The Truth About Income Inequality
Reason magazine|February 2020
“The issue of wealth and income inequality, to my mind, is the greatest moral issue of our time,” said presidential candidate Sen. Bernie Sanders (I–Vt.).
David R. Henderson

Former Secretary of Labor Robert Reich claims that “great wealth amassed at the top” will cause us to lose democracy. To fight economic inequality, presidential candidate Sen. Elizabeth Warren (D–Mass.) is calling for a 2 percent annual tax on household net worth between $50 million and $1 billion and a 3 percent tax on net worth above $1 billion.

Language like that and proposals like Warren’s make increasing inequality sound like a crisis. But they misread the situation and misdiagnose the underlying problems.

On a global scale, inequality is declining. While it has increased within the United States, it has not grown nearly as much as people often claim. The American poor and middle class have been gaining ground, and the much-touted disappearance of the middle class has happened mainly because the ranks of the people above the middle class have swollen. And while substantially raising tax rates on higher-income people is often touted as a fix for inequality, it would probably hurt lower-income people as well as the wealthy. The same goes for a tax on wealth.

Most important: Not all income inequality is bad. Inequality emerges in more than one way, some of it justifiable, some of it not. Most of what is framed as a problem of inequality is better conceived as either a problem of poverty or a problem of unjustly acquired wealth.

MEASURING INEQUALITY

FIRST, THOUGH, LET’S look at how much inequality there is. The Congressional Budget Office (CBO) produced a report in November 2018 on the growth of household income in each of five quintiles. Between 1979 and 2015, average real income for people in the top fifth of the population rose by 101 percent, while it rose for people in the bottom quintile by “only” 32 percent. For the middle three quintiles, average real income increased by 32 percent as well.

Or at least those are the numbers if you ignore the effects of taxes and direct government transfers. But you really shouldn’t leave those out: If you’re debating whether to increase taxes on the rich and transfers to the poor, it seems important to take into account the taxation and safety net already in place. Once the CBO researchers subtracted taxes and added welfare, Social Security, and so on, the picture changed dramatically for the lowest quintile: Income rose by 79 percent. (For the middle three quintiles, it increased by 46 percent. For the highest quintile, it went up by 103 percent—slightly more than before, probably thanks to Ronald Reagan’s and George W. Bush’s tax cuts.)

The above data on real income growth actually understate the growth of income for each quintile. When the CBO compares incomes over time, it measures inflation using the Consumer Price Index (CPI). But many economists have concluded that the CPI overstates inflation by not sufficiently adjusting for new products, improvements in quality, changes in the mix of goods and services purchased, and shifts in where consumers buy their goods. (The latter factor is sometimes called “the Walmart effect,” but that term is arguably dated. Maybe we should call it “the Amazon effect” instead.)

Stanford economist Michael Boskin estimates that the CPI overstates inflation by 0.8 to 0.9 percentage points a year. That’s small for any given year, but over time it doesn’t just add up—it compounds up. If you go with the conservative estimate of 0.8 percentage points and adjust the CBO’s after-tax, after-transfer data accordingly, the top quintile’s average real income between 1979 and 2015 increased by 168 percent and the bottom quintile’s average real income increased by 136 percent.

That’s still an increase in income inequality, of course. But it’s not an inequality increase in which the poor and near-poor are worse off. They’re much better off. Everyone is.

And those numbers don’t do complete justice to how much better off we are. Donald J. Boudreaux, an economist at George Mason University, has compared the prices of items you could have bought from a Sears catalog in 1975 with prices for similar items in 2006. He shows that with the average wage in 2006, you would have to spend far less time working to earn enough to buy the items than you would have had to spend in 1975. Moreover, he notes, the 2006 items are almost always of much higher quality. Who wants a 1975 TV? In 2010, my local Goodwill wouldn’t even accept a working 1999 TV. And those awful primitive cellphones everyone had in 1975? Oh, wait.

I asked Boudreaux to update his data to 2019. Since 2013, he told me, the “time cost” of his chosen goods has fallen by another 30 percent.

I should note that while most consumer goods have been getting cheaper, education, housing, and health care have become more expensive. Interestingly, these are all areas in which governments have had a substantial influence on prices. In education, state and local governments have almost a monopoly; in housing, governments on the West Coast and in the Northeast have so restricted new construction that supply has not kept up with demand, causing prices to explode; and in health care, extensive regulation and subsidization have driven up the cost, though not always the price, of health care. (The difference is that the price to the consumer is often low because insurance and government subsidies hide the true cost, which is often high.)

On a global level, meanwhile, inequality is declining—and it’s likely to fall further.

Economists measure inequality with something called the Gini coefficient. A coefficient of 100 would mean that one person gets all the income while everyone else gets nothing; a coefficient of zero would mean complete equality. In a 2015 study published by the Peterson Institute for International Economics, Tomas Hellebrandt of the Bank of England and Paolo Mauro of the International Monetary Fund tracked the global Gini coefficient from 2003 and 2013. During that time it fell from 69 to 65, thanks to rapid economic growth in lower-income countries—not just India and China but also sub-Saharan Africa. Hellebrandt and Mauro project that by 2035 it will have declined to 61.

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