Who is Exactly to Blame for Income Inequality?

By Casey Barr on February 9, 2016

The topic of income inequality is one of the most polarizing arguments in modern political and economic debate. Popular media outlets, social movements, and even some candidates vying for the U.S. presidency have vocalized their beliefs on how the Federal government needs to take a more active hand in the unequal distribution of wealth; but what if the government has inadvertently exacerbated it?

A basic elucidation of the definition of income inequality follows as such: Income inequality is the unequal difference in how income is distributed among individuals and/or populations. To be clear, income inequality in and of itself is not necessarily a negative thing. Inequality can actually lead to growth and modernization. A debatably natural consequence of capitalism, the cause for the massive demarcation in views on the subject is to what extent should this inequality be allowed to grow.

One of the most recognizable names when it comes to the topic of income inequality is Thomas Piketty, French economist and author of the global best-seller, Capital in the Twenty-First Century. An exhaustingly comprehensive compilation of empirical data related to income and wealth disparity, some argue that it is not without faults and is contested accordingly; however, the majority of economists agree that the widening spread of income inequality is backed by data. A little over a year ago, Dr. Piketty spoke at a TED conference where he outlined the major themes of his book, one of which included the, “… unprecedented rise of top managerial compensation in the U.S.” In recent years, the idea of this particular motif has inspired many social movements to form and publicly lament the U.S. government for their inability to act upon the rise of top management salaries. 

It turns out the government already has. Predictably Irrational, a book on behavioral economics written by renown psychologist Dan Ariely, expounded upon what he calls the truth about relativity in its first chapter. A basic synopsis of the theory states that when evaluating an object, humans tend to view the object not as itself, but we compare it to others: jobs with jobs, vacations with vacations, wines with wines, etc. This economic theory of relativity, as some have called it, exhibited a perverse effect on top executive compensation that is only clear when one is looking back in hindsight.

In 1993, the SEC enacted a series of amendments designed to make Executive Compensations – i.e. CEO and other top management salaries – more transparent. The goal was to publicly display the exorbitant salaries paid to these executives in the hopes of stymieing the increasing disparity between the incomes of the CEOs and the incomes of the average workers in their companies. Ironically, this also allowed the same executives to view each other’s salaries; now if a CEO of a corporation was underpaid relative to his or her peers, he or she was able to know. This created a spiraling cycle of increasing executive salaries that led to – as Thomas Piketty so put it – unprecedented heights. To illustrate how high these salaries climbed, in 1993 when the SEC passed these amendments, executive compensation was 131 times that of the average workers income. By the time Ariely wrote his book it had risen to 369x.

CC Image courtesy of Income Inequality by Wayne S. Grazio on Flickr

Income inequality is a difficult subject to debate. Like most important issues in society, it has very distinct political connotations. Many clamor popular rhetoric such as “big banks are bad” or “tax the 1%” while others champion laissez-faire capitalism and believe that the government should let things be and keep out of markets. There is a myriad of factors that both directly and indirectly influence the distribution of wealth. This brings the need for thorough empirical analysis of the topic. To some, it seems the logical thing would be to petition the government to help prevent this widening gap; but what if the government itself contributed to it?

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