Growing Income
Inequality: Roots and
Remedies
THE URBAN
INSTITUTE
THE FUTURE OF
THE PUBLIC SECTOR
Edward M. Gramlich and Mark Long
A series on
the long-term
forces affecting
U.S. social policy
A
merican history goes in waves. The
The same general trends are also visible
dominance of corporate interests durin wage data for other developed countries,
ing the Gilded Age of the late 1800s was
including Sweden, the United Kingdom, the
succeeded by the socially conscious legislaNetherlands, France, and Canada.4 Unlike the
tion of the Progressive Era. The stock market
case in the United States, these increases have
explosion of the Roaring Twenties was sucbeen accompanied by large rises in unemceeded by the social insurance revolution of
ployment among lower income workers.
the New Deal.
What has caused these trends?
The nation may now be on
Numerous theories exist, but the
the crest of another big wave.
balance of evidence seems to be
What has caused
Scores of articles have docutipping toward one explanamented a major change in
tion: growing returns to eduthese trends?
the income distribution,
cation.5 The global econoNumerous
theories
exist,
beginning in the late
my is often fingered as the
but the balance of evidence
1970s. Between 1947 and
villain behind increasing
1973, all incomes grew
economic inequality, but
seems to be tipping toward
together; between 1973
there is evidence that
one explanation: growand 1979, all incomes stagrefutes this.6 The share of
ing returns to edunated together. But from
trade in the U.S. economy did
1979 to 1989, the rate of
not make a precipitous leap in
cation.
income growth was highest for the
the 1980s (at the height of the
top group and dropped steadily
growth in income inequality) but
through the income distribution (see figure on
instead has been rising gradually over time.
page 2).
In any case, trade still represents only slightThis change is sufficiently startling that
ly over one-tenth of the U.S. economy, too
it has been examined and reexamined for
small to have such pervasive effects on the
confirmation. Even more of a gap in income
entire wage distribution.
growth among high and low segments of
households along the income distribution was
Was Public Policy to
found when the Congressional Budget Office
Blame?
(CBO) resolved uncertainties in the Census
1
reporting of capital income. What the CBO
An obvious candidate for blame is public
found was that even within the top group, the
policy. But are tax and transfer policies at
highest growth was concentrated among the
fault for growing income inequality? The
top 1 percent of households. The same trends
short answer is—not really. Is there somehold for both labor and capital income and,
thing public policy can or should do to cordespite considerable individual income mobilrect these tendencies? That answer, though
ity, for lifetime incomes.2 Household wealth,
unpopular in the current climate, is yes.
with and without adjustments for public penSince the greatest movement toward
sion income such as Social Security benefits,
inequality occurred in the 1980s during the
Reagan administration, it is tempting to link
has also experienced these trends.3
No. 3, June 1996
No. 3
THE FUTURE OF THE PUBLIC SECTOR
2
this problem to the trickle-down ecodo to the distribution of income over
they are assessed only on the first
nomics then espoused by the White
the 1980s, perhaps they should do
$62,500 of wage income. In the long
House. Tempting, but by and large,
more.
run, however, the Social Security proinaccurate.
One policy change would
gram provides a substantial amount of
Public policy affects the distribuinvolve taxes and transfers. Taxes
internal redistribution. Low-wage
tion of income most obviously through
could be made more progressive, and
workers may have paid more Social
tax and transfer policies. Income and
transfer payments more generous. It
Security taxes (proportionate to their
corporate taxes are moderately prowill not escape notice that both sugwages) than did high-wage workers
gressive, while transfer policies are
gestions run counter to movements
during their working years, but will
very progressive. To assess how pronow sweeping Washington.
get these taxes back upon retirement,
gressive, CBO analysts computed the
On the tax side, heated debate
with a reasonable rate of return.
distribution of income before and
revolves around the “flat tax.” This
Social Security taxes should therefore
after all federal taxes and transfers
has been proposed by Congressman
be disregarded when computing Gini
in 1990, using the Gini coefRichard Armey (R.ficient. This coefficient
Texas) and the Kemp Tax
ranges from zero to one,
Commission (not to menIncome Growth, 1947–1989, By Income Quintile
with zero denoting full
tion former Republican
equality. They found that
presidential candidates).
