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  • Writer's pictureEvelyn Chen

The Rise of Income Inequality

Income is a flow concept and includes profits from businesses, wages, and rents from properties and interests from savings. Income inequality is the unequal distribution of household or individual income across the various participants in an economy. For example, in the UK the share of income going to the top 10% of the population fell over the 40 years to 1979, from 34.6% in 1938 to 21% in 1979, while the share going to the bottom 10% rose slightly. However, since 1979 this process of narrowing inequality has reversed sharply; inequality rose considerably over the 1980s, reaching a peak in 1990. Inequality peaked in 2009-2010 after the financial crisis of 2008 before falling again but not to pre-1980 levels. Therefore, in the UK, rising inequality has seen a dramatic increase in the share of income going to the top, a decline in the share of those at the bottom and, more recently, a stagnation of incomes among those in the middle. Indeed, in 2010, while the top 10% received 31% of all income, the bottom 10% received just 1%.

Some argue a society with economic inequality is fairer than a society with equal wealth distribution, especially from the perspective of the wealthy. This is because although redistribution of income does generally benefit all members of society, the majority of the costs for those social benefits are borne by the wealthy segments of society. If redistributive taxes become too high, wealthy households may be forced to move abroad or find ways to avoid and evade tax. This means that the government would get less in tax revenue each year, which would damage the economy because of the budget deficit, and thus the national debt might increase, possibly leading to the government becoming bankrupt. Besides, the government would have less to spend on public goods and transfer payments which lower the living standards of the most vulnerable in society. For example, the sums obtained from the supertax were meager, standing at €260m in 2013 and €160m in 2014, and affecting 1,000 staff in 470 companies. Over the same period, the budget deficit soared to €84.7bn. François Hollande’s unpopular tax changes that imposed a 75% rate on earnings above €1m (£780,000) will quietly disappear.

In addition, economic inequality does produce economic benefits. For example, income inequality incentivises people to become more productive and innovative, which drives economic growth and so improves the living standards of everyone in the economy. Large salaried executive positions, for example, create an incentive for lower-paid workers to win coveted labor positions. The lower-paid members of a society can also work harder, create new businesses, or invent new products to become a member of the highest income group. On the other hand, when the gap between income levels is small, those in lower-income groups have less of an incentive to move up in income.

This can be shown in the US, where the economy expanded and the rates of income inequality increased in the years prior to 2008. Inequality fell between 2007-2008, during the economic recession. Then, as the U.S. economy recovered from the recession, so did rates of income inequality.

However, inequality can also stifle growth in the long term. There are many reasons for this. For example, a high level of economic inequality results in increased crime, a low standard of public health and a low standard of state education. This lowers the productivity of the workforce as well as wasting the talent of people who grew up in poverty and failed to reach their full potential because of poverty. Therefore, income inequality stifles economic growth by causing the productive potential of the economy to fall.

Moreover, in the face of increasing food prices and lower incomes, support for pro-growth government policies can decline. In the long term, this can cause the economy’s growth to decline. Therefore, income inequality causes a lack of political support for pro-growth policies, which lowers everyone’s living standards. This has actually happened in the US. Low-skilled workers were either more likely to be unemployed or paid less than highly skilled workers in the US. Due to globalisation, firms in the US outsourced low-skilled manufacturing jobs to countries like China whilst specialising in highly skilled industries such as computer science. As a result, many low-skilled workers believed that applying protectionist policies would give them back their jobs and so voted for Donald Trump as President. Donald Trump’s presidency could cause the US’s economy to decline because of his protectionist policies which make free trade between the US and other countries harder.

Overall, the economic effects of rising income inequality are more negative than positive. This is because great income inequality creates poverty, which has negative effects on both the people in poverty and the economy as a whole. Although income inequality can incentivise people to become more innovative and productive which increases economic growth, many people from low-income households cannot find high-skilled jobs or obtain the capital to start their own businesses because of the negative externalities created by poverty. For example, people in poverty have a poorer education than others and so cannot acquire the skills to obtain the highly-skilled jobs they want. Moreover, income inequality is not fair as some free-market libertarians claim because wealthier people could exploit the poor, manipulate the tax system to their advantage, and have more opportunities than the poor. Therefore, the government should decrease levels of income inequality to promote economic growth and make their countries fairer places to live in.

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