Reading: Measuring Income Inequality

HOW DO YOU SEPARATE POVERTY AND INCOME INEQUALITY?

Poverty levels can be subjective based on the overall income levels of a country;
typically poverty is measured based on a percentage of the median income. Income
inequality, however, has to do with the distribution of that income, in terms of which
group receives the most or the least income. Income inequality involves comparing
those with high incomes, middle incomes, and low incomes—not just looking at those
below or near the poverty line. In turn, measuring income inequality means dividing up
the population into various groups and then comparing the groups, a task that can be
carried out in several ways.

Growth in U.S. Family Income: 1947-1979 Versus 1980-2007   by Joe Wolf, CC-BY-ND.

 
Poverty can change even when inequality does not move at all. Imagine a situation in
which income for everyone in the population declines by 10%. Poverty would rise, since
a greater share of the population would now fall below the poverty line. However,
inequality would be the same, because everyone suffered the same proportional loss.
Conversely, a general rise in income levels over time would keep inequality the same,
but reduce poverty.

It is also possible for income inequality to change without affecting the poverty rate.
Imagine a situation in which a large number of people who already have high incomes
increase their incomes by even more. Inequality would rise as a result—but the number
of people below the poverty line would remain unchanged.

Why did inequality of household income increase in the United States in recent
decades? Indeed, a trend toward greater income inequality has occurred in many
countries around the world, although the effect has been more powerful in the U.S.
economy. Economists have focused their explanations for the increasing inequality on
two factors that changed more or less continually from the 1970s into the 2000s. One
set of explanations focuses on the changing shape of American households; the other
focuses on greater inequality of wages, what some economists call “winner take
all” labor markets. We will begin with how we measure inequality, and then consider the
explanations for growing inequality in the United States.
Measuring Income Distribution by Quintiles
One common way of measuring income inequality is to rank all households by income,
from lowest to highest, and then to divide all households into five groups with equal
numbers of people, known as quintiles. This calculation allows for measuring the
distribution of income among the five groups compared to the total. The first quintile is
the lowest fifth or 20%, the second quintile is the next lowest, and so on. Income
inequality can be measured by comparing what share of the total income is earned by
each quintile.

U.S. income distribution by quintile appears in Table 14.5. In 2011, for example, the
bottom quintile of the income distribution received 3.2% of income; the second quintile
received 8.4%; the third quintile, 14.3%; the fourth quintile, 23.0%; and the top quintile,
51.14%. The final column of Table 14.5 shows what share of income went to
households in the top 5% of the income distribution: 22.3% in 2011. Over time, from the
late 1960s to the early 1980s, the top fifth of the income distribution typically received
between about 43% to 44% of all income. The share of income that the top fifth
received then begins to rise. According to the Census Bureau, much of this increase in
the share of income going to the top fifth can be traced to an increase in the share of
income going to the top 5%. The quintile measure shows how income inequality has
increased in recent decades.
 Lowest Second Third Fourth Highest Top
Year
Quintile Quintile Quintile Quintile Quintile 5%

1967 4.0 10.8 17.3 24.2 43.6 17.2

1970 4.1 10.8 17.4 24.5 43.3 16.6

1975 4.3 10.4 17.0 24.7 43.6 16.5

1980 4.2 10.2 16.8 24.7 44.1 16.5

1985 3.9 9.8 16.2 24.4 45.6 17.6

1990 3.8 9.6 15.9 24.0 46.6 18.5

1995 3.7 9.1 15.2 23.3 48.7 21.0

2000 3.6 8.9 14.8 23.0 49.8 22.1

2005 3.4 8.6 14.6 23.0 50.4 22.2

2010 3.3 8.5 14.6 23.4 50.3 21.3

2011 3.2 8.4 14.3 23.0 51.1 22.3

Table 14.5. Share of Aggregate Income Received by Each Fifth and Top 5% of
Households, 1967–2011 (Source: U.S. Census Bureau, Table H-2)

It can also be useful to divide the income distribution in ways other than quintiles; for
example, into tenths or even into percentiles (that is, hundredths). A more detailed
breakdown can provide additional insights. For example, the last column of Table 14.5
shows the income received by the top 5% percent of the income distribution. Between
1980 and 2011, the share of income going to the top 5% increased by 5.8 percentage
points (from 16.5% in 1980 to 22.3% in 2011). From 1980 to 2011 the share of income
going to the top quintile increased by 7.0 percentage points (from 44.1% in 1980 to
51.1% in 2011). Thus, the top 20% of householders (the fifth quintile) received over half
(51.1%) of all the income in the United States in 2011.
Measuring Income Inequality

