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Another relevant measure is labor’s share in GDP (labor costs, wage and salary income as a percent of GDP). Labor’s share in nominal GDP has been steadily declining since 1970 not only in the U.S., Germany, Japan and Britain, where it declined from around 70% to about 65%: The decline has been very sharp in both South Korea and Mexico (see Figure 4-5). The low Mexican share for labor is perplexing, until one realizes the very heavy importance of petroleum (and government returns from petroleum) in nominal GDP.

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Some of the decline in labor’s share in developed nations has been due to globalization (of trade, of financial markets, of investments), as exports of developing nations to the West have soared. One estimate, by researchers at the Federal Reserve Bank of San Francisco and the Fed in New York, estimates that of the 4% decline in labor’s share in the U.S. since 1990, 3.3 percentage points have been due to imports.

But we will also see in Chapter 7 that technological factors have been important as well: digital displacement of labor especially from robotics, has helped to reduce labor’s share in national income in both developed and developing nations. Technological changes over the past 35 years have meant that the cost of investment goods relative to consumption goods has fallen by one-quarter, Loukas Karabarbouras&Brent Neiman (2014),” The Global Decline of the Labor Share”, The Quarterly Journal of Economics , 129(1): 61-103. Retrieved from http://qje.oxfordjournals.org. making labor-saving investment in capital goods more attractive.

Remedies for income inequality

Income inequality is not an issue to be treated lightly anywhere. Serious questions are involved. The last 200 years of history suggest that no “quick fixes” are available. Rectification of income inequality takes time, if it is to be sustained.

In later chapters dealing with fiscal and monetary policy, we discuss these remedies in some detail. However, at this point it is useful to summarize what has worked well (or not) in reducing income inequality. There are two basic approaches for attempting to reduce income and wealth inequality: “leveling up incomes” or “leveling down” of the income distribution.

“Leveling up” relies on the expenditure side of the budget. This involves spending to foster human capital formation through outlays for education and public health (see Chapter___), as well as direct government transfers to low income families, as in Brazil and Mexico in recent years.

Indeed, later in Chapter___, we consider evidence that Brazil’s decade-old system of “conditional cash transfers” to low-income families with school age children was the most important factor in reducing income inequality there after 2009.

“Leveling down” involves primarily using the tax side of the budget and has not worked well in rectifying income inequality over the long term.

Throughout most of the 20th Century, there was a pervasive belief worldwide in the efficacy of steeply progressive income tax rates in raising government revenues and in reducing income inequality. Neither expectation was realized. Consider the U.S. experience. From 1950-1963, the top rate of income tax was 91%. From 1964-1981, the top rate was reduced to 65%. The maximum rate dropped to 45% in 1982, to 35% in 1986, and has been in the 35-38% range since the year 2000 until 2014 when it again rose to 44% (including changes in 2013). What happened to Federal revenues as a percent of GDP over the period 1950-2008 as the rates declined? Federal taxes as a percentage of GDP have been roughly constant at about 21% from 1950-2008, in spite of highly varying rates over time. Reducing the steeply progressive rates of income tax after 1969 did not lead to a fall in the Federal tax share in GDP. And while income inequality has increased in U.S. in the past 2 decades, it also worsened in the early nineties, after the top tax rate increased from 35% to 40%. In this period, inequality increases were essentially traceable to technology change and globalization, and failure of public education K-12 not tax cuts.

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Source:  OpenStax, Economic development for the 21st century. OpenStax CNX. Jun 05, 2015 Download for free at http://legacy.cnx.org/content/col11747/1.12
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