Income inequality is consistently a major topic in U.S. presidential races. Gini coefficient figures have ranked the U.S. as one of the worst places for income equality among developed economies for many years now and this issue is only getting worse.
With a host of social ills—such as slavery, immigration problems, and Japanese internment camps—correlated with high levels of income inequality, it is crucial for the U.S. to figure out how to reduce its income inequality. Fortunately, history gives us a useful guide to policies that can be implemented to aid in that goal. A brief history of income inequality in the U.S. from the beginning of the 20th century until the present day shows that the nation's level of income inequality has been substantially affected by government policies concerning taxation and labor.
- Income inequality has long been a significant problem in the U.S., with a large percentage of wealth going to a small percentage of the population.
- Income inequality has been correlated with higher levels of crime, stress, and mental illness.
- Historical social ills—such as slavery, immigration problems, and Japanese internment camps—are correlated with high levels of income inequality.
- The shared prosperity of the decades following World War II would come to an end during the 1970s; the poor economic situation led to new policies that favored the wealthy.
- It is imperative that future government policies provide opportunities to those with less in an effort to bridge the income-inequality divide.
Late 19th and Early 20th Centuries
In 1915, a statistician by the name of Willford I. King expressed concern over the fact that approximately 15% of America’s income went to the nation’s richest 1%. A more recent study by Thomas Piketty and Emmanuel Saez estimates that, in 1913, about 18% of income went to the top 1%.
Perhaps it is no wonder then that America’s current income tax was first introduced in 1913. Strongly advocated by agrarian and populist parties, the income tax was introduced under the guise of equity, justice, and fairness. One Democrat from Oklahoma, William H. Murray, claimed, “The purpose of this tax is nothing more than to levy a tribute upon that surplus wealth which requires extra expense, and in doing so, it is nothing more than meting out even-handed justice.”
Though there was a personal tax exemption of $3,000 included in the income tax bill that passed, ensuring that only the wealthiest would be subject to taxation, the new income tax did little to level the playing field between the rich and poor.
There was never any intention of using it to redistribute wealth; instead, it was used to compensate for the lost revenues of reducing excessively high tariffs, of which the rich were the main beneficiaries. Thus, the income tax was more equitable in the sense that the rich were no longer allowed to receive their free lunch but had to start contributing their fair share to government revenues.
The countries with the highest wealth equality are Slovenia, the Czech Republic, Slovakia, Belarus, and Moldova.
The new income tax did little to put a cap on incomes, as was evidenced by the low top marginal tax rate of 7% on income over $500,000, which in 2022 inflation-adjusted dollars equals approximately $14 million. Income inequality continued to rise until 1916, the same year in which the top marginal tax rate was raised to 15%. The top rate was changed subsequently in 1917 and 1918, reaching a high of 77% on incomes over $1,000,000.
Interestingly, after reaching a peak in 1916, the top 1% share of income began to drop, reaching a low of about 15% of total income in 1923. After 1923, income inequality began to rise again, reaching a new peak in 1928—just before the crash that would usher in the Great Depression—with the richest 1% possessing 21.3% of all income. Not surprisingly, this rise in income inequality also closely mirrored a reduction in top marginal tax rates starting in 1921, with the top rate falling to 25% on income over $100,000 in 1925.
Though the relationship between marginal tax rates and income inequality is interesting, it is also worth mentioning that at the beginning of the 20th century, total union membership in the U.S. stood at about 10% of the labor force. Though this number escalated during World War I, reaching almost 20% by the end of the war, anti-union movements of the 1920s eliminated most of these membership gains.
Slavery in the United States has a direct relation to current income inequality. There is a cross-state relationship between the Gini coefficient of land inequality in 1860 and the Gini coefficient of income inequality in 2000. The relationship is strong, underlying the impact of past slave use on current economic inequality.
From the Great Depression to the Great Compression
Though the Great Depression served to reduce income inequality, it also decimated total income, leading to mass unemployment and hardship. This left workers without much left to lose, leading to organized pressure for policy reforms.
Further, progressive business interests believed part of the economic crisis and inability to recover was at least partly due to less-than-optimal aggregate demand as a result of low wages and incomes. These factors combined would provide a fertile climate for the progressive reforms enacted by the New Deal.
The New Deal and marginal tax rates
The New Deal paved the way for a rise in union membership and better workers' rights. In the three decades after World War II, up until the early 1970s, median compensation increased and labor productivity approximately doubled, increasing total prosperity while ensuring that it was shared more equitably.
