The distribution of income between capital and labour has, until very recently, been ignored by the majority of the economics profession. At the same time, the rate of wage growth has systematically lagged the growth of productivity, leading to a fall in the share of wages in total income. This paper considers the links between shifts in the functional distribution of income, rising personal income inequality and the mechanisms which led to the financial crisis of 2007-2008. The paper argues that the most widespread explanation for increasing inequality – increasing demand for skilled labour due to technological change – is not convincing, and that political factors have played an important role. Mechanisms by which increasing inequality feed through into financial instability are considered. These include debt as an insurance mechanism against greater income volatility; debt as an adjunct to emulative consumption behaviour; debt as a political tool to defuse the growing gap between wages and productivity; and debt as a way to overcome the stagnationary macroeconomic effects of rising inequality.