Policy Approaches to Inequality

Sandra BlackMember

Council of Economic Advisers

November 17, 2016

Wage and Income Inequality Have Increased Substantially

1

• Between 1979 and 2015, real wages for the highest earnings (90 th percentile) grew by 42%

while median wages rose by 12% and wages at the 10th percentile rose by just 4%.

90th Percentile

2015

50th Percentile

10th Percentile

70

80

90

100

110

120

130

140

150

1979 1984 1989 1994 1999 2004 2009 2014

Hourly Wage Inequality, 1979-2015Real Hourly Wage Index (1979 = 100)

Income Inequality Has Increased Even After Taxes and Transfers

2

• From the business cycle peak in 1979 to the business cycle peak in 2007, the after-tax-and-

transfer income share of the top 1% more than doubled, and the after-tax-and-transfer Gini

rose by almost 30%.

• While taxes and transfers reduce inequality at any point in time, they offer only a partial

correction that has not kept pace with the growth in market inequality in recent decades.

Market Income Plus Taxes and Transfers

Market Income2013

0

5

10

15

20

25

1979 1983 1987 1991 1995 1999 2003 2007 2011

Top 1 Percent Share of Income and the Effects of Taxes and Transfers, 1979-2013

Top 1 Percent Share of Total Income (Percent)

Reduction due to transfers and taxes

Market Income Plus Taxes and Transfers

Market Income2013

0.00

0.10

0.20

0.30

0.40

0.50

0.60

0.70

1979 1983 1987 1991 1995 1999 2003 2007 2011

Inequality in Market Income and the Effects of Taxes and Transfers, 1979-2013

Gini Index

Reduction due to transfers and taxes

Causes of Inequality: Competitive and Non-competitive Forces

3

Competitive market forces caused by shifts in supply and/or demand

curves.

Globalization, skill-biased technological change

Increasing relative returns to capital and high-skilled labor

1. Non-competitive forces: employer monopsony /wage-setting

power in labor market. A shift in the balance of bargaining

power toward employers may lead to:

Redistribution of worker wages to managerial earnings and profits

rising disparities in pay among workers with similar skills

inefficient levels of employment

College Earnings Premium

2015

1.0

1.1

1.2

1.3

1.4

1.5

1.6

1.7

1.8

1975 1980 1985 1990 1995 2000 2005 2010 2015

College Earnings Premium Over TimeEarnings Ratio

Note: The earnings ratio compares the median full-time, full-year worker over age 25 with a bachelor’s degree only to the same type of worker with just a high school degree. Prior to1992, bachelor's degree is defined as four years of college.Source: CPS ASEC

• In 2015, the college earnings premium reached a record high. The median full-time,

full-year worker over age 25 with a bachelor’s degree earned roughly 70% more than a

worker with just a high school degree.

Causes of Inequality: Competitive and Non-competitive Forces

4

Non-competitive forces: employer monopsony/wage-setting

power in labor market.

A shift in the balance of bargaining power toward employers may lead to:

Redistribution of worker wages to managerial earnings and profits

Inefficient levels of employment

Rising disparities in pay among workers with similar skills

5

Labor’s Share of Income Has Been in Steady Decline

• Over the past 15 years, the decline in labor’s share of national income accelerated,

reaching its lowest level ever since World War II, though there have been signs of

reversal since 2014.

Sources of Wage-Setting Power: Search Costs, Frictions

6

Search Costs and Labor Market Frictions. Competition in the labor

market requires that workers be able to switch employers easily in response to changes in wages or working conditions.

Several types of frictions can make job-switching costly, including:

• Information barriers

• Moving costs

Sources of Wage-Setting Power: Employer Behavior

7

Employer Behavior. Employers can also engage in behavior that

limits workers’ options and restricts competition.

• Collusion. Recent court cases have brought suit against:o Silicon Valley employers for “non-poaching agreements” to

suppress pay of programmers and engineers

o Several hospitals for alleged collusion to depress pay of

hospital nurses

• Non-compete agreementso Use extends well beyond cases where plausibly justified by

the need to protect trade secrets

o 1 in 5 workers currently covered (Starr, Bishara and Prescott

2016)

o Roughly 15% of those earning <$40K

o Even in states (e.g., CA) where they are not enforced

8

Sources of Wage-Setting Power: Declining Worker Mobility

• Long-run declines in various measures of labor market fluidity suggest the U.S. market may

be more conducive to monopsony power than in the past.

• Research also shows that wages are less sensitive to current labor market conditions than

was true in the past – consistent with an increase in job-switching costs and a reduced

ability of workers to renegotiate their wages (Malloy et al. 2016)

9

Erosion of Worker Bargaining Power Due To Decline in Unionization and Real Value of Minimum Wage

• Employers may be better able to exercise wage-setting power today than in the past due to

declines in union membership and in the real value of the federal minimum wage.

• In the past 60 years, union membership fell from 25% to 10% of total employment.

• The real value of the Federal minimum wage has declined 24% since its peak of $9.55 (in

2015 $) in 1968.

Changes in Tax Policy and the Coverage Provisions of the Affordable Care Act Have Sharply Reduced Inequality in After-Tax Incomes

10

• Changes in tax policy and the coverage provisions of the ACA will increase the share of after-tax income received by the bottom 99% of families by 1.2 percentage points in 2017 relative to what it would have been under the continuation of 2008 policies. (The income share of the top 1% will decrease by the same amount.)

• These policies will boost incomes for families in the bottom 20% by 18%, equivalent to more than a decade of average income gains.

-1.0

-0.8

-0.6

-0.4

-0.2

0.0

0.2

0.4

0.6

0.8

Change in Share of After-Tax Income by Income Percentile: Changes in Tax Policy Since 2009

and ACA Coverage Provisions, 2017Change in Share of After-Tax Income (Percentage Points)

Source: U.S. Treasury, Office of Tax Analysis.

-15

-10

-5

0

5

10

15

20

Change in After-Tax Income by Income Percentile: Changes in Tax Policy Since 2009

and ACA Coverage Provisions, 2017Percent Change in After-Tax Income

Source: U.S. Treasury, Office of Tax Analysis.

The U.S. Tax and Transfer System Does Less to Reduce Inequality Than Other Countries’ Tax and Transfer Systems

11

• The US has relatively high inequality of market income compared to other advanced

economies—though we are still less unequal than the United Kingdom, Israel, and Ireland.

• We have the highest after-tax-and-transfer inequality of major advanced economies with the

exception of Israel.

0.00

0.10

0.20

0.30

0.40

0.50

0.60

0.70Gini Index

Inequality in Market Income and the Effects of Taxes and Transfers by Country, 2010

12

Multi-Pronged Approach to Promoting Greater Equality in Long Run

• Continued investment in education and skills that boost

productivity:

• Pre-K through college

• Apprenticeships and job training

• Promotion of competition in labor market:

• Facilitate independent anti-trust enforcement

• Reform non-compete laws

• Improve transparency and worker information

• Enhance worker mobility through ACA, reform of

occupational licensing and land use regulations

• Support for institutions that counter wage-setting power

• Support workers’ rights to collective bargaining

• Increase the federal minimum wage

Policy Approaches to Inequality

Sandra BlackMember

Council of Economic Advisers

November 17, 2016