Claims of ever-increasing shares of wealth going to top earners are a perennial complaint. This year, partly due to the publication of Thomas Piketty's Capital in the Twenty-First Century, discussions of inequality are
preoccupying policymakers and political pundits.
Today Economics21.org is releasing Income Inequality in America: Fact and Fiction, a series of essays from leading experts on different aspects of measuring inequality. For Winston Churchill, inequality was an unavoidable part of economic life in capitalist societies. "The main vice of capitalism," said the British Prime Minister, whose youngest daughter, Lady Mary Soames, died last weekend at the age of 91, "is the uneven distribution of prosperity. The main vice of socialism is the even distribution of misery."
For President Barack Obama, income inequality is not only a pressing problem, it is "the defining challenge of our time." But the extent of inequality differs with the measure used. An International Monetary Fund report published in February 2014 measures inequality using "market income"-defined as income before taxes on upper-income individuals are removed and transfers to lower-income individuals added back.
This makes little sense. This pre-tax, pre-transfer measure of inequality fails to properly measure well-being, according to University of Chicago professor Bruce Meyer, one of the volume's contributors. Upper-income individuals cannot spend the money that is taken away in taxes, so it gives them no benefit (other than, perhaps, higher social status). On the other hand, lower-income individuals clearly benefit from more spending power with, among others, the Supplemental Nutrition Assistance Program, Medicaid, housing vouchers, and unemployment insurance. As such, it would be inaccurate not to include the latter in measures of their well-being.
Data from the Congressional Budget Office that account for these differences show smaller increases in income concentration over time. Figures from Piketty and Emmanuel Saez that focus on earnings and exclude investment income indicate even smaller increases in income concentration. Furthermore, incomes below the top five percent did not stagnate, writes my Manhattan Institute colleague Scott Winship. Incomes among the bottom fifth were one-third higher in 2007 than in 1979, and those among the middle fifth were 43 percent higher.
Cornell University economist Philip Armour found that when he incorporated estimates of all capital gains accrued by a household over the past year (taxable or tax-exempt, sold or not) from investments in public companies and housing into income, a shocking result emerges. "From 1989 to 2007, the incomes of the bottom and middle fifth rose (by 13 percent and 6 percent), but the income of the top 5 percent declined by 5 percent. Inequality-even between the top and everyone else-falls. The decline is even more pronounced when we incorporate gains from privately-held businesses," he writes.
Demographics also affect inequality. Increasing life expectancy, greater likelihood of divorce, and the rising percentage of births to single mothers all affect the distribution of inequality. Every time two earners marry or divorce, the distribution of inequality is affected. No less important in measuring inequality is the respective life-cycle stages of different individuals. A graduating student has no income and probably some debt, but a reasonable prospect of landing a job. If she marries another similarly-placed student, they might before long transform into a two-income family located in the middle or upper income quintiles.
This is the natural life-cycle progression, and the student's income should not be a social policy problem. Conversely, when the students retire after 50 years in successful careers, they might have assets but little income and return back, again, to the bottom quintile. This, likewise, is not a social policy problem in need of correction.
One vital question is whether mobility has declined as income gaps have widened. Treasury economist Gerald Auten concludes, "In an examination of two 10 year periods, 1987 to 1996 and 1996 to 2005, there was identical mobility from the bottom quintile in the two periods, as 43.7 percent in the bottom quintile remained there after 10 years. In other words, 56.3 percent moved up. Overall, there is slightly more upward mobility into the top income groups in the more recent period even though the income gaps were wider."
How to increase mobility? Heritage Foundation economist James Sherk suggests, "The actual way to increase living standards is by increasing productivity...Charter schools increase their student's productivity and economic mobility." People in their thirties now who attended charter schools have measurably higher incomes than their peers who did not attend charter schools.
American Enterprise Institute scholar Edward Conard, examines the role of risk. He concludes, "Success is relative: one person's success raises the bar for others. Our most talented workers are working longer hours than their counterparts in Europe, and with higher productivity than their counterparts in Japan. Our best students no longer want to be doctors and lawyers. They are going to business school."
Companies such as Google and Yahoo, as well as concentrations of experts, like Silicon Valley and the Research Triangle, give our workers vital job training. This increases their chances of success and, in turn, the payoff for risk-taking.
These companies' success puts funds into the hands of entrepreneurs, who are more willing to choose to underwrite the risks that produce innovation. The United States has more equity per employee and per dollar of GDP than both Europe and Japan. It is also growing faster.
Empirical analysis shows that many commonly accepted ideas about income inequality are false or overstated. If policy recommendations are to be effective, they must be informed by an accurate picture of the current situation. Income Inequality in America: Fact and Fiction offers the empirical tools for such an analysis.
Diana Furchtgott-Roth is a contributing editor at RealClearMarkets. A former chief economist at the U.S. Department of Labor, she directs www.economics21.org at the Manhattan Institute where she is a senior fellow. Follow her on Twitter: @FurchtgottRoth.
Interested in real economic insights? Want to stay ahead of the competition? Each weekday morning, e21 delivers a short email that includes e21 exclusive commentaries and the latest market news and updates from Washington. Sign up for the e21 Morning eBrief.