Income Inequality

Brian Keeley

• Publisher: OECD
• Year: 2015
• ISBN:
  9789264250024
• Topic: Social Sciences
• Subtopic: Sociology
• Index: Social Sciences

1 What are income and wealth?

A number of key concepts are essential to any discussion of income inequality. These include the distinction between income and wealth as well as definitions and measures of inequality and poverty.

Key themes

For centuries, the nursery song “Tinker, Tailor” was used by children to determine who they might marry. Counting out cherry stones or daisy petals, they would chant a still familiar rhyme:

Tinker, tailor, soldier, sailor,

Rich man, poor man, beggarman, thief.

With origins that can be traced back to at least 1475, the song is a reminder that, in much of human history, some level of economic inequality has been a recurring theme. In other words, some people have usually had more than others. But the extent of this inequality has varied considerably. Today in northern Europe, for example, the gap between rich and poor is still relatively narrow compared to other developed countries. In other countries, such as the United States and Turkey, China and in Central and South America, it’s typically much wider.

Why does this matter? Later sections will explore the impacts of income gaps on our economies and societies. But, for now, it’s enough to say that we need to understand how economic resources are spread across society to determine the extent to which people are in the economic mainstream or on its fringes.

To develop a full picture of people’s economic resources, two concepts are particularly important – income and wealth. Income is the flow of money that comes into a household from employers, owning a business, state benefits, rents on properties, and so on. Wealth essentially represents people’s savings and it’s typically higher – and spread out more unevenly – than income. Wealth matters but, in some ways, income matters more. That’s because it’s usually a better indicator of people’s day-to-day economic resources.

The task of measuring income (and wealth) inequality is challenging. It’s hard, too, to represent the results in a meaningful way. Today, the most widely used measure is the Gini coefficient. But the Gini only shows part of the story. While it gives a good overall sense of income distribution, it doesn’t show us how many people are lacking even basic resources. For that reason, inequality measures are usually supplemented with measurements of poverty.

• 1.1. Income vs. wealth: Similar but different
• 1.2. Measuring inequality: A challenge for data
• 1.3. Measuring poverty: Relative and absolute

1.1. Income vs. wealth: Similar but different

Income and wealth are often used interchangeably but they’re not the same. A pensioner living in a house valued at $500,000 might be considered wealthy, but if her pension brings in just $100 a week, most would consider her as having a low income. This is why it’s important to understand the difference between income and wealth.

What is income?

People sometimes think of their before-tax salary as their income, even though it’s rarely the same as what they actually receive into their hands each month. So, instead, it’s useful to think in terms of disposable income (or income after taxes and transfers), which gives a much clearer sense of how much money people actually have available to them to spend on rent, food, clothes and so on.

In basic terms, disposable income is determined by the flow of money into a household (usually salaries and payments from the state) minus what goes out in taxes. Think of it as “incomings” and “outgoings”:

• The incomings side can include salaries or wages, earnings from investments and rents on properties. It also includes direct benefits, or transfers, received from the state, such as child benefits. Some measures of disposable income also include non-cash benefits from the state, such as education or healthcare – an important benefit for many families.
• The outgoings side typically includes taxes and other charges, such as social security, that are paid to the state as well as some payments to other households, such as to divorced spouses.

The difference between market income (i.e. income before taxes and transfers) and disposable income is substantial in most OECD countries. Without taxes and transfers, inequality would be even higher than it currently is (see Section 3.5).

Income is also often discussed in terms of “equivalised household income” or “household per capita income”. To explain: Households vary greatly in size – in a wealthy country, an income of $10,000 might be enough to support someone living on their own but could pose problems for a family of four. That’s not to say that such a family needs four times what a single individual needs – one TV set, one fridge should be enough to meet their needs. But such economies of scale don’t apply quite so much in other areas, like clothing and food. The equivalised figure takes account of all this. It’s computed by dividing household income by the square root of the household size. So, according to standard economic calculations, to match that income figure of $10,000 for a single person, a family of four would actually need an income of $20,000 to reach the same level of well-being.

