The Financial Crisis Could Reduce U.S. Income Inequality

The role of income inequality in the Financial Crisis of 2007-2010 will be analyzed and debated for many years in the future. The time series above plots the percent of income being received by the top 99-100% of income earners in the US (the data are from Emmanuel Saez, here, and are controversial--read both sides here). What is very interesting is that income inequality peaked right before the Great Depression and right before the Great Recession. The coincidence (?) suggests a number of hypothesis about income inequality and financial speculation (here).

In this post, I'm going to beg the obvious question "If there is too much income inequality in the U.S., how much income should the upper 1% of income earners be making?" One approach to answering this question is to assume that the earnings of the top 1%, like the earnings of every other worker, should be tied to growth in the U.S. economy. If the economy grows by 4%, however, how much of that 4% growth premium should be captured by the upper 1%? All of it? Some of it? None of it?
What turns out to be a better model and one that fits the data better is that, regardless of growth in the U.S. economy, the share of income to the upper 1% should remain at about 13%, about where it is right now in 2010 after the Financial Crisis. Interestingly, from 1950 to about 1990, the upper 1% weren't getting their share! Something changed after 1990 (a nice topic for analysis and speculation) and that innovation, whatever it was, created a huge inequality bubble--a bubble that was popped by the Subprime Mortgage Crisis.
For the future, the model predicts that we will return to the level of income inequality that marked the U.S. economy from WWI to the 1990s. What new innovation might come along to create the next inequality bubble? We can't know the future but the model predicts that without shocks, the income of the top 1% would stabilized around 13%--something I probably won't see in my lifetime.