The Misleading Tale of Income Inequality

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President Obama has proposed $1.7 trillion in tax increases over the next decade.

In his State of the Union Address he said, "We need to change our tax code so that people like me, and an awful lot of members of Congress, pay our fair share of taxes."

Although cries for redistribution by government echo in the press and among some politicians, by some measures economic inequality is no greater now than it was in the 1980s.

To appraise economic inequality, it makes more sense to look at spending, not cash income. The effective purchasing power of those with the least cash income is augmented by food stamps, rent supplements, Medicaid-funded health care, subsidized school lunches, and other social programs.

Government data on individual spending patterns show that the ratio of spending between the top and bottom 20 percent of the income distribution, measured on a per person basis, was essentially unchanged between 1985 and 2010. In 1985 people in the top quintile had spending that was 2.5 times that of people in the bottom quintile. By 2010, this ratio was 2.4.

This metric suggests that economic inequality has diminished slightly, rather than increased. (One must acknowledge that this analysis omits the capacity to save for people with additional discretionary income. Savings do indeed rise with income.)

Why look at spending? Spending is vital because it is the principal determinant of standard of living. It influences confidence in the future. It shows more comprehensively than cash income how much purchasing power individuals and families have. In sum, spending inequality provides a more meaningful measure of well-being than cash inequality.

Many studies that have found growing inequality of income use pretax income and omit transfers, such as food stamps, etc. Measuring income on an after-tax basis and including transfers reduces real and perceived inequality.

Further, some increase in perceived inequality since the 1980s is due to the Tax Reform Act of 1986, which lowered top individual income-tax rates from 50 percent to 28 percent, leading more small businesses to file taxes under individual, rather than corporate, tax schedules.

In addition, many studies do not take into account changes in the composition of households over the past 30 years. These changes include more two-earner couples at the top of the income scale and more one-person households at the bottom. Although much Census Bureau data are reported for households, income per capita-based on the number of persons in a household-yields more meaningful comparisons.

Consider the effect of the trend towards later marriage. Both men and women are postponing marriage, getting post-secondary education, and entering the workforce before marriage, and so the number of young singles has risen over recent decades. Before the 1970s, the median age at first marriage for women was under 21. Since 1970, the median age at first marriage for women has steadily risen from 21 to 26 in 2010, and for men from 23 to 28.

When two individuals get married, if both have worked and continue to work, they comprise a household with higher earnings-and the measured distribution of income in society widens. There are more such households now that in the 1980s. In 2010, 58 percent of married couples were in the top two quintiles, and only 7 percent of married-couple families were in the lowest quintile.

Spending per person by income quintile shows how individuals are doing over time both in absolute terms and relative to those in other income groups. These data can be calculated from the government's Consumer Expenditure Survey. An examination of these data from 1985 through 2010 shows that inequality has declined rather than increased.

The average annual spending for a household in the lowest quintile in 2010 was $12,325 per person. In contrast, the average spending for a household in the top quintile was $29,022 per person.

On a per-person basis, Labor Department data show that in 2010, households in the top fifth of the income distribution spent 2.4 times the amount spent by the bottom quintile. That was about the same as 25 years ago. There is no increase in inequality. In addition, the overall level of inequality is remarkably small. A person moving from the bottom quintile to the top quintile can expect to increase spending by only 140 percent.

But compared with 1985, the big winners are the lowest-income group, whose expenditures per capital increased by 6.5 percent in constant dollars. In contrast, spending per person in the top income quintile increased by 1.5 percent. This shows that even though the income spread from top to bottom might be larger, those at the bottom are doing better than they did 25 years ago because they have greater spending power, after adjusting for inflation. This is important for the bottom quintile-economically, socially, psychologically.

Growth in inequality in America is illusory, a mirage. Economic studies and commentators that find increased inequality are celebrated, those that find none are ignored. Cursory reviews reveal no increase in real inequality, merely changes in demographic patterns such as increases in single-head-of-household families or an aging population.

Much "inequality" in the United States is a problem in search of reality, caused by writers who know a certain storyline will sell to an audience anxiously looking for additional reasons to have the government inject itself even more into the lives of ordinary Americans.



Diana Furchtgott-Roth, former chief economist at the U.S. Department of Labor, is senior fellow and director of Economics21 at the Manhattan Institute. Follow her on Twitter: @FurchtgottRoth.   

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