A national and international conversation takes hold
Over the last decade, in the United States and abroad, there has been an explosion of interest in high and rising income inequality. A broad national conversation has developed, one that has included academics, journalists, policymakers, political figures, and the general public. The Occupy Movement of 2011–12 provided a crucial spark, and, since then, this intensified interest has driven—and been driven by—methodological advances, new research institutes, enlarged data options, expanded media coverage, and a mountain of scholarship.
Not surprisingly, many who participate in this conversation have asked a core question: why should societies care about income inequality? Some on the right argue that inequality is the result of freely operating markets, so socioeconomic outcomes are best left as they are. Many on the left argue that markets hardly operate freely or fairly, thus state interventions are needed to reduce unacceptable disparities between the “haves” and the “have-nots.” The left-leaning view often rests on normative grounds: extreme income disparities are simply incompatible with a fair and inclusive society.“New lines of research have indicated that high and rising inequality limits intergenerational mobility, harms economic growth, and damages the democratic process.”
Yet, in recent years, a new consensus has emerged, as observers on both the right and left have shifted attention toward more instrumental concerns. Today, diverse voices argue that excessive income inequality worsens a range of other outcomes—outcomes that, by all accounts, are unwanted and harmful. New lines of research have indicated that high and rising inequality limits intergenerational mobility, harms economic growth, and damages the democratic process. What used to be seen as a marginal view—that income inequality is problematic—has now become a mainstream claim, in the United States, in countless other countries, and in several influential supranational organizations, including the World Bank, the International Monetary Fund, the United Nations, and the Organization for Economic Cooperation and Development. Although some conservatives continue to argue that inequality is not harmful1See, for example, Don Watkins and Yaron Brook, Equal Is Unfair: America’s Misguided Fight Against Income Inequality (New York: St. Martin’s Press, 2016) and Edward Conard, The Upside of Inequality: How Good Intentions Undermine the Middle Class (New York: Portfolio, 2016).—to the contrary, it encourages productivity and competition—that view has been increasingly relegated to the sidelines.
Based on our own cross-national research, we find that income inequality among households varies markedly across rich countries, and that is true both before and after accounting for the effects of income taxes paid and transfers received. In all countries that we’ve studied, these redistributive mechanisms—taxes and transfers—mitigate the inequality that is generated in the market, although to widely varying degrees. We also find that, in general, income inequality increased since the middle 1980s; inequality in market income (mostly earnings) rose in most countries, as did inequality in households’ income after taking into account taxes and transfers. In addition, across countries, the share of the population that falls into the middle class varies dramatically—currently, ranging from 59 percent in the United States to 79 percent in Finland—and, in recent decades, nearly everywhere, the size of the middle class declined.
Cross-national comparisons: Shining a light on income inequality
Observers of inequality often turn their attention to cross-national comparisons, in part because variation across countries, especially relatively similar countries, offers powerful research opportunities for assessing the causes, nature, and consequences of income inequality.
We have taken a close look at income inequality across a group of 15 high-income countries, using data made available from LIS.2The LIS datasets are based on nationally-representative household surveys; some of LIS’ data providers supplement survey data with information from national administrative records. The archive is located in Luxembourg, with a satellite office at the Graduate Center of the City University of New York. Here, we summarize some of our key findings. We begin with a portrait of income inequality across these 15 countries, with a focus on the role of two essential public institutions that reduce inequality: income taxes and income transfers. We then turn our attention to the size of the middle class. In both cases, we provide a contemporary snapshot—as of approximately 2016—and then a portrait of changes since approximately 1985, the point in time when income inequality began to rise in many high-income countries. We close with brief remarks about the drivers of high and rising income inequality.
We selected our 15 study countries, from among the 50-plus that participate in LIS, because they are all high-income—our comparisons are most meaningful among relatively similar countries—and because the associated datasets include the variables that we need. Although these countries are all rich, they encompass a range of social policy models—including, for example, the famously egalitarian Nordic region (Denmark, Finland, Norway), the corporatist regime dominant in continental Europe (Austria, Belgium, Germany, Luxembourg, Netherlands), and the more laissez-faire, antistate, Anglophone cluster (Australia, Canada, United Kingdom, United States).
