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How Changing Demographics Affect Inequality

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How Changing Demographics Affect Inequality

June 23, 2014

The following is an excerpt from Economics21’s new inequality primer, Income Inequality: Myths and Facts.

Economists often divide

households into income quintiles (fifths) and measure the differences in their incomes. However, the demographic characteristics of these quintiles have been changing over time, so comparisons of quintiles are misleading. Quintiles differ in the number of people per household, as well as in the number of earners per household. Table 1 shows that in 2012, households in the lowest fifth had an average of 1.7 people, and in half these households, there were no earners. The highest fifth, however, had 3.1 persons per household, with 2 earners.

 

 

The lowest-income group contains at least three significant groups of individuals. Some have low incomes because of lack of employment and are searching for jobs or better-paying jobs. A second group comprises elderly people who may have small amounts of retirement income but substantial assets, such as stocks and a home. These individuals are not in the labor force. A third group consists of students or recent graduates whose education levels ensure that they will have a prosperous future. Clearly, the first group is a social problem in need of a solution, but not the other two.

 

 

In 1990, median income for a family with one earner was about $41,800. In 2012, that median income for that one-earner family rose to about $43,300, a 4 percent difference. But the increase between a family with two earners in 1990 and 2012 was far greater. That family’s income rose from about $71,000 to about $82,600, a 16.5 percent difference, resulting in a measured increase in inequality. 

This reflects the contribution of the second earner, which comes from increasing women’s wages in the job market, as young women have invested in their education in preparation for a full-time career. If there were more one-earner households, the distribution of income would be far more even.

Another change is the shrinkage in household size at the bottom of the income scale, adding to a false perception of increased inequality. This is due to the increased longevity of today’s seniors and to the higher numbers of divorced people and single- parent households.

In 1960, 13 percent of households had just one person. By 2011, 27 percent of households, more than double the previous share, had one person. 

It is notable that 30 percent of female households without a husband are living in poverty. In contrast, only 7 percent of married couples and 17 percent of male households without a wife are poor. 

Census data in Table 2 show that men and women living alone are most likely to be in the lowest-income quintiles. Some 46 percent of women living alone were in the bottom quintile in 2012, and 72 percent of women living alone were in the bottom two quintiles. Only 3.4 percent of women living alone were in the top quintile. The trends are similar for men. Some 60 percent of men living alone were in the bottom two quintiles, and only 6.8 percent were in the top quintile.

 

 

In contrast, married couples are more likely to be in the top quintiles. Some 32 percent of married couples were in the top quintile, and 58.4 percent were in the top two quintiles. 

Another factor, which can influence measures of inequality, is change to the tax code. The Tax Reform Act of 1986 lowered the top individual tax rate to 28 percent, and the corporate rate to 35 percent. In 1986, the top individual rate was 50 percent, and the top corporate rate was 46 percent, so small businesses would pay tax at a lower rate if they incorporated and filed taxes as corporations. With the implementation of the Tax Reform Act of 1986, the top individual tax rate of 28 percent meant that small businesses were often better off filing under the individual tax code. Revenues shifted from the corporate to the individual tax sector. In the late 1980s and 1990s, that made it appear as though people had suddenly become better off and income inequality had worsened. This had not happened; rather, income that had been declared on a corporate return was being declared on the individual return. This makes any comparisons between pre-and post-1986 returns meaningless.

A more meaningful measure of inequality that avoids changes in tax laws and changes in demography comes from an examination of spending, as Bruce Meyer notes in chapter 2.

Differences in per-person spending, from the lowest-income fifth to the highest, are not different from 25 years ago. These measures of spending show less inequality than do measures of income. Spending is vital because it determines our current standard of living and our confidence in the future. It shows how much purchasing power individual Americans have.

I calculate spending on a per-person basis in order to produce comparable measures. These data are converted into 2012 dollars using the Bureau of Labor Statistics Consumer Price Index for all urban centers. It is important to compute spending on a per-person basis because the number of people in a household varies by quintile. For a given level of income, a family is better off with fewer people.

Table 3 shows that the average annual spending for a household in the lowest quintile in 2012 was $13,032 per person. In contrast, the average spending for a household in the top quintile was $32,054 per person.

On a per-person basis, the new Department of Labor numbers show that in 2012, households in the top fifth of the income distribution spent 2.5 times the amount spent by the bottom quintile, as can be seen in Table 3. 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 146 percent.

 

 

 

Many commentators today bemoan a supposed inequality in the United States. Much of this concern is a “problem in search of reality”, caused by problems of measurement and changes in demographic patterns over the past quarter-century. Government data on spending patterns show remarkable stability over the past 25 years and, if anything, a narrowing rather than an expansion of inequality.

Taken from the Economics21 issue brief, Income Inequality: Myths and Facts.

 

Diana Furchtgott-Roth, former chief economist of the U.S. Department of Labor, directs Economics21 at the Manhattan Institute. You can follow her on Twitter here.

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