Income Inequality

 
 

Income Inequality

The Gini coefficient measures income inequality by calculating the extent to which the distribution of income among individuals within a country deviates from a perfectly equal distribution.
 

Please note:
The data on this page are current as of January 2013.

Key Messages

  • Canada gets a “C” grade and ranks 12th out of 17 peer countries.
  • Income inequality in Canada has increased over the past 20 years.
  • Since 1990, the richest group of Canadians has increased its share of total national income, while the poorest and middle-income groups has lost share.

Income Inequality, Late 2000s (chart)

Putting income inequality in context

Income inequality is the extent to which income is distributed unevenly in a country. It is an important indicator of equity in an economy, and has implications for other social outcomes such as crime and life satisfaction.

Although the 17 peer countries are among the wealthiest in the world, the income per capita figure does not tell us how this income is distributed. Income inequality within a country is often masked by the national average.

The Economist magazine recently devoted an issue to income inequality. While noting that the relative living standards of the poor in the U.S. are better they were in the 1880s and 1890s—a period referred to as the “first Gilded Age” and associated with industrialists like John D. Rockefeller, Andrew W. Mellon, Andrew Carnegie, J. P. Morgan, and Cornelius Vanderbilt—the magazine writes: “The democratization of living standards has masked a dramatic concentration of incomes over the past 30 years, on a scale that matches, or even exceeds, the first Gilded Age.”1 As evidence, the article notes that the share of national income (including capital gains) going to the richest 1 per cent of Americans has doubled since 1980—from 10 per cent to 20 per cent, the level it was in the first Gilded Age. The share going to the richest 0.01 per cent quadrupled—from 1 per cent to almost 5 per cent, which is larger than it was in the 1880s.

The concentration of income among the super-rich is happening in many countries, including Canada.

Why is income inequality now in the media spotlight?

Despite the rise in income inequality over the past several decades, the issue was largely ignored. The Economist article on income inequality suggests this lack of attention in the years before the financial crisis was because “asset bubbles and cheap credit eased life for everyone. Financiers were growing fabulously wealthy in the early 2000s, but others could also borrow ever more against the value of their home.”2

The situation changed after the financial crisis: “The bank rescues shone a spotlight on the unfairness of a system in which affluent bankers were bailed out whereas ordinary folk lost their houses and jobs.”3 Inequality moved into the media and political spotlights. For example, the World Economic Forum’s Global Risks 2012 report surveyed 469 experts from industry, government, academia, and civil society on what global risk was perceived to be most likely to occur over the next 10 years. “Severe income inequality” topped the list, tied with “chronic fiscal imbalances.”4

Why should we care about rising income inequality?

The standard response has historically been that high inequality raises a moral question about fairness and social justice. While that’s still true, noted economist Joseph Stiglitz now argues that it is no longer just a moral issue: income inequality is hurting the economy.5

This view has not always been widely accepted. Up until fairly recently, the economic argument has been that equality and efficiency were trade-offs—that more income equality reduced incentives to work harder, to invest, and to get more education.

Current thinking on the subject has changed somewhat; The Economist notes that “some of today’s inequality may be inefficient rather than growth promoting.”6 A 2011 study by the International Monetary Fund found the following:

When growth is looked at over the long term, the trade-off between efficiency and equality may not exist. In fact equality appears to be an important ingredient in promoting and sustaining growth. The difference between countries that can sustain rapid growth for many years or even decades and the many others that see growth spurts fade quickly may be the level of inequality. Countries may find that improving equality may also improve efficiency, understood as more sustainable long-run growth.7

In fact, the authors argue the recent global financial crisis “may have resulted, in part at least, from the increase in inequality.”8 This is because, they argue, inequality tends to be related to financial crises—as inequality rises, people on the bottom of the income scale tend to borrow more in order to keep up, which, in turn, increases the risk of a major crisis. Second, severe inequality increases social and, in turn, political instability, which reduces foreign investment.

