This study analyzes urban and rural inequalities in Vietnam by applying two techniques of inequality decomposition by population groups and income sources based on two data sets from the nationwide household surveys in 2002 and 2004. It is found that within-sector inequalities in income distribution are substantially higher than that in expenditure distribution because expenditure level is more dependent on location characteristics of a household, while the determinants of income level seems to stay in other characteristics such as education and occupations of household members. Income inequality within the urban sector is higher than that in the rural sector because urban income mainly comes from wage employment and non-farm self-employment, which are more unequal than agricultural income. Interestingly, wage employment appears to be an equalizing income source in both urban and rural areas. Agricultural income is undeniably an inequality-equalizing source. Therefore, much of income inequality stays in the distribution of sources other than wage and agriculture. Based on the review of current policies related to income distribution and decomposition analysis, the paper suggests that income diversification, development of private sector, encouraging rural-urban migration and trade liberalization would be appropriate for increasing income level while restraining increasing inequality.