Income inequality: Levels and trends
We began our research by assessing income inequality at approximately 2016.3Data from four of our 15 countries are available only for slightly earlier years, but none earlier than 2013. We assess inequality using two income definitions. The first is household income after taxes and transfers are taken into account, referred to as “disposable household income” (or DHI). DHI includes income from the labor market and from capital, plus private and public income transfers, minus income taxes paid (including social contributions, such as FICA in the United States). This amount is reported by survey respondents. The second definition is household income before taxes and transfers are captured. This amount—widely referred to as “market income”—is calculated by us, mechanically, by subtracting income transfers received and adding taxes paid back in. (Going forward, we use the terms “DHI” and “market income”).
In addition, we implemented some standard methodological practices. For both types of income, we adjust for household size. We limit our analyses to nonelderly households,4Nonelderly households are those in which the household head is below age 60. to avoid mixing households that blend market income and transfers with those that rely primarily on the latter. Finally, inequality is measured by the widely used Gini coefficient, in which a higher value represents a more unequal distribution.
We present our first contemporary snapshot in Figure 1. Inequality of DHI, across households, is reported in the dark blue bars, and inequality of market income in the light blue bars. Looking at inequality of DHI, we see that the highest level of income inequality is reported in the United States (at .38), and the lowest level is reported in three Nordic countries, Finland, Norway, and Denmark (all with much lower inequality, at .25). When we turn to inequality of market income—which is substantially higher everywhere—a fairly similar story emerges. The United States again reports the highest level of inequality, now tied with the United Kingdom; however, some other countries shift rank, and the Nordic countries no longer stand out as exceptionally egalitarian.
A key benefit of this analytic framework is that it allows us to consider the extent to which states redistribute income via taxation and income transfers. It is common in this field to consider the difference between these two inequality indicators as a proxy for redistribution—and we followed suit. Two of our study countries reduced inequality by as much as 14–15 Gini points (Finland and Denmark), whereas five countries reduced inequality by as little as 9–10 Gini points (Canada, Italy, Israel, Spain, and the United States)—and this latter group started with higher levels of market-income inequality. Through this lens, we can see why inequality of DHI—inequality in the income that households have “at the end of the day”—is so high in the United States. Market income inequality—i.e., inequality generated, mainly, from the labor market—is high, and redistribution is modest, bordering on meager.
In our next analysis, we look at changes—using these same two measures—in the last three decades (see Figure 2). Again, we do not always have data for our defining year, 1985; data from some of these 15 countries are from 1986 or 1987. Note that, here, we report results for only 10 of our 15 countries; in five countries, we lack full information on market income at the earlier time point.
We often hear that income inequality has risen in many rich countries. Is that true? If so, has the increase been in income before taxes and transfers, or after, or both? Our results indicate a common pattern in eight of these 10 countries—all except for the Netherlands and Israel. In these eight countries, inequality rose both before and after accounting for taxes and transfers. Those increases were in the range of 4–10 Gini points with respect to market income, and 2–6 Gini points for DHI inequality. (Magnitudes like these are considered to be both statistically significant and substantively meaningful.) In all eight cases, the increase in DHI inequality was less than the increase with respect to market income, indicating that, in all eight countries, redistributive mechanisms mitigated the rising inequality generated in the market. Furthermore, in seven of those eight cases—the United Kingdom is an exception—the magnitude of redistribution itself increased between the first and second time points.
In the Netherlands and Israel, market income inequality actually fell slightly during this time interval, while DHI inequality increased. That reveals that the tax-and-transfer systems became less redistributive during these two time points. The Netherlands and Israel did not take advantage of the falling market income inequality—at least not enough to reduce disparities in households’ disposable income.
The “middle class”: How is the middle faring?
The ongoing conversation about income inequality has often raised an intertwined question: how is the middle class doing? Across academic disciplines, and in political and popular discourse as well, a strong middle class is understood to be a necessary condition for a robust democracy and a resilient economy. A sizable middle class is required to ensure sustainable levels of public investment in core institutions, including public schools, hospitals, public safety, and transportation.