Rate of
Income Growth
federal taxes and transfers
Versions of the flat tax
3
were moderating inequalvary, but most are combi1947–1973
1973–1979
ity by accomplishing subnations of a consumption
2.5
1979–1989
stantial redistribution. In
tax and flat or non2
1990, the Gini coefficient
increasing marginal tax
1.5
before all taxes and transrates that effectively
fers were taken into
reduce progressivity in
1
account was .523. The
the marginal rate sched0.5
post-tax transfer Gini was
ule.
.463, a drop of 11.5 perMany
economists
0
cent, even near the end of
favor moving to some
-0.5
three Republican presitype of consumption tax.
Bottom
Second
Third
Fourth
Top
dential terms.
Eliminating progressivity
Income Distribution
Further calculations
in marginal rates, howevSource: Current Population Survey.
reveal a potentially larger
er, is a different matter.
role for the tax and transSince there is simply no
fer policies of the 1980s in contributcoefficients. That done, we are then
way to replicate the present distribuing to today’s income inequality. To
back to the observation that, over the
tion of income tax payments without
illustrate, in 1980, before Ronald
1980s, public policy had almost no
some progressivity in the rate strucReagan assumed office, federal taxes
net effect on the distribution of
ture, all conceivable flat tax proand transfers reduced the preincome. The 1980s saw a big shift
grams—at least if they merely replace
tax/transfer Gini by 16.5 percent,
current income taxes—would involve
away from equality in the distribution
from .473 to .395. Over the decade of
a significant further shift to inequality
of income before taxes and transfers,
the 1980s, however, massive changes
in post-tax incomes.
federal policy effected some redistriraised the pre-tax/transfer Gini from
On the transfer side, attempts to
bution in 1980, and did the same, in
.473 to .523. Were tax/transfer policy
balance the federal budget and limit
roughly similar amounts in present
to have lowered the Gini coefficient
entitlement spending have been
value and percentage terms, in 1990.
by the same percentage in 1990 as in
directed at trimming, not increasing,
Furthermore, adjusting for in1980, the resulting Gini would have
transfer payments. The issues here are
kind benefits such as Medicaid and
been .437 in 1990, rather than .463
broad, ranging from the degree to
Food Stamps—which are not counted
(the actual post-tax/transfer Gini for
which states versus the federal govin Census incomes but for which fed1990 as quoted above). Judged in this
ernment should be expected to design
eral spending grew rapidly in the
stricter manner, it appears that federal
and pay for welfare benefits, to appro1980s—indicates that the federal govtax and transfer policies in the 1980s
priate incentives for Medicare and
ernment may even have ameliorated
did contribute to widening inequality.
Medicaid health providers to control
the distribution of income over the
But not so fast. It turns out that
service costs. However these complex
decade.
the major policy change responsible
and politically sensitive issues shake
for reduced income redistribution was
out, it is clear that cutting entitlement
Should Policy Be
a rise in Social Security payroll taxes
spending will raise inequality.
Changed?
in the middle of the decade. Measured
One promising vehicle for reducin the short term, higher Social
ing
income inequality could be an
The next question is normative.
Security taxes are regressive because
improved
version of the Earned
Whatever tax and transfer policies did
Levy, Frank, and Richard C. Michel. 1991. The Economic Future of
American Families: Income and Wealth Trends. Washington,
D.C.: Urban Institute Press.
Norwood, Janet (ed.). 1994. Widening Earnings Inequality: Why
and Why Now. Washington, D.C.: Urban Institute.
THE FUTURE OF THE PUBLIC SECTOR
RELATED READING
No. 3
Income Tax Credit. The EITC is a
nation cannot create well-designed
Notes
wage subsidy for workers from lowprograms to boost school achieveincome families who have low wages.
ment and college attendance for low1. Gramlich, Edward M., Richard
Kasten, and Frank Sammartino. 1992.
