA (come to Texas, see how a real free state works), you guys are getting sucked into the DC black hole.

  • Report this Comment On December 19, 2013, at 11:17 AM, Mathman6577 wrote:

    So what is the proposal? Wealth confiscation? 95% tax rate?

  • Report this Comment On December 20, 2013, at 12:48 PM, anash91 wrote:

    An easy fix would be to make dividends tax deductible like in other countries, and tax dividends at higher rates as you move up with how much you make. That would help out the little investor a lot, as dividends would be a higher payment to shareholders. Income inequality doesn't matter when everyone is rich compared to the rest of the world though. My sister and her husband live with one income of $17 an hour, and they own their own home in CA. It's all about how you allocate. How many luxuries were there in the 40's-70's as there are today? Few had a computer, owned more than 1 car, air conditioning wasn't standard in homes. If we lived now with only the luxuries that were available in that time period, we would have lots of extra cash. The reason income inequality is brought up is to make americans turn against each other.

  • Report this Comment On December 20, 2013, at 1:20 PM, SkepikI wrote:

    ^ an even easier "fix" if you need one is to print lots of fiat currency so that the measure of wealth becomes worthless and then lavish bunches of it on people who don't work and are in the bottom 10%. AND THEN we could actually shrink the bottom 40% and raise them up by not charging them income tax and REFUNDING them money that they dont pay... .. ohhh, wait we already do those things... and they all worked...ulp, not so well. Maybe if we did the opposite things would turn out better.

    My proposal Mathman is to tax the poor. If you tax something you will get less of it. This proposal scandalized my 25 year old daughter...until she got her first post grad degree paycheck.... ;-)

  • Report this Comment On December 24, 2013, at 8:01 AM, Mathman6577 wrote:

    We should tax the government -- I'd like to see less of it.

  • Report this Comment On December 24, 2013, at 4:55 PM, SkepikI wrote:

    ^ Well, now there's a thought I hadn't explored.... maybe some sort of fine... every elected official state, local and federal and all their staffers have to pay...mmm and we could start low, tie it to inflation times the number of years since the individual has actually worked in private industry, with exclusions for those who contract to government... Brilliant!

    I hear very often from public employees that they pay taxes too... a 40% surcharge seems about right since ALL of their wages come from the rest of us...

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