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5 Reasons Janet Yellen Shouldn't Focus on Income Inequality

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5 Reasons Janet Yellen Shouldn't Focus on Income Inequality

October 20, 2014

Janet Yellen heads one of the most important agencies in America, the Board of Governors of the Federal Reserve. It has many tasks, but analyzing the state of inequality and education in America is not one of them. Nevertheless, Yellen on Friday returned to her role as professor of labor economics and delivered an address on economic inequality at the Federal Reserve Bank of Boston.

It would have been far better for those on the bottom of the economic heap if Yellen had spoken about how to increase economic growth. Specifically, why have the Fed’s near-zero interest rates and quantitative easing left us with 2% growth and a Carter-era labor-force participation rate? More growth means more jobs and higher mobility.

Instead, Yellen said: “The extent of and continuing increase in inequality in the United States greatly concern me. The past several decades have seen the most sustained rise in inequality since the 19th century after more than 40 years of narrowing inequality following the Great Depression.”

No matter that the decades following the Great Depression saw World War II, the Korean War and the Vietnam War, all of which used valuable resources and killed hundreds of thousands of Americans. Since 1970, income inequality has increased for a number of reasons that should not concern Janet Yellen. Here are five.

Women moved into the workforce in record numbers in the 1980s. With these new opportunities, they invested in education, and have now reached parity with men in medicine, law and academia. Women are awarded 58% of bachelor’s and master’s degrees, half of medical and law degrees, and over half of doctorates. President Obama appointed the first woman to head the Secret Service, and yes, the Federal Reserve.

It has become increasingly common for mothers with children to work outside the home, with higher salaries. In 2013, households averaged two earners per family in the top fifth of the income distribution. In the middle quintile, households have one earner, on average, and in the bottom fifth, they have about half an earner per household.

It’s not just that some households have two earners, but couples tend to meet in the workplace or in school, increasing inequality. Unless Yellen is suggesting that the government randomly assign spouses, or that America goes back to one major earner per household, as was the case after World War II, increasing income inequality is here to stay.

The size of households has changed since 1980, contributing to perceived inequality. With the increased prevalence of divorce, delayed marriage, and longer life expectancy, there are more households composed of one person, or non-family households. These households tend to be in the bottom quintile.

On average, households in the bottom fifth have fewer than two members, and those in the top quintile have three members. Measures of household inequality are not adjusted for the size of the household. Yes, a household in the top fifth has higher earnings than one in the bottom fifth, but higher levels of earnings have to support more people.

The Tax Reform Act of 1986 resulted in a movement of income away from corporate tax returns and on to individual income tax returns beginning in 1987, because the top individual rate of 28% was lower than the top corporate rate of 35%. Before 1987, the top individual rate was 50%, making it advantageous to file as a corporation. All data series on individual incomes show a jump in income after 1987, but these data are not truly comparable with data from prior years, and do not indicate a real increase in inequality.

Many analyses of income inequality use income before taxes are subtracted and transfers are added. Pre-tax, pre-transfer measures of income are not realistic measures of inequality because top earners pay substantial taxes and low-income earners get transfers. Two recent analyses are Thomas Piketty’s “Capital in the 21st Century” and an International Monetary Fund report titled “Fiscal Policy and Income Inequality.

Specifically, the top 1% paid 35% of all federal individual income taxes in 2011, the latest data available. The top 5% paid 57% of such taxes, and the top half of earners paid 97%. The bottom half of earners paid 3%, and received back a share of the 97% paid by the top half for programs including Medicaid, food stamps, the earned income tax credit, housing vouchers and unemployment insurance.

More realistic measures of income and inequality have been calculated by experts such as University of Chicago professor Bruce Meyer and Cornell University professor Richard Burkhauser. They conclude that inequality has not increased and that poverty is declining.

People move around the income distribution during their life cycle. They start off with low earnings when they enter the job market and earn more as they gain in skills and experience. If they get married to another earner, they might move up one or two fifths in the distribution.

Income inequality is only a problem if people cannot move up. By some measures, America is the most unequal of modern industrial countries, but it is a magnet to millions of potential immigrants. Cuba or Russia with their more egalitarian societies are not attractive.

Yellen suggests ways of increasing upward mobility, such as more preschool education (even though the effects of Head Start are unrecognizable by 5th grade), lower college tuition, and increased business ownership. But she does not mention one of the most significant sources of upward mobility: faster economic growth.

This is especially surprising because the Federal Reserve and Yellen spend a great deal of time considering how to raise employment through higher economic growth. Higher economic growth means more jobs, and more jobs mean people can leave unemployment or their current job and move up the income ladder.

Raising GDP growth from its current sluggish rate of 2% to 4% would provide new opportunities for millions of Americans. But despite massive monetary accommodation, the Fed has consistently been dialing down its growth forecasts rather than up. Perhaps Yellen can explain why.

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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