June 10, 2021

Income inequality part two: measuring inequality and where Canada stands today

In this series on inequality, we seek to better understand the gap between low- and high-income earners and its potential consequences in Canada. In this second commentary, we take a look at how to measure inequality, and at the levels and trends in Canadian inequality over the years.

Commentary Series on Inequality: each individual commentary will cover a different facet of this important topic:

Measuring inequality 

Though the concept of inequality may be intuitive—people earn different amounts of money—its measurement is not. This is part of what confuses and complicates discussions on an already charged topic. It’s like an American and a European showing up to play football; there’s going to be a lot of confusion and arguing and no one’s going to win because they’re not even talking about the same thing.   

Ultimately, there is no single right or wrong way to measure inequality. The most complete studies consider multiple measures to best understand the landscape. This is what we seek to do in our analysis to see just how unequal Canadians were before the pandemic, and if the gap between low- and high-earners continues to grow.

Considerations when measuring inequality:
Income or wealth
The first question is what to measure. One option is to look at differences in income earned from work and other sources like investments. Another is to look at differences in overall wealth—often referred to as “net worth”—which is the total assets an individual owns minus the debt that is owed.

In this analysis, our primary focus will be on differences in income earned, for a couple of reasons. First, there is a greater availability of data because income is much easier to measure and track. Second, with the exception of inheritance or acquired assets, differences in wealth generally stem from, or are built upon, differences in income earned.

How to measure the level of inequality
The second question is how to measure how much inequality there is between the haves and have-nots, so to speak. One way is to look at how much the top earners—say the top 5% or top 1%—make relative to the rest of the population. Another way is to divide the population up into equal-sized groups (usually five or 10) and compare the share of income earned by each. A third would be calculating what share of income growth accrues to the richest cohort.

Pre- or post-government taxes and subsidies
Another question is whether what matters is the amount earned before government taxes and transfers or after. For instance, if an individual earns very little from work but, through low-income support policies, has more available to them to spend, which of these two perspectives matters most?

Other considerations
Beyond this are a number of other factors which can influence inequality—family size, marital trends, and the average age of the population, to name a few. For instance, a population with a lot of young adults and/or a large, retired population may show high inequality because income tends to be lower at those points in life, compared to a person’s peak earning years.

How unequal are incomes in Canada?  

One way to assess how widely incomes are dispersed in a society—or, how many Canadians are part of a middle class versus falling into opposite extremes of relative rich and poor—is via a graph known as the Lorenz curve.  

Measure of inequality: the Lorenz curve
The best way to understand this graph is to imagine lining up all individuals in Canada based on their income, from the lowest earners on the left—some of whom may not be employed at all—all the way up to the very highest earners on the right, where we’re likely to find top athletes, executives, and innovators.

Now, what we want to know is how much worse off are lower income households relative to those as the top. Said another way, what percentage of the income “pie” do the bottom 20% of earners get?

In a society with no inequality, the bottom 20% of individuals would earn 20% of the total income in Canada. In fact, there would be no “ordering” necessary since everyone would earn the same amount. This situation is represented in Chart 1 by the straight, dotted line.

In practice, however, this never happens. The bottom 20% of earners will receive something less than 20% of income. And the top 20% will receive more than that share. The result is a curved line of income distribution called the Lorenz curve that always sits below the straight dotted line. The degree of inequality is measured by the size of the gap between the straight line and the Lorenz curve. The bigger the gap, the more unequal the society is.

What this tells us 

Canada’s Lorenz curve tells us two important things about inequality.

First, as expected, there is income inequality in Canada, pre and post-taxes. Based on the graph below, the bottom 20% in Canada earn just about 3% of the total income pre-taxes and transfer payments. After taxes and transfers, they take home more: around 8%. Similarly, continuing up the curve, we see that the bottom 40% earn about 13% of the total income before taxes and transfers but take home closer to 21% after taxes and subsidies.

Chart 1: Canada’s income inequality

Second, this tells us that the tax system plays a fairly substantial role in decreasing the gap between the lowest and highest earners. This is due to the progressivity of the tax system, which—through higher marginal taxation on the one end and means-tested income supports on the other—redistributes some income from higher earners to lower earners.

The magnitude is notable: redistribution through the tax system has the result of decreasing income inequality in Canada by nearly 30%, which is more progressive than the US, though less than Denmark, France, and the UK.

To put this in perspective, the chart below shows how this plays out for different income groups. Though the top 20% of households earn on average about $131,000, after taxes, they take home around $26,000 less. Meanwhile, the poorest earn about $8,300 but take home close to $21,000, after governmental support.