This makes it a more efficient lowincome, disadvantaged students,
“Growing Inequality in the 1980s: The
wage subsidy than the minimum
many of whom are now attending
Role of Federal Taxes and Cash
wage, which benefits all low-wage
poor and overcrowded elementary
Transfers.” In Peter Gottschalk and
workers whether or not they are from
and secondary schools.
Sheldon Danziger, eds., Uneven Tides:
low-income families (and many are
There are caveats to viewing
Risking Inequality in America. New York:
not). Offering the wage subsidy as a
education as a panacea. Numerous
Russell Sage Press.
tax credit to needy workers also helps
studies indicate that simply throwing
sidestep the employment reductions
money at public schools will not
2. Sawhill, Isabel V., and Mark
Condon. 1992. “Is U.S. Income Inequality
that can result from minimum wage
work. Programs must be wellReally Growing?” Policy Bites (June).
policies. The EITC has many virtues,
designed and have sensible incentives
Washington, D.C.: The Urban
but as presently constituted
Institute; Slemrod, Joel. 1991.
presents some problems of
In the long run the most important
“Taxation and Inequality: A Time
enforcement. If ways could be
Exposure Perspective.” Mimeo.
thing
government
at
all
levels
can
do
to
found to improve administration of wage subsidies, it might
3. Wolff, Edward N. 1995.
address inequality involves education. . . .
Top Heavy: A Study of the
be possible to extend such subit is almost impossible to imagine that
Increasing Inequality of Wealth in
sidies further into the wage
America. New York: Twentieth
distribution.
this nation cannot create well-designed
Century Fund.
The trends in pre-tax, preprograms to boost school achievement
transfer income are so striking
4. Gottschalk, Peter, and
that even large government
and college attendance for low-income,
Mary Joyce. 1992. “Is Earnings
interventions may not fully
Inequality Also Rising in Other
disadvantaged students, many of whom
offset them. In the long run the
Industrial Countries?” Mimeo.
most important thing governare now attending poor and overcrowded
5. Levy, Frank, and Richard
ment at all levels can do to
elementary and secondary schools.
Murnane. 1992. “U.S. Earnings
address inequality involves
Levels and Earnings Inequality: A
education.7 Studies of preReview of Recent Trends.”
school education have shown that
Journal of Economic Literature, vol. 30
built into them. Also, even wellprograms like Head Start can more
(September).
designed education programs can
than pay their way for low-income
6. Krugman, Paul. 1994. Peddling
only be effective over time. They will
preschool children. Studies of higher
Prosperity. New York: W.W. Norton and
not cause a significant improvement
education indicate positive investCompany.
in the income distribution by, say, the
ment returns for students, particularly
year 2000. Even so, improving educanow that wages paid to highly educat7. Gramlich, Edward M. 1986.
tional levels, especially for those at
ed people have risen so dramatically.
“Evaluation of Education Projects: The
the bottom, will work against the
It is harder to observe and measure
Case of the Perry Preschool Program.”
trend toward increasing income
returns to investment in elementary
Economics of Education Review, vol. 1.
and secondary education. But it is
disparities.
almost impossible to imagine that this
Edward M. Gramlich is
Dean of the School of Public
Policy at the University of
Michigan and Professor of
Economics and Public Policy.
His many publications include
“Different Approaches for
Dealing with Social Security,”
Journal of Economic Perspectives (forthcoming).
Mark Long is a public
policy graduate student at the
University of Michigan.
3
No. 3
Other Briefs in the Series
No. 1. Declining Economic Opportunity in America,
Isabel V. Sawhill and Daniel P. McMurrer
This series, funded in part by the
Ford Foundation, focuses on challenges for policymaking in the 21st
century.
Advisory Board
C. Eugene Steuerle
Christopher Edley, Jr.
Edward M. Gramlich
Hugh Heclo
Pamela Loprest
Demetra S. Nightingale
Isabel V. Sawhill
William Gorham
No. 2. Whither Federalism?, Martha Derthick
No. 4. Reforming Employment and Training Policy,
Paul Osterman
Published by
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Copyright © 1996
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Cycles of Antistatism
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THE FUTURE OF THE PUBLIC SECTOR
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