A Leftist Misconception: Income Inequality

One of the most important issues to Americans is the economy. The state of the economy is something all Americans have a stake in, and there are a number of indicators we use to know how it’s fairing. GDP, unemployment rates, income, interest rates, and stock market returns are probably the most well-known indicators used by economists today. But there’s one lesser known indicator that leftists prefer to use for measuring the health of the economy: income inequality. While the previously mentioned indicators all measure efficiency in the economy, income inequality measures its equity. In other words, it’s a measure of one person or group’s economic welfare in relation to another. Leftists believe that the income divide between the rich and the poor in America has been widening. This is the misconception.

The main reason for the propagation of this misconception is a misreading of data from the U.S. Census Bureau. The Current Population Survey, the Bureau’s monthly survey of demographic information on roughly 50,000 people, has facilitated the collection of labor statistics for over 50 years. In the year 2000, the Census Bureau published a report summarizing the survey’s findings on income statistics over that time period, with special attention given to the disparity between the concentrations of household income within certain arbitrary statistical ranges. In order to quantify disparity, the report used the Gini Coefficient: a point on a 0 to 1 scale, where at 0 income is equally shared among all people, and at 1 all income resides with one person. According to the report, the Gini coefficient has been increasing steadily from 1968 to 1998, meaning that America has been becoming more unequal. Leftists like to take these data at face value because it justifies their egalitarian tendencies.

Unfortunately, there are some problems with measuring inequality this way. The first is the use of household incomes instead of individual incomes. The average household size for all Americans, according to Current Population Survey, has been steadily decreasing since before 1968, and that downward trajectory continues to this day. As we would expect, this has allowed the concentration of income in each quintile of households to change despite contradictory changes in median individual income over the same time period. Unfortunately, individual incomes cannot be effectively used to calculate the Gini Coefficient because of factors like unearned income, the earned income tax credit, government in-kind transfers, and countless other variables which can only be measured individually.

The main problem with the Gini Coefficient, however, is that it relies on measuring the concentration of incomes within statistical ranges. When you do this, income stops being a characteristic of a person, and starts being a characteristic of a given statistical range. Statistical ranges such as quintiles only outline boundaries, however, which are superimposed onto an income scale to capture multiple units of data. Looking only at these boundaries instead of looking at the people within them is going to give us a distorted view of the economy. The simple reason for this is that the statistical ranges of income on which the Gini Coefficient relies do not change: the bottom income quintile will always be the bottom income quintile, no matter how much income the people within that quintile individually earn over time.

This fact approaches the heart of the problem. What if a person within one income quintile begins to make so much money that he/she moves to a higher quintile? Likewise, what if a person takes such a sharp pay cut that he/she moves to a lower one?

The Gini Coefficient cannot measure these occurrences. In other words, the Gini Coefficient cannot measure income mobility.  We should all be concerned with the phenomenon of income mobility (the ease with which one can change their own income) because it is the free-market remedy for inequality, and it is one of our most important traditional values as Americans. It can be contrasted with redistribution, which is the leftist remedy for inequality.

We’ve now established that the Gini coefficient is inadequate for ascertaining the state of income mobility, so we need another measurement to use in its stead. What happens when we abandon the Gini Coefficient’s reliance on measuring household income concentrations within quintiles, and focus instead on the changes in individual incomes over time? Do we still see the growing disparity between the rich and poor in this country like the Census would suggest is occurring? No! In fact, the opposite has been occurring! In 2007, the U.S. Department of the Treasury published a report of trends in income mobility in the decade of 1996 to 2005. Using data from a sample of tax returns for over one-hundred and sixty thousand primary and secondary taxpayers, the Treasury finds that

There is considerable income mobility of individuals in the U.S. economy over the 1996 through 2005 period. More than half of taxpayers (56 percent by one measure and 55 percent by another measure) moved to a different income quintile between 1996 and 2005. About half (58 percent by one measure and 45 percent by another measure) of those in the bottom income quintile in 1996 moved to a higher income group by 2005.

In addition to reporting on income mobility, the report offers some insight on the overall strength of the economy. Also, the poor benefited more from income mobility than did the rich:

Median incomes of taxpayers in the sample increased by 24 percent after adjusting for inflation. The real incomes of two-thirds of all taxpayers increased over this period. Further, the median incomes of those initially in the lowest income groups increased more in percentage terms than the median incomes of those in the higher income groups. The median inflation-adjusted incomes of the taxpayers who were in the very highest income groups in 1996 declined by 2005.

The composition of the very top income groups changes dramatically over time. Less than half (40 percent or 43 percent depending on the measure) of those in the top 1 percent in 1996 were still in the top 1 percent in 2005. Only about 25 percent of the individuals in the top 1/100th percent in 1996 remained in the top 1/100th percent in 2005.

The report also comments that

The degree of relative income mobility among income groups over the 1996 to 2005 period is very similar to that over the prior decade (1987 to 1996). To the extent that increasing income inequality widened income gaps, this was offset by increased absolute income mobility so that relative income mobility has neither increased nor decreased over the past 20 years.

Referenced in the study is a litany of prior research on income mobility dating back to the 1960s, all of which indicates that there was a large amount of mobility within past decades as well, especially in the decade of 1979-1988, where by one measurement, “86 percent of taxpayers in the lowest income quintile in 1979 had moved to a higher quintile by 1988 and 15 percent of them had moved all the way to the top quintile.”

Leftists and others looking at the Current Population Survey might suggest that more government regulation and more progressive tax policies are needed to improve equity in the economy, but if we’ve learned anything here, it’s that liberty and opportunity are the greatest equalizers. If we wish to promote equality of opportunity, we should ensure a free market economy, of which economic freedom and mobility is a central component. We should accordingly dismiss the policies that, in an effort to achieve equality of outcomes, must necessarily destroy that freedom and mobility.

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