Wednesday, May 14, 2014

Why Income Inequality Has Increased in Canada

Incomeinequality in Canada has increased over time. Wealthy households are getting wealthier and poor and middle class households are not getting better off. This increase in inequality is due to the decrease in  the share of the compensation of employees in the gross domestic product (GDP) and to the increase in the share of gross operating surplus in GDP. The compensation of employees is made up of wages and salaries, and social contributions at the expense of employers. As for gross operating surplus, it consists of the profits before taxes of corporations and government business enterprises, investment incomes, and capital consumption allowances.  The share of the compensation of employees fell from nearly 54 % in 1981 to half of the GDP three decades later whereas the share of gross operating surplus rose from 24 % to 28.28 % over the same period. Only a minority of households benefits from the increase in the share of gross operating surplus: the wealthy entrepreneurs and investors.

To measure income inequality, Economists use the Gini coefficient. The Gini coefficient is a summary statistics that indicates how far income distribution across the population is from a hypothetical society where everybody has the same income. It lies between zero and one, with zero indicating equality of income across the population.  I have plotted below the pre-tax Gini coefficient in comparison with, on the one hand, the share of the compensation of employees and, on the other hand, the share of the gross operating surplus over the time period 1981-2011 in Canada.
Gini Coefficient along with the Share of the Compensation of Employees in GDP (Left-Hand Side Panel) and the Share of Gross Operating Surplus  (Right-Hand Side), 1981-2011, Canada, Data Source: Statistics Canada
Gini Coefficient along with the Share of the Compensation of Employees in GDP (Left-Hand Side Panel) and the Share of Gross Operating Surplus  (Right-Hand Side), 1981-2011, Canada, Data Source: Statistics Canada
It appears in the first panel of the above figure that income inequality increases while the share of the compensation of employees decreases. Income inequality increases by 1.04% when the share of the compensation of employees decreases by one percent. The second panel shows the inverse relationship. Income inequality increases along with the increase in the share of gross operating surplus.

It seems to me that an increase in the tax on capital, the lightening of the tax burden on employees, and employment policies designed to have more people prefer getting back to work rather than living on benefits are solutions to reduce income inequality.