Large income gaps can also diminish economic growth if these gaps mean the country is not fully using the skills and capabilities of all its citizens or if they undermine social cohesion, leading to increased social tensions.

What does the Gini coefficient mean?

The most commonly used measure of income inequality is the Gini coefficient, which is measured on a scale of 0 to 1. Named after the Italian statistician Corrado Gini, the Gini coefficient calculates the extent to which the distribution of income among individuals within a country deviates from an exactly equal distribution:

  • a Gini coefficient of 0 represents exact equality—that is, every person in the society has the same amount of income
  • a Gini coefficient of 1 represents total inequality—that is, one person has all the income and the rest of the society has none

How does Canada compare to its peers on income inequality?

Income inequality is higher in Canada than in 11 of its peers. Although Canada’s wealth is distributed more equally than in the U.S., Canada’s 12th-place ranking suggests it is doing a mediocre job of ensuring income equality. Canada gets a “C” grade on this indicator.

The Nordic countries are the clear leaders on the income inequality report card. The United States is the worst performer and the only peer country to get a “D.”

Is Canada becoming more unequal?

Income inequality in Canada has increased over the past 20 years. Canada reduced inequality in the 1980s, with the Gini coefficient reaching a low of 0.281 in 1989. Income inequality rose in the 1990s, but has remained around 0.32 in the 2000s.

Income Inequality (chart)

Another way of tracking income inequality is to divide the population into five groups (quintiles) from poorest (bottom quintile) to richest (top quintile), and then calculate the share of income that accrues to each group. If each of the five income groups has the same share of total national income—that is, 20 per cent—the distribution could be described as equal.

The pie chart shows the share of national income going to each quintile in 2010 in Canada. The richest income group (top quintile) has by far the largest share of Canada’s economic pie—with 39.1 per cent of total national income. And this richest group is the only quintile to have increased its share of national income over the past 20 years—from 36.5 per cent in 1990 to 39.1 per cent in 2010. All other quintile groups have lost share, including middle-income groups.

Richest Group Accounts for the Largest Share of Canadian National Income, 2010 (chart)

Many of Canada’s peers have also experienced rising income inequality, including not only the U.K., the U.S., and Germany, but even the Nordic countries of Denmark, Finland, Norway, and Sweden.

The richest 1 per cent of Canadians took almost a third of all income gains from 1997 to 2007—the decade with the fastest-growing incomes in this generation, according to a 2010 study by Armine Yalnizyan.9

But the recent recession hurt the top earners, according to a new study by Statistics Canada. The top 1 per cent of Canada’s tax filers accounted for 10.6 per cent of the nation’s total income in 2010, down from a peak of 12.1 per cent in 2006.10 Still, the 2010 figure remained higher than the 7 per cent in the early 1980s and the 8 per cent in the early 1990s.11

Why is income inequality rising?

The causes tend to fall into two broad categories: market forces and institutional forces.

Market forces, particularly skill-biased technical change and increased globalization, are increasing demand for highly skilled labour. As Edward Lazear, chairman of the U.S. President’s Council of Economic Advisors, noted in a 2006 speech: “In our technologically advanced society, skill has higher value than it does in a less technologically advanced society.”12 As developed countries import more low-skills-intensive goods and export more skills-intensive goods, jobs in low-skilled industries are lost in those developed countries. The Economist echoes Lazear’s argument, noting that new technologies have “pushed up demand for the brainy and well-educated” at the same time as “the integration of some 1.5 billion emerging-country workers into the global market economy . . . hit the rich world’s less educated folk with unaccustomed competition.”13

Not all researchers agree that skill-biased technical change (SBTC) and globalization are at the root of all or even most of the rising inequality. In a paper published in the Journal of Labor Economics, David Card and John DiNardo argue that “contrary to the impression conveyed by most of the recent literature, the SBTC hypothesis falls short as a unicausal explanation.”14

An alternative explanation, put forward by economist Paul Krugman and others, is that the increase in inequality can be attributed to institutional forces, like declines in unionization rates, stagnating minimum wage rates, deregulation, and national policies that favour the wealthy. In Canada, Armine Yalnizyan notes that falling top marginal tax rates are part of the explanation for the rise of the richest 1 per cent of the population.15

Do government taxes and transfers help to reduce inequality?

