Review on Income Inequality

1. Introduction

The debate about economic inequality is not a new topic, and it has been heavily discussed for the past centuries but now rises to a new level. Milanovic (2014) reports in his review “The Return of Patrimonial Capitalism” that from a historical point of view economic inequality continuously rises in a capitalistic world and is going to only increase more rapidly in the next years. Therefore Milanovic (2014) underlines this by demonstrating the historical development of the ratio between capital and annual income. Economic inequality is a global theme, as well as a domestic problem and has, therefore, serval different causes and effects.

This paper investigates the question of whether or not economic inequality is a driving force for economic and social development, while the focus lays on income inequality.

Firstly, the paper shows evidence on the extent of income inequality in India, as a representative example. Then it takes a broader view of the topic and identifies the causes of income inequality. Thirdly, it describes the general problems associated with income inequality and then explains the advantages associated with income inequality. During the examination of this aspects, the paper will focus on the economic background, especially on aspects such as the equity-efficiency-trade-off, taxation and the role of the government, as well as on the deadweight loss. Then it will analyze what the government can do to deal with that problem. Finally, it summarizes and compares the findings of this paper.

2. Evidence on the extent of income inequality in India

Over the past years, the Indian economy achieved a high economic growth. Nevertheless, not everybody profited equally from it (Sakrar & Metha, 2010). The Net Gini Index, which is one of the most important indicators for economic inequality, in India was in 2013 on a value of 51.36, which confirms the high-income inequality (Bansal,2017).

In the following graph, the income share of the middle 40% of the Indian population remains stable from 1950 until 2000 between 40% to 45% of national income. from 2000 on, the income share of the middle 40% decreased sharply to a level of 30% in 2010. Meanwhile, the income share of the top 10% decreased slightly since 1950 from 37% to 30% of national income in 1980. Then it climbs sharply to a level of 55% in 2010. This results in a huge gap between the top 10% and the middle 40% with a difference in income shares of 25% in 2010. This development underlines the increasing income inequality.

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Figure 1. India Income share. From: “India may have worst income inequality levels for almost a century,” by S. Subramanian, 2017, The National

Table 1 below demonstrates that there is an overall growth of the per adult income of 3.3% in India. Furthermore, it is important to pay attention to the income per adult growth rates of the individual income groups in India. The lower 50% have a total growth rate of 1.9%, while the top 0.001% have a total growth rate of 9.4%. Therefore, the huge income growth differentiates between the different income groups. Moreover, mostly the wealthy people profited from the massive economic increase in the past years.

Table 1. Total real per adult income growth.

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From: “Indian income inequality, 1922-2015: From British Raj to Billionaire Raj,” by L. Chancel, and T. Piketty, 2017, World Inequality Database working paper N°2017/11, p. 61

Chancel and Piketty (2017) conclude, that strong market regulations, a strict progressive tax system, and nationalization, was the reason for having a relatively stable level of economic inequality from 1950 to 1980. As a result of more free market orientated economic policies since 1980, the income inequality in India rises dramatically to new levels. These findings can be underlined by the following graph, which shows the development of the top marginal income tax rate in India. This shows the gradual decline in the top marginal income tax rate in India since 1972, which is directly correlated to the rapid rise in total income of the top 10% income group.

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Figure 2: Top marginal Income tax rate in India. From: “Indian income inequality, 1922-2015: From British Raj to Billionaire Raj,” by L. Chancel, and T. Piketty, 2017, World Inequality Database working paper N°2017/11, p. 52

3. Causes of income inequality

Income inequality has several different causes. Biewen and Juhasz (2012) believe that increasing inequality in labour market returns is one of the causes of income inequality. First of all, in a mostly free market economy wages are determined by the labour market, by the supply of labour (employee) and the demand of labour (employer). If there are is a high supply of less-skilled workers and a low demand for them, the wages will be low and vice versa. Furthermore, the growth of technological development and the general skill level divides the workers in workers with a small skillset who have to work in low paid jobs and workers with a large skillset, who can earn more money. In addition to this, there is also the effect of globalization, which leads to higher competition on the labour market. As well as, leads companies to outsource their production (Dabla-Norris, Kochhar, Suphaphiphat, Ricka, & Tsounta, 2015). Thus, corresponding to a decrease in wages in the work areas for less skilled workers. Moreover, Biewen and Juhasz (2012) claim that changes in the transfer system are also a reason for increasing inequality when they do not help the lower classes in society. Furthermore, one of the main causes of increasing income inequality is the decrease in the marginal tax rate, which is confirmed by Biewen & Juhasz (2012) and also by Chancel & Piketty (2017). Another cause for income inequality is the difference in education, a higher degree of education leads to a higher level of skill and this leads to a higher income (Becker & Murphy, 2007).

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