One often hears the phrase "The
rich get richer and the poor get poorer," but how true is
that statement in the United States? On one hand, according to several
statistics, income inequality is widening. In 1981, the total combined
income earned by the wealthiest 5 percent of Americans was 6.9 times
greater than the combined income earned by the poorest 20 percent.
By 2001, the ratio of the wealthiest to the poorest had increased
to 8.4. On the other hand, U.S. Census Bureau studies show that
during that same time, poverty rates steadily decreased—from 14 percent in 1981 to
11.7 percent in 2001. It seems almost contradictory that significant inequality
ratios stand next to decreasing poverty rates. Yet this contrast exemplifies
the complexity of the issues regarding income inequality.
Income inequality exists in the United States, but what
does that mean for our society? Perhaps income inequality is an acceptable
part of a dynamic and prosperous economy, providing incentives to work
hard and advance in education. Or does it disrupt social cohesion and
disenfranchise the poor? In this year’s essay contest, students
are asked to consider the economics of income inequality and determine
what policy, if any, the government should take regarding these issues.
The Statistics Behind Income Inequality
Economists have long debated the causes of income inequality; however,
it is generally agreed that educational attainment and family structure
are currently two significant factors.
Over the past few decades, more jobs have required high-skilled workers.
Therefore, wages for college-educated workers have increased faster than
those of low-skilled workers as demand for high-skilled workers increased.
This trend accelerated during the late 1990s when companies continued
to rely more on technology. In 2000, individuals with college degrees
were on average paid 80 percent more than those who had graduated solely
from high school. Therefore, the changing nature of the American economy,
with its increasingly greater emphasis on education and information, has
contributed to increased income inequality.
Changes in family structure have also widened the income gap. A growing
percentage of Americans live in single-parent households. These families,
often headed by single-mothers, earn about half the income of two-parent
families. Among the highest paid 20 percent of households, 90 percent
are married-couple families; among the poorest 20 percent of households,
two-thirds are single or single-parent families. This trend in household
structure is a second significant factor explaining income inequality
in the United States today.
Identifying the Problem
The economic concept of externality can help identify the costs and/or
benefits regarding income inequality issues and help inform the role government
might play, if any, in addressing income inequality. Externalities
are social costs and benefits that spill over beyond the private costs
and benefits faced by an individual. One classic example of an externality
is a factory's smokestack that pollutes the air and causes health problems
for people living nearby. The factory does not face any costs as a result
of its pollution; instead, that pollution is a cost that has "spilled
over" to the people nearby, who have to "pay" for its
unpleasantness and toxicity. One role of government is to sometimes step
in and address this form of market failure through regulations, taxes
or programs—for if left alone, a market tends not to solve externalities.
One way to begin looking at the essay contest question is to ask whether
there are external costs or benefits to income inequality.
On one hand, some argue that there are significant external costs due
to income inequality. They argue that inequality weakens social cohesion
as the lives of the rich and poor become more isolated and separate. With
greater inequality, the poor feel disenfranchised and do not participate
in civic life, while the rich gain an increasingly powerful influence
in politics—thus weakening democracy. Greater income inequality
may also result in lower health and increased crime nationally. Furthermore,
some contend that poverty breeds poverty, as the children of the poor
have to work harder to succeed than the children of the rich. Without
intervention, the problems caused by income inequality will only get worse
in the future.
On the other hand, others contest the validity of these external costs
and point to possible external benefits of income inequality. Many say
that some of the external costs brought up in the previous paragraph—
such as higher crime, lower health and less opportunity—are not
effects of income inequality, but of poverty. External costs due to poverty
exist (individuals in poverty are more likely to commit crime, have health
troubles and have children who enter kindergarten not ready to learn),
but these problems are separate from the issue of income inequality. In
fact, some contend that instead of disenfranchising, income inequality
provides incentives for those who are at low- to middle-income levels
to work hard, attain more education and advance to better-paying jobs.
There is a great deal of contention over the external costs and benefits
of income inequality. And externalities are not the only economic lens
to look through when considering the issue. Often the results of income
equality and inequality are discussed as a trade-off between equity and
efficiency. Some argue that relatively equal levels of income may promote
social cohesion, but market efficiency may be lost due to government intervention
or central planning.
Once a student has determined how they view income inequality, he or
she can then begin to consider what policy, if any, government should
adopt to address the issue.
What to do?
Those in favor of reducing income inequality might, in their essay, describe
why income inequality results in externalities or problems and propose
measures government could take to remedy them. Possible policies include
a more progressive tax system, increased earned income tax credits, or
other such policy that redistributes income from the rich to the poor
in order to decrease the income divide. Not only, they might argue, would
the external costs of income inequality be removed, but poverty itself
would also be reduced.
In contrast, those opposed to government involvement in income inequality
might argue that externalities do not stem from income inequality, but
rather from poverty. Government should therefore focus on the welfare
of the poor, rather than worrying about the income gap. Policies to address
the welfare of the poor might include programs that provide preventive
medical care or housing subsidies—or a policy that promotes early
childhood and K-12 education in order to provide greater opportunity for
Other papers might argue that the government should remain out of the
issue completely, arguing that income inequality is not a problem to current
American society—or, perhaps, that it is a natural result of our
changing economy and the increasing valuation of education.
Essay writers may also, if they wish, compare income inequality in the
United States with other countries. For example, the distribution of income
in Germany and France is more equal than in the United States. Germany
and France also have more extensive government services, like health care
and unemployment benefits. However, there may be a trade-off in these
benefits. While Germany and France have lower income inequality, they
also have higher unemployment rates than the United States.
The ideas suggested in this primer are just a few of the ways students
can think about income inequality when they research the topic and write
their essays. Students are encouraged to take an innovative position as
well as carefully consider the economic concepts involved. The Minneapolis
Fed staff look forward to reading this year's papers.
Best of luck!