Chart 2: Impact of taxation

What this chart does not tell us, however, is whether this degree of inequality is problematic. As detailed in Part I of our series, some inequality of income for different jobs and types of work plays an important role in prosperity and economic growth, whereas too much can trigger undesirable social and economic outcomes. 

How does Canada compare to other countries?

To gain a better perspective, it’s useful to compare Canada to other countries. While cumbersome to compare the Lorenz curve across countries, luckily we can take this graph and translate it into a single number, known as the Gini coefficient

Measure of inequality: the Gini coefficient
We noted above that the space between the diagonal dotted line and the Lorenz curve is a measure of the degree of inequality in a society. Calculating the size of that area produces a number known as the Gini coefficient.

The straight line on the chart represents perfect equality. So, if a society is perfectly equal, then there is literally no difference between the Lorenz curve and the straight line. That scenario produces a coefficient of 0. This means everyone in the society earns the same amount of income, regardless of their experience, knowledge, or contribution.

A coefficient of 1 represents the opposite extreme: this would be the figurative scenario in which a single individual, say Jeff Bezos, earns all of the money and no one else has a job or income. Put simply, the closer to 1, the more unequal the society.

So how does Canada compare? 

Canada, along with Alberta, is actually much more egalitarian than you might think. Though geographically close to the US, it is far less unequal, as shown on the inequality spectrum below. Canadian inequality is more similar to that of France and Germany than of the US or the UK. This is an important finding. Narratives and research from the US have a way of spilling north of the border but they may not reflect the realities in Canada.

Chart 3: Income inequality

Is inequality increasing? 

Inequality was growing in Canada for a while, but this trend has mostly stopped.

Let’s look first at inequality due to differences in income earned from work and other market sources (i.e., before individuals pay taxes or receive any income support). Beginning in the 1970s (for the years where data were available), the Gini coefficient was about 0.38. It rose through the 1980s and 1990s, reaching about 0.45 in 1998. However, inequality stopped increasing after that and has since been more or less stable.

Chart 4: Amount of income inequality in Canada pre-taxes

Looking at the income Canadians take home after taxes and transfers, the story is considerably different. The growing gap in market incomes did not translate to the same level of inequality in take-home pay. The increase in the after-tax Gini coefficient was small over the 1980s and 1990s and is now actually down slightly from the level in the 2000s.  

Chart 5: Amount of income inequality in Canada before and after taxes

In fact, as of 2019, the Gini coefficient for after-tax or “disposable” income was at its lowest level since the mid-90s. In other words, based on this metric, inequality has not budged substantially since the Friends theme song was topping the charts.  

Chart 6: Amount of income inequality in Canada after-taxes

A comparison across developed countries shows no clear trends in any direction. Like Canada, some have seen after-tax inequality level off. Others have seen an increase, and some a decrease. In other words, trends of inequality have been unique across countries and therefore cannot be easily simplified into a single narrative. 

Limitations of the Gini coefficient 

Because the Gini coefficient boils the concept of inequality down to a single number, it risks oversimplifying the complexity of the issue. It is neither perfect, nor should it be used in isolation.

The Gini coefficient: what it does not capture
How wealthy a country is overall
Two countries can have very different states of prosperity but have a similar Gini coefficient. Guinea and Canada have a similar Gini coefficient, but the level of poverty and wealth is markedly different: Canada’s per capita GDP is over 30 times that of Guinea (in 2011 PPP$).
Differences in income among the middle class versus at the extremes
Likewise, two countries can have very different distributions of income but the same Gini coefficient. For instance, recent research found that the ratio between the rich and the poor can vary by a factor of 12 or more but still have the same Gini index. In other words, the gap between the richest and the poorest could look quite different but still generate the same Gini coefficient.

Have the lowest earners been losing ground to the highest earners?  

Another way to see if inequality is increasing in Canada is to divide individuals into five equal-sized groups—called “quintiles”—from the lowest to the highest earners, to see how they have fared over time relative to one another. In other words, are the highest income earners taking an ever-larger slice of the pie while everyone else is taking home a smaller slice?   

This approach tells a similar story to the Gini coefficient analysis, but adds a little more colour.  

In terms of market income earned, the highest 20% of earners did receive a growing share of the total from the 1970s to the 2010s–overall, their share increased from 41% to 46%, while all other groups saw a decline. Over this time, the average incomes of the bottom 80% was roughly flat while the highest 20% of earners saw around a 25% increase.  