More from the OECD: How does your income compare with everyone else’s? And how well do you understand how income is spread out across society? Get the answers with the OECD’s Compare Your Income tool: http://www.oecd.org/statistics/compare-your-income.htm.

What is wealth?

Most people have an instinctive feeling of what wealth means – money in the bank, property and land, shareholdings, jewellery and art, pension rights and possibly life assurance, and so on. But wealth has both a positive and a negative aspect. As well as assets, like our savings, we may also have liabilities, such as loans and mortgages. Combine these assets and liabilities and we come up with a picture of people’s net wealth.

Wealth is important for several reasons: It gives people a cushion if they lose their job or fall on hard times; it can also provide a source of income, for example, through interest payments on bank deposits or dividends on shares; and it allows people to make one-off or large-scale investments, such as in their education or in property.

Measuring wealth is a complex business, and not all countries do it the same way – for example, some may include the value of a pension, others may not. For this reason, it’s important to look at the fine print of any measure of wealth to see what’s included and what’s left out.

Comparing wealth and income

Because wealth is accumulated over time, it’s unsurprisingly typically higher on average than income. For example, in OECD countries average household disposable income per capita is $25,908 a year but average household net financial wealth per capita is $67,139.

A second feature of wealth is that it’s typically spread out even more unequally than income – in other words, wealth inequalities tend to be more pronounced than income inequalities. Why does this matter? Wealth can, in itself, generate income, and so as wealth inequalities widen, they, in turn, fuel income inequalities. And as wealth is a source of investment, widening inequalities mean a growing gap between rich and poor in their abilities to take advantage of investment opportunities.

More from the OECD: Data on income and wealth can be found at the OECD’s Better Life Index (http://www.oecdbetterlifeindex.org) and at the OECD Data Portal (https://data.oecd.org).

1.2. Measuring inequality: A challenge for data

Inequality can be explored in several ways, all of which give a different sense of how economic resources are spread out across society and even the world. One approach is to look at global wealth inequalities, which are extreme. For example, Credit Suisse’s annual Wealth Report reported in 2014 that “that the lower half of the global population collectively own less than 1% of global wealth”. By contrast, the bank calculated that the richest 10% owns 87% of global assets, while the top 1% accounts for “almost half of all assets in the world”.

Such wealth studies are eye-catching, but they present problems. Not the least of these is that data on wealth is extremely hard to come by, so it’s hard to develop reliable figures. That’s one reason why inequalities in income have historically been studied more closely.

More from the OECD: Wealth inequality generally fell in the middle of the 20th century but has risen in recent years. See “The Distribution of Wealth”, (Bonesmo Fredriksen, 2012), an OECD working paper, http://dx.doi.org/10.1787/5k9h28t0bznr-en.

Representing inequality

Finding a way to represent inequality using just a single number is challenging, and over the years many approaches have been taken. But the one that’s probably best known today is the Gini coefficient, which was defined by the Italian economist and statistician Corrado Gini in the early 20th century.

The basic idea behind the Gini coefficient is straightforward. It uses a value of 0 to represent a society where everyone has the same income and which, therefore, has no inequality; at the other end of the scale, it uses 1 to represent a society where only one person has all the income and which, thus, has maximum inequality. To make them easier to understand, Gini values can also be represented as Gini points. This is done simply by multiplying each value by 100, so a Gini coefficient of 0.28 becomes 28 Gini points. In public debate, a Gini score of 40 points and above is sometimes considered critical.

Data: In the OECD, income inequality varies from around 25 Gini points in some Nordic countries to over 40 Gini points in Turkey and Mexico.

Income inequality in OECD countries, 2012

Source: OECD (2015a), OECD Data Portal, https://data.oecd.org/chart/4lzS.

What are typical Gini values? The average Gini value across OECD countries is 31.5 points, although there is quite a lot of variation between countries. The societies with the lowest levels of inequality, Slovenia and some of the Nordics, score around 24 to 28 Gini points; the most unequal societies, such as Mexico and Chile, score around 45 points.

Discussions of Gini values can revolve around very small changes, perhaps around only one or two points. Can these really matter? It depends. Small fluctuations from one year to the next ma...