Yes. Personal income taxes and government transfers (such as social assistance, unemployment insurance, old age security, and child benefits) play an important role in reducing income inequality.

We can see this by comparing two Gini coefficients: one calculated using income before taxes and transfers, and the second using income after taxes and transfers.

The red squares show the levels of the Gini coefficients before taxes and transfers for each peer country. So, for example, the most unequal county using this measure is Italy, with a Gini coefficient of 0.53, followed by the U.K. and Germany. The U.S. has the fourth-highest inequality, while Canada has the eleventh-highest inequality.

After income is adjusted by taxes and transfers, the situation changes dramatically for some countries. The chart ranks the countries from left to right based on the size of the decline in inequality due to the tax and transfer system. Of the 17 peer countries, the tax and transfer system affects inequality in Belgium the most. The Gini coefficient falls from 0.469 before taxes and transfers to 0.259 after taxes and transfers. This represents a 45 per cent drop.

At the opposite end, the U.S. tax and transfer system has the relatively smallest effect on income inequality of the 17 peer countries. The U.S. Gini coefficient falls from 0.486 to 0.370—a 22 per cent decrease. Germany, whose inequality before taxes and transfers is worse than the U.S. (with a German Gini coefficient of 0.504) performs much better than the U.S. after taxes and transfers—Germany’s Gini coefficient falls to 0.295.

Relative to its peers, Canada’s tax and transfer system does reduce inequality but only by 27 per cent—the Canadian Gini coefficient falls from 0.441 to 0.324.

Gini Coefficient Before and After Taxes and Transfers, Late 2000s (chart)

Footnotes

1 “For Richer, For Poorer,” The Economist, October 13, 2012, 3.

2 “For Richer, For Poorer,” The Economist, October 13, 2012, 4.

3 “For Richer, For Poorer,” The Economist, October 13, 2012, 4.

4 World Economic Forum, Global Risks 2012, 2012, 11.

5 Joseph Stiglitz, “Some Are More Unequal Than Others,” The New York Times, October 26, 2012 (accessed November 4, 2012).

6 “For Richer, For Poorer,” The Economist, October 13, 2012, 21.

7 Andrew G. Berg and Jonathan D. Ostry, “Equality and Efficiency,” Finance and Development Vol. 48, No. 3 (International Monetary Fund, September 2011), 13.

8 “For Richer, For Poorer,” The Economist, October 13, 2012, 9.

9 Armine Yalnizyan, The Rise of Canada’s Richest 1% (Ottawa: Canadian Centre for Policy Alternatives, 2010).

10 Statistics Canada, “High-Income Trends Among Canadian Taxfilers, 1982 to 2010.” The Daily (Ottawa: Statistics Canada, 2013).

11 Statistics Canada, “High-Income Trends Among Canadian Taxfilers, 1982 to 2010.” The Daily (Ottawa: Statistics Canada, 2013).

12 Edward P. Lazear, “The State of the U.S. Economy and Labor Market.” Remarks at the Hudson Institute, May 2, 2006 (accessed February 28, 2010).

13 “For Richer, For Poorer,” The Economist, October 13, 2012, 9.

14 David Card and John E. DiNardo, “Skill Biased Technological Change and Rising Wage Inequality: Some Problems and Puzzles,” Journal of Labor Economics 20, 4 (2002), 735.

15 Armine Yalnizyan, The Rise of Canada’s Richest 1% (Ottawa: Canadian Centre for Policy Alternatives, 2010), 16

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