Distribution of Income

What It Means

When people say things such as “the rich get richer, and the poor get poorer,” they are referring to distribution of income. It describes how all the money (income) earned in a nation is divided among people of various income levels. The most common image used to talk about distribution of income is a pie. If we think of a pie as representing all of the income earned by the people of a certain country, then the sizes of the slices of that pie given to the rich, the poor, and the middle classes represent the distribution of income.

In any capitalist society (in which most businesses are owned by individuals, not the government), the rich tend to get a disproportionately large piece of the economic pie; this is called income inequality. Economists explain this imbalance in terms of the workings of natural market forces, but there are many other factors that contribute to income inequality, and some of them lie beyond the range of economic explanations. The issues connected with income distribution are among the most controversial in economics, and they are of interest to ordinary citizens as much as to economists and government leaders. Because government has some power to affect the distribution of income in a capitalist society, people’s opinions on the issue are often closely related to their political views.

When Did It Begin

Before the rise of capitalism in Europe in the sixteenth to eighteenth centuries, the distribution of wealth was determined primarily by heredity, tradition, and force. People who inherited or ruled large areas of land were able to extract wealth from the people who lived and worked on that land, and those who did not own land could not amass wealth beyond the amounts dictated by the commands and traditions of the landowning classes of society. As capitalism became more widespread, so did the ability of non-landowners to generate more income. Once markets (places where buyers and sellers freely come together to do business) became the primary means of determining the economic structure of society, there ceased to be a centralized authority in charge of dividing up wealth. Market forces (such as the laws of supply and demand) determined who benefited from an economy, and to what degree.

Income distribution in capitalist societies has been a subject of interest since the field of economics was established in 1776 with the publication of An Inquiry into the Nature and Causes of the Wealth of Nations by the Scottish philosopher Adam Smith (1723–90). Smith and other so-called classical economists explained the distribution of wealth as a natural and efficient outgrowth of market forces, but German political philosopher Karl Marx (1818–83) and his followers contended that capitalism unfairly favored owners over workers in any business enterprise. Subsequent examinations of income distribution have been complex and wide-ranging, and debate about the fairness of unequal income distribution has continued.

More Detailed Information

The ways in which income is distributed in a capitalist society is extremely complex, and people’s views on it are substantially affected by their political beliefs and other assumptions and interpretations that lie outside the realm of economics.

The basic economic explanation for unequal distribution of income is that individuals are rewarded in proportion to the value they bring to the economic process. Value, in this context, refers to a complicated mixture of intelligence, education, training, health, experience, talent, motivation, and willingness to give up leisure time to engage in economically productive activity. These and other desirable personal attributes make up what economists call an individual’s human capital.

As a simple illustration of how human capital affects income, consider a neurosurgeon and a janitor. A neurosurgeon must possess many of the attributes listed above in extremely high degrees. People who have such attributes in abundance are rare. Therefore, neurosurgeons typically command very high salaries. The job requirements of being a janitor, however, are not nearly so rigorous. A person need not offer high measures of human capital to qualify for a janitorial position. Therefore, there will always be a much larger supply of potential janitors than neurosurgeons in the labor market, and janitors accordingly are not able to command nearly as large salaries.

But many other factors affect income distribution. One of the primary factors is luck. For instance, a software programmer who happens to work for a small company that is bought out by the software giant Microsoft Corporation might suddenly see her income rise dramatically, while a programmer with an equal amount of human capital who happens to work for a similar small company sees no equivalent increase in income.

Likewise, deep-rooted societal problems can greatly affect a person’s potential earning ability. According to U.S. census estimates, for example, African-American and female heads of households consistently earn less than their white male counterparts. Economists, however, can offer little explanation for these uncomfortable facts. It is left to historians and sociologists (who study human societies) to explain how patterns of discrimination might figure into an individual’s earning potential.

At either extreme of the income-distribution spectrum, the role of human capital is complicated by additional factors. For instance, poor people might be poor because they do not have many skills deemed desirable by the market system, but their poverty itself might prevent them from being able to obtain those skills, especially when the educational opportunities available to the poor, the middle class, and the rich are unequal. Also, the poor are often surrounded by other poor people in isolated neighborhoods, so that they do not have many positive role models. This can lead to situations in which insufficiently developed work habits are passed down from generation to generation.

Many of the richest people in the United States and the world, meanwhile, either inherit a portion of their wealth or amass great wealth out of proportion to their abilities and productive capacities. For an example of the second type of wealth creation, imagine a person who invents a new software product and opens a business selling that product. While he is in private business, his profits might be seen as corresponding with his human capital, the value he brings to the economic process. If, however, his business goes public (that is, if shares of it are offered for sale to investors on the stock market), investors may contribute vast amounts of money to the project of selling that software in the belief that the business can become profitable on a large scale. Thus, the individual entrepreneur can suddenly become far richer than he ever could have done through simple business transactions. In this way people such as Microsoft founder Bill Gates go from being college dropouts (albeit a brilliant one, in Gates’s case) to being billionaires in a matter of one or two decades.

Some people who are concerned about inequality of income distribution worry, therefore, about noneconomic factors that seem to rig the system for or against various groups. Additionally, those who favor equalizing income distribution to some degree (this could be done by raising taxes on the upper classes) worry about the correlation between wealth and political power. If the rich are able to influence government, they might push for legislation that encourages economic developments that give them a bigger slice of the economic pie.

Those who maintain that income inequality is beneficial to society, however, point out that if incomes were equalized, there would be no incentive for people to act in ways that benefit society as well as the individual. If all occupations paid $20,000, why would anyone engage in the most demanding forms of work? Most people, if given the choice between living in a society in which all jobs paid $20,000 or a society in which one set of jobs paid $10,000 and another, more challenging set of jobs paid $30,000, would choose the second society because it offers the possibility of a better life, even though it also offers increased risk. According to this argument, the incentive of making the higher salary (and being able to live more comfortably) encourages people to be productive. In the society where everyone makes $20,000, no one has an incentive to be productive.

Recent Trends

In 1929 (just before the economic collapse known as the Great Depression), the wealthiest 20 percent of Americans earned more than half (54.4 percent) of the nation’s income. Meanwhile, the bottom 20 percent of U.S. families earned only 3.5 percent of the total income. By 1947 the American middle class had grown greatly, and the proportions of income claimed by the top tiers of society had dropped: the wealthiest 20 percent of Americans claimed 43.3 percent of the total income in that year, while the share of the bottom 20 percent had risen to 5.1 percent. The change was most drastic among the very elite: in 1929 the richest 5 percent earned 30 percent of U.S. income, but by 1947 that number had decreased by almost half, to 17.5 percent. The numbers changed only slightly through 1970, and this period is considered to be the heyday of the American middle class.

After 1970, however, the proportion of income claimed by the top 5 percent of society rose again, and at the same time the earnings of families in the lowest 20 percent fell. By 1995 the top 5 percent claimed 20 percent of the nation’s income, and the bottom 20 percent claimed 4.4 percent. Between 1973 and 1995 the productivity of the United States increased significantly: gross domestic product per capita (the average amount of wealth produced annually in the country per person) grew 39 percent. Almost all the income stemming from this increase went to the top 20 percent of the American workforce. During this period the incomes of nonsupervisory workers (those who are not managers or supervisors) fell 14 percent. These trends have caused a renewed debate over the acceptable levels of income inequality.