Further, during the Great Depression, marginal tax rates increased. By 1944, the top marginal tax rate was 94% on all income over $200,000. Such a high rate acts as a cap on incomes because it discourages individuals from negotiating additional income above the rate at which the tax would apply and firms from offering such incomes. The top marginal tax rate would remain high for almost four decades, falling to 70% in 1965, and subsequently to 50% in 1982.
Significantly, during the Great Depression, income inequality came down from its peak and was relatively stable, with the richest 1% taking approximately 15% of total income between 1930 and 1941. Between 1942 and 1952, the top 1% share of income dropped to 10% of total income, before stabilizing at around 8% to 9% for nearly three decades. This period of income compression has been aptly named the Great Compression.
1942's Mexican Farm Labor Act
In 1942, the Mexican Farm Labor Program was established, called the Bracero Program. It was done by executive order. The program allowed millions of Mexican men to obtain short-term labor contracts and work legally in the United States.
The Bracero Program ended on Dec. 31, 1964, due to the increased use of machinery. Its lasting effect included a large amount of undocumented and documented laborers in the U.S., cheap labor from Mexico for the program's entire duration, and remittances to Mexico.
1942-1945 internment of American citizens of Japanese origin
During World War II, approximately 110,000 to 120,000 Japanese Americans were forced from their homes on the West Coast and sent to internment camps. Of these individuals, 70% were born in the U.S.
The Japanese Exclusion Act ended in 1945, freeing these individuals, but it changed their financial prospects forever. In 1980, researchers found that, 35 years after individuals were released, those in the poorest camp, Rohwer, in Arkansas, earned 17% less than those in the wealthiest camp, Heart Mountain, in Wyoming.
The shared prosperity of the decades following World War II would come to an end during the 1970s, a decade characterized by slow growth, high unemployment, and high inflation. This dismal economic situation provided the impetus for new policies that promised to stimulate more economic growth.
The policies that were adopted did result in a return to growth, but the main beneficiaries were those at the top of the income ladder. Labor unions came under attack in the workplace, in courts, and in public policy. Top marginal tax rates were reduced in an attempt to direct more money toward private investment rather than the government, and deregulation of corporate and financial institutions was enacted.
President Joe Biden has spoken at length about tackling wealth inequality and vowed to be the “most pro-union president leading the most pro-union administration in American history.”
Labor union membership stood at 23.9% in 1978; by 2011, it had fallen to 11.3%. As the strength of unions declined, so did the shared prosperity that defined the three decades following World War II. Since 1973, labor productivity has almost doubled while median wages only increased by 4%.
The top marginal tax rate has declined significantly, too. The amount the wealthiest get taxed fell considerably in the 1980s and has since remained at much lower levels than the first few decades after the war. Over the past 30-odd years, the top marginal tax rate has fluctuated between 28% and 39.6%.
The decline in union membership and reduction of marginal tax rates roughly coincide with current increases in income inequality, which has come to be called the Great Divergence. In 1976, the richest 1% possessed about 8% of total income. This percentage has been on the rise ever since, peaking at about 32% at the end of 2021.
What Causes Income Inequality?
Income inequality is caused by a variety of factors, including historical racial segregation, governmental policies, a stagnating minimum wage, outsourcing, globalization, changes in technology, and the waning power of labor unions.
Why Is Income Inequality a Problem?
Income inequality is a problem because it puts power in the hands of the rich, resulting in little-to-no social or economic mobility for large portions of the population. It can result in a higher cost of living for many, increased hardship, and rises in crime, mental illness, and social unrest.
How Do You Measure Income Inequality?
Income inequality is measured by the Gini index, the share of aggregate household income held by each quintile, as well as by estimates of the ratios of income percentiles, which include the Theil Index, the mean logarithmic deviation of income (MLD), and the Atkinson measure.
What Is the Gini Ratio?
The Gini ratio measures the distribution of income across a population. The ratio ranges from 0 to 100, with 0 indicating perfect equality in income distribution and 100 representing a complete lack of equality in income distribution. The Gini ratio is represented graphically by the Lorenz curve.
Which Countries Have the Greatest Income Inequality?
The countries with the greatest income inequality are South Africa, Namibia, Suriname, Zambia, and Sao Tome and Principe.
The Bottom Line
History can be a helpful guide to the present. Far from accepting the current economic situation as inevitable, a brief history of income inequality in the U.S. is evidence that governments can tilt the balance of economic compensation by implementing policies that put ethnic and racial groups at burdensome economic disadvantages that continue to have a lasting impact for generations, based on the political and social climates of the time.
With the past 200 years disproportionately favoring White residents and citizens and greater income inequality proven to be associated with higher levels of crime, stress, and mental illness, the United States must implement effective policies to overcome income disparities.