Chart 7: Share of pre-tax income by income group
Income groups are not static
One misconception worth noting is, when we look at a particular “income group” (e.g., the top 10% of earners) over time, these are not necessarily the same individuals and families over all these years.

Many individuals may be a part of 3 or 4—or even all 5—income quintiles over their life course, from their first job as a young adult to their last role before retirement, after years of working their way up the corporate ladder.

Meanwhile, some may be born into and remain in the same level of income their whole life. For instance, a child may be born into a low income household and—for a multitude of reasons, including barriers or inequities of the system—remain at a similar socioeconomic status their entire life.

The extent of this movement, of climbing the income ladder, across generations and over the life course in Canada will be explored in a forthcoming commentary.

When taxes and subsidies are taken into account, however, the story changes. The top 20% of income earners saw a much smaller increase in total take-home pay, rising from 37% in the 1970s to 39% in the 2010s. The difference, of course, is due to the fact that higher incomes are taxed at a higher rate.  

As with the Gini coefficient, this measure of inequality has not deteriorated since the 2000s. Since then, all groups have seen at least a modest increase in market income, with their relative share staying roughly the same.  

Chart 8: Share of after-tax income by income group

Have the very highest earners continued to outpace others?

Yet another approach is to use tax records to look at ever smaller and more affluent groups to see if the very highest earners have continued to pull apart from others since the early 2000s.   

Since 2000, the share of income among the top 10%, 5%, and 1% of earners has been amazingly flat, taking home 30%, 20%, and 8% of total income respectively (1). It is also worth noting that this more recent trend is a break from the trend in the US for the top 1% and top 10% of earners, which continue to pull further away from the rest of the population.

Chart 9: Share of income of highest income households

But how about the highest echelon of earners—the top athletes, chief executives, renowned authors, and tech titans? Zeroing in on the very top earners—the 0.01%—does not show a different story either. In fact, we actually see a decline in their share of income since 2000, both on the basis of market and after tax income.

Chart 10: Share of income of highest 0.01% households

In other words, across all of these measures we see two things: inequality increased in Canada for a few decades, but since the 2000s it has stalled, and, by some measures, declined. 

What caused Canada to change course?  

A few key trends were likely at play. Factors that explain increasing inequality in the 80s and 90s include:  

  • Less opportunity for some workers—technology advancements, notably in manufacturing, displaced many workers.
  • The technology boom and higher returns for the highly skilled—meanwhile, highly skilled workers saw greater productivity and pay due to technology advancement. 
  • The recession in the early 1990s—economic recessions can increase inequality and this was notably true following the recession of the 90s.  
  • Federal budget cuts—this was also a time of fiscal conservatism, as the federal government reigned in spending and federal debt, which translated to a decrease in transfer payments.  

Meanwhile, factors that explain flat or decreasing inequality since the 2000s are still being debated but likely include:  

  • The Canada Child Benefit—introduced in 2016, this program gives financial support to lower earners with children, up to $6,765 a year per child under age 6.
  • Increase in the top tax rate—also in 2016, the marginal tax rate of income earned above $200,000 was increased from 29% to 33%.
  • Other governmental supports—some economists also believe that benefits for seniors, government housing support and strategies as well as funding for child care and transportation have also had an impact on both the poverty and inequality rates.  

Inequality in Canada 

Inequality is a multi-faceted issue with different measures and numerous complexities. Our analysis highlights a few key things.

First, it shows that inequality has not continuously and ceaselessly increased in Canada, at least not more recently. In fact, inequality has remained relatively stable and in check in Canada over the past 20 years and is on par with a number of other progressive democracies around the world. This underscores the importance of looking at Canada’s trends specifically, as opposed to grouping Canada into a global narrative or akin to the US. In particular, Canada is distinctly different from its US neighbour in terms of overall inequality, the progressivity of the tax system, and the inequality trends since 2000.

Second, it shows the relatively large role policy has played in minimizing inequality of economic outcomes overall and, increasingly, over time. Redistribution plays an important role in the Canadian system. It has helped to minimize the otherwise growing divide in earlier decades and has likely played a role—through programs like the Child Benefit Credit—in minimizing growth in inequality since.

To better understand whether or not Canada’s current system is healthy and enabling for all, however, comes down to the fairness of the system as well as the ease of movement up and down the income ladder. This is the important facet of inequality which we will turn to in our next paper in this series. 

(1) Including capital gains from asset appreciation over time, the share is slightly higher for these groups but remains flat from 2000 to 2018.

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