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 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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The article U.S. Income Inequality Has Reached Pre-War Europe Levels originally appeared on Fool.com.

Fool contributor Dan Newman has no position in any stocks mentioned, and neither does The Motley Fool. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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