There is no one definition of the middle class, among scholars, policymakers, nor the general public.5For discussions about defining the middle class, see Janet Gornick and Markus Jantti, introduction to Income Inequality: Economic Disparities and The Middle Class in Affluent Countries, eds. Janet C. Gornick and Markus Jäntti (Palo Alto, CA: Stanford University Press, 2013); and Richard V. Reeves, Katherine Guyot, and Eleanor Krause, “Defining the Middle Class: Cash, Credentials, or Culture?” (Brookings Institution, 2018). We chose a definition that is relatively common in literature on the middle class. We take the distribution of DHI as our starting point—that is, we proxy “class” by income alone—and we define households as middle class if their DHI falls between 50 percent and 150 percent of their country’s median DHI. Our lower boundary (50 percent) corresponds to the poverty threshold used by governments in many high-income countries and, often, in cross-national research.6This poverty line is well higher than the one used to calculate official poverty rates in the United States. Our upper boundary (150 percent) is essentially arbitrary; we chose it because it produces population shares of affluent persons that are largely in line with popular perceptions.
We start by looking back three decades. In the middle 1980s, the shares of these populations situated within the middle class are presented in Figure 3 (see the blue portion of the bars). To the left of the middle class, we report the shares of persons who are poor (in dark blue), and, to the right, the shares that are affluent (in light blue). The countries are ordered to reflect ascending middle-class shares, from top to bottom.
At approximately 1985, among our study countries, the United States reported the smallest middle class. Only 59 percent of persons—fewer than two in three—lived in middle-class households. So, thirty-some years ago, the United States was already home to an unusually small middle class, one that was substantially smaller than that of many of our neighbors, especially across the Atlantic.
The high level of inequality in the United States—and its polarized income distribution—is on full display in Figure 3. In addition to having the smallest middle class, the United States also reported the highest poverty rate among these countries (18 percent) and the largest share defined as affluent (24 percent). At the other end of the spectrum is notoriously egalitarian Finland with the largest middle class (a remarkable 86 percent), one of the lowest poverty rates (5 percent), and the smallest share of affluent (9 percent).
Next, we turn our attention to the present. Population shares, as of 2016, are presented in Figure 4, using the same framework and the same country ordering. The position of the United States is nearly the same as it was 30 years earlier. In 2016, the US middle class remains the same size: 59 percent. (Now, Israel’s middle class is slightly smaller, at 57 percent.) The US poverty rate (17 percent) is among the three highest; its rate of affluence, at 25 percent, is tied with those in Israel and Spain. Finland, likewise, is situated in 2016 very much like it was in 1985.
Overall, what has been the trend during these three decades? Has the middle “hollowed out,” as we often hear? Is that a widespread pattern? Our results indicate that, yes, the dominant pattern has been a shrinking middle class. In 14 out of our 15 study countries, the share of the population situated in the middle declined. (The exception is Australia, where the middle class grew by about 1 percentage point.) The magnitude of change was, however, remarkably varied. In seven of these 14 countries, the size of the middle fell by a substantial 8–11 percentage points. In five countries, it fell by 3–5 percentage points. In two countries, the middle shrank but only slightly, declining by less than one percentage point.
The over-time result in the United States was somewhat unexpected. The United States is in that last group in which the middle class was nearly stable over the last three decades. (It is important to note that this finding is sensitive to the placement of the upper threshold; when we shift the upper boundary to 200 percent of the median, the US middle class fell in size, during these 30 years, by 2 percentage points.) Yet, in the United States, the stability in middle-class size offers little reason to celebrate, given its exceptionally small size at the start (and end) of this time period.
Finally, in those countries where the middle class did decrease, we ask: Where did they go? Did the population portions that exited the middle go down or up? There is no single pattern. In nine of the 14 cases where the middle class shrank (by any amount), a larger percentage of persons moved down into poverty, than up into affluence. In those cases, poverty rates increased substantially, rising by 4–7 percentage points. In the other five of these 14 countries, we see the reverse: a larger share of the population moved up than slid down. In those cases, increases in affluence shares ranged from a modest 1–2 percentage points (Canada, Denmark, United Kingdom, United States) to a marked 5 percentage points in Finland.“Although income inequality increased within all three groups—poor, middle-class, and affluent—the greatest increase, by far, was among the affluent.”