The U.S. economy has a relatively high degree of income inequality by global
standards. As Table 14.7 shows, based on a variety of national surveys done for a
selection of years in the last five years of the 2000s (with the exception of Germany,
and adjusted to make the measures more comparable), the U.S. economy has greater
inequality than Germany (along with most Western European countries). The region of
the world with the highest level of income inequality is Latin America, illustrated in the
numbers for Brazil and Mexico. The level of inequality in the United States is lower than
in some of the low-income countries of the world, like China and Nigeria, or some
middle-income countries like the Russian Federation. However, not all poor countries
have highly unequal income distributions; India provides a counterexample.

Survey First Second Third Fourth Fifth

United
2011 3.2% 8.4% 14.3% 23.0% 51.1%
States

Germany 2000 8.5% 13.7% 17.8% 23.1% 36.9%

Brazil 2009 2.9% 7.1% 12.4% 19.0% 58.6%

Mexico 2010 4.9% 8.8% 13.3% 20.2% 52.8%

China 2009 4.7% 9.7% 15.3% 23.2% 47.1%

India 2010 8.5% 12.1% 15.7% 20.8% 42.8%

Russia 2009 6.1% 10.4% 14.8% 21.3% 47.1%

Nigeria 2010 4.4% 8.3% 13.0% 20.3% 54.0%

Table 14.7 Income Distribution in Select Countries (Source: U.S. data from U.S. Census
Bureau Table H-2. Other data from The World Bank Poverty and Inequality Data Base,
http://databank.worldbank.org/data/views/reports/tableview.aspx#)
Link It Up

Visit this website to watch a video of wealth inequality across the world.

Lorenz Curve
The data on income inequality can be presented in various ways. For example, you
could draw a bar graph that showed the share of income going to each fifth of the
income distribution. Figure 14.8 presents an alternative way of showing inequality data
in what is called a Lorenz curve. The Lorenz curve shows the cumulative share of
population on the horizontal axis and the cumulative percentage of total income
received on the vertical axis.

Figure 14.8. The Lorenz Curve. A Lorenz curve graphs the cumulative shares of income received by everyone
up to a certain quintile. The income distribution in 1980 was closer to the perfect equality line than the income
distribution in 2011—that is, the U.S. income distribution became more unequal over time.

Every Lorenz curve diagram begins with a line sloping up at a 45-degree angle, shown
as a dashed line in Figure 14.8. The points along this line show what perfect equality of
the income distribution looks like. It would mean, for example, that the bottom 20% of
the income distribution receives 20% of the total income, the bottom 40% gets 40% of
total income, and so on. The other lines reflect actual U.S. data on inequality for 1980
and 2011.

The trick in graphing a Lorenz curve is that you must change the shares of income for
each specific quintile, which are shown in the first column of numbers in Table 14.6, into
cumulative income, shown in the second column of numbers. For example, the bottom
40% of the cumulative income distribution will be the sum of the first and second
quintiles; the bottom 60% of the cumulative income distribution will be the sum of the
first, second, and third quintiles, and so on. The final entry in the cumulative income
column needs to be 100%, because by definition, 100% of the population receives
100% of the income.

Share of Cumulative Share Share of Cumulative Share

First
4.2 4.2 3.2 3.2
quintile

Second
10.2 14.4 8.4 11.6
quintile

Third
16.8 31.2 14.3 25.9
quintile

Fourth
24.7 55.9 23.0 48.9
quintile

Fifth
44.1 100.0 51.1 100.0
quintile

Table 14.6. Calculating the Lorenz Curve

In a Lorenz curve diagram, a more unequal distribution of income will loop farther down
and away from the 45-degree line, while a more equal distribution of income will move
the line closer to the 45-degree line. The greater inequality of the U.S. income
distribution between 1980 and 2011 is illustrated in Figure 14.8 because the Lorenz
curve for 2011 is farther from the 45-degree line than the Lorenz curve for 1980. The
Lorenz curve is a useful way of presenting the quintile data that provides an image of all
the quintile data at once. The next section shows how income inequality differs in
various countries compared to the United States.