The Hidden Facts Behind Inequality Statistics

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Americans underestimate the actual levels of income and wealth inequality and believe the ideal income and wealth distributions are even more equal than what they imagine reality to be, according to research by Harvard's Michael Norton (read Jordan Weissmann's write-up of the research here). This, not particularly surprising result tells us very little as I suspect that most Americans would also underestimate the value of benefits provided to the poor in this country, the number of polar bears living in the Arctic, and many other facts that may or may not be of importance. The more interesting point is that anyone thinks this matters.

Income and wealth distributions are not arrived at by consensus, but rather by the confluence of free markets, innovation, work effort, and government policy. Surely neither Weissmann nor Norton is suggesting that we should listen to the survey respondents and redistribute income and wealth to the extreme that the survey results would demand.

Further, Norton's research exaggerates the amount of income inequality between average workers and "corporate CEOs." As outlined by American Enterprise Institute's Mark J. Perry, people who want to stress income inequality compare average earnings for lower-wage workers to average earnings of the CEOs of a few hundred of the biggest corporations in the country in order to arrive at a ratio of 331 to 1. The average pay for all CEOs in the country is actually only $178,400, roughly four times the pay of the average worker. That is less than the average anesthesiologist and just a smidgeon more than a poor underpaid member of Congress.

While that suggests that people advocating for reductions in income inequality should be more careful and truthful with their words and statistics, it does not change the fact that some people earn very large amounts of money. A few CEOs, top doctors, top lawyers, top authors, top movie stars, top athletes, the top few people in almost any profession today earn huge sums of money.

This ability to earn large sums of money starts with a talent and recently has been magnified due to the Internet, and technology in general, enabling the top performers in many professions to capture an ever larger share of customers. Hedge fund managers can handle the money of thousands of people, athletes can be watched by millions on television, and doctors can use telemedicine to treat patients anywhere in the world.

However, the fact that top earners are taking home a larger share of the pie does not in any way stop the pie from getting bigger. In fact, those top earners are generally the ones most responsible for growing the pie that we all get to share. And not only has the pie been growing, but the size of pie pieces we all get to consume has been growing, too.

As the Congressional Budget Office has repeatedly documented, both mean and median household income has been rising steadily (even after accounting for inflation) as long as one looks at after-tax, after-government benefits income. (See, either summary figure 1 or (regular) figure 1in this CBO report). In fact, this CBO report shows that gains between 2007 and 2009 were largest in the lower income ranges while the top earners lost ground due to the recession.

While it may be true that the distribution of pre-tax earned income has been shifting toward those at the top of the earning distribution, government redistribution has actually managed to produce gains in spending power for those at the bottom. Before you say that those gains for the poor and middle class are only in spite of the rich, not because of them, perhaps you should reflect on where the government got all the money that it is redistributing. Hint: it's the rich.

In truth, income inequality is only an interesting topic if we desire a country in which the government does not redistribute income or provide a social safety net for its citizens. In the country we actually live in, it is not the distribution of income that matters, but the distribution of purchasing power.

After all, if my employer gives me a $1,000 per year raise while raising my contribution to employer-provided health insurance by $100 per month ($1,200 per year), I just experienced a drop in purchasing power even though my "income" went up. This is a scenario familiar to many families over the past few years and is likely to continue as Obamacare raises insurance rates for most people.

Alternatively, if my pay is stagnant, but the government suddenly provides me with a health insurance subsidy through Obamacare, my purchasing power has gone up even though my income has not. Somewhere north of ten million people may be in this general category thanks to Obamacare subsidies and the expansion of Medicaid.

The CBO helpfully provides lots of reports that document the current and past distribution and level of after-tax after-government benefits income which is a very good approximation to the purchasing power of households. These data paint a very different story than the pre-tax, market income distributions that are commonly employed by those clamoring for more income redistribution. The reality is that after all of our government income redistribution, people in all parts of the income distribution are better off than they were a generation ago and have been making fairly consistent gains over time.

These CBO reports are well known, as are plenty of other analyses of the distribution of consumption or purchasing power rather than income. Thus, while the Occupy-style protestors may not know the difference, many of the academic and political voices from the left that you hear bemoaning the increase in income inequality know the difference between pre-tax and post-tax, post-government benefits inequality. They are making a conscious choice to overstate the problem in order to claim support for their preferred political outcome.

Until the government disappears and everyone's pre-tax income is the same as their purchasing power, the distribution of pre-tax income would seem to be of little value. Many people probably cannot even tell you their gross pay; they only know the net amount they take home in their check. Anyone who wants to have a serious discussion about inequality should be focused on how much people are able to consume and save since those are the things that matter. Concentrating on the proper facts will make the debate better and a solution to any problem more likely.

 

Jeffrey Dorfman is a professor of economics at the University of Georgia, and the author of the e-book, Ending the Era of the Free Lunch

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