As noted, we were surprised that the size of the US middle class remained so stable, both because that’s at odds with popular discourse about the “declining American middle class,” and because of the well-known increase in inequality that unfolded during the same period. Our own results (see Figure 2) indicate that inequality (also based on DHI) rose by a substantial 4 Gini points over these last three decades. How do we reconcile this apparent contradiction? The answer is that the overall increase in inequality in the United States was driven mainly by changes that occurred among the affluent—changes that arose above the upper threshold of the middle class. Although income inequality increased within all three groups—poor, middle-class, and affluent—the greatest increase, by far, was among the affluent.7We calculated changes in inequality within each of the three income groups. Between 1985 and 2016, inequality increased by 9 percent among poor households, by 3 percent among middle class households, and by 43 percent among affluent households. Likewise, although average income also increased within all three groups, it grew substantially more among affluent households; between our two time points, average income increased by 21 percent among poor households, by 17 percent among middle class households, and by 37 percent among affluent households. In contrast, in some countries, the rising inequality (indicated in the overall Gini) was manifested in a hollowing out of the middle. For example, in Germany, between 1985 and 2016, inequality of DHI increased by 6 Gini points and the middle-class share fell by 10 percentage points; the link is clear. The trend in the United States unfolded differently.
Drivers of high and rising income inequality
Our work indicates that the dominant pattern in the last three decades has been one of rising income inequality—in both market income and DHI. Other studies, considering larger sets of rich countries, have reached similar conclusions: on the one hand, income inequality has risen in many (if not all) high-income countries; on the other, underlying income distributions have shifted in diverse ways.8See inequality reports produced by the Organization for Economic Cooperation and Development: Growing Unequal? Income Distribution and Poverty in OECD Countries (Paris: OECD, 2008); Divided We Stand: Why Inequality Keeps Rising (2011), and In It Together: Why Less Inequality Benefits All (2015).
A full analysis of the drivers of high and rising income inequality is beyond the scope of this brief. However, we offer a quick summary of prevailing conclusions from the literature.
Many scholars and political actors point to overarching transnational forces, primarily globalization and technological change. Both forces, it is argued, shape national income distributions, especially by increasing earnings dispersion and thus, at the household level, inequality of market income. Transnational competition may drive countries to cut taxes, which in turn puts downward pressure on the tools of income redistribution.“Many inequality scholars have concluded that these country-level particulars overwhelm the effects of most transnational forces—and we agree.”
While transnational forces are surely consequential, most scholars of income inequality conclude that national-level institutions matter—and they matter a lot. Similar countries, even geographically contiguous countries, often report vastly different socioeconomic outcomes; thus, most inequality scholars locate core explanations in country- and time-specific institutions and policies. National institutions—e.g., those that regulate wage-setting, working time, collective bargaining, and human capital accumulation—shape market income distributions. National redistributive policies determine how market income is augmented to become DHI. These country- and time-specific institutions are the product of national political processes. Many inequality scholars have concluded that these country-level particulars overwhelm the effects of most transnational forces—and we agree.
It is important to note that, while a confluence of factors is exacerbating income inequality, there are countervailing pressures. First, in many countries—as our own results indicate—redistribution via taxes and transfers has mitigated increases in inequality emanating from the market. Second, women’s rising employment rates and/or earnings have had an equalizing effect on the distribution of income across households.9See Susan Harkness, “Women’s Employment and Household Income Inequality” in Income Inequality: Economic Disparities and The Middle Class in Affluent Countries, eds. Janet C. Gornick and Markus Jäntti (Palo Alto, CA: Stanford University Press, 2013); Rense Nieuwenhuis, Henk van der Kolk, and Ariana Need, “Women’s Earnings and Household Inequality in OECD Countries, 1973–2013,” Acta Sociologica 60, no. 1 (2017): 2–20; and Divided We Stand: Why Inequality Keeps Rising (Paris: OECD, 2011). Women’s rising earnings, in general, pull up the bottom of the household income distribution more than they push up the top.
A large social science literature has assessed the political determinants of social and labor market policy formation in rich countries. Yet—perhaps fortunately—much less is known about how enormous, destabilizing shocks reshape levels and trends in income inequality, either by vastly modifying markets or by altering public policies and institutions, or both. We write this brief during a time of sudden, unfathomable, social and economic upheaval. We can only imagine how the outcomes that we have reported here will evolve during the coming months and years.