Myths about Inequality

“Inequality is the defining challenge of our time,” according to President Obama. It’s certainly the topic of the day for Paul Krugman, Joe Stiglitz and a whole raft of liberal pundits.

But have you noticed that hardly anyone else is talking about it? When is the last time you heard a shoeshine person or a taxi cab driver complain about inequality? For most people, having a lot of rich people around is good for business. But if average folks are not complaining should they be?

Unfortunately, a lot of what passes as serious commentary is actually myth. What follows are five examples.

Myth No 1: Income for the average family has stagnated over the past 30 years.

Here is an oft-quoted statistic: From 1979 to 2007, taxpayers’ median real income, before taxes and before government transfers, rose by only 3.2 percent. Cornell University economist Richard Burkhauser, via Greg Mankiw, shows why that statistic is misleading:

  • If we combine the income of all the taxpayers within each household to get household median income, that meager 3.2 percent rises to a bit more respectable 12.5 percent.
  • If we add in government transfer payments, that 12.5 percent number becomes an even better 15.2 percent.
  • Factoring in middle class tax cuts over the period, the 15.2 percent figure rises to 20.2 percent.
  • But not all households are the same size, and the size of households has fallen over time. Adjusting for household size increases that 20.2 percent to 29.3 percent.
  • Finally, if we add the value of employer-provided health insurance, the 29.3 percent figure rises to 36.7 percent.

So there you have it: real income for the average household actually increased by more than a third over the past 30 years.

This conclusion is consistent with other studies. A CBO study of family income over the same period of time found an increase almost twice that size: the average family experienced a 62 percent increase in real income.

Economists have a way of measuring inequality that includes the entire population, not just the average family or the top 1 percent. It’s by means of a Gini coefficient, which varies between 0 (complete equality) and 1 (complete inequality). One study found that between 1993 and 2009, the Gini value actually fell from .395 to .388 — meaning that inequality has actually declined in recent years.

Myth No. 2: People at the bottom of the income ladder are there through no fault of their own.

In a study for the National Center for Policy Analysis, David Henderson found that there is a big difference between families in the top 20 percent and bottom 20 percent of the income distribution: Families at the top tend to be married and both partners work. Families at the bottom often have only one adult in the household and that person either works part-time or not at all:

  • In 2006, a whopping 81.4 percent of families in the top income quintile had two or more people working, and only 2.2 percent had no one working.
  • By contrast, only 12.6 percent of families in the bottom quintile had two or more people working; 39.2 percent had no one working.

The average number of earners per family for the top group was 2.16, almost three times the 0.76 average for the bottom.

Henderson concludes:

…average families in the top group have many more weeks of work than those in the bottom and, in the late 1970s, the 12-to-1 total income ratio shrunk to only 2-to-1 per week of work, according to one analysis.

Having children without a husband tends to make you poor. Not working makes you even poorer. And there is nothing new about that. These are age old truths. They were true 50 years ago, a hundred years ago and even 1,000 year ago. Lifestyle choices have always mattered.

Myth No. 3:  Government transfer programs, like unemployment insurance, are an effective remedy.

Government transfers can ameliorate the discomfort of having a low income and few assets. But at the same time they tend to encourage people to remain dependent, rather than achieving self-sufficiency. And the loss of benefits as wage income rises acts as an additional “marginal tax” on labor.

University of Chicago economist Casey Mulligan is the leading authority on welfare programs and how they affect employment. At The New York Times economics blog, he wrote:

As a result of more than a dozen significant changes in subsidy program rules, the average middle-class non-elderly household head or spouse saw her or his marginal tax rate increase from about 40 percent in 2007 to 48 percent only two years later. Marginal tax rates came down in late 2010 and 2011 as provisions of the American Recovery and Reinvestment Act expired, but still remain elevated — at least 44 percent…A few households even saw their marginal tax rates jump beyond 100 percent — meaning they would have more disposable income by working less…work incentives were eroded about 20 percent for unmarried household heads…in the middle of the skill distribution, while they were eroded about 12 percent among married heads and spouses…with the same level of skill.

Overall, Mulligan estimates that up to half of the excess unemployment we have been experiencing is because of the generosity of food stamps, unemployment compensation and other transfer benefits.

Myth No 4: Raising the minimum wage is an effective remedy.

One of the few policy ideas President Obama has for dealing with inequality is raising the minimum wage. He thinks this will lift people out of poverty. Paul Krugman says the same thing. The difference is that Krugman is an economist who must surely know that the economic literature shows that raising the minimum wage does almost nothing to lift people out of poverty. (See David Henderson’s brief analysis)

Richard Burkhauser and San Diego State University economist Joseph J. Sabia examined 28 states that increased their minimum wages between 2003 and 2007. Their study, published in the Southern Economic Journal, found “no evidence that minimum wage increases…lowered state poverty rates.” Part of the reason is that very few people earning the minimum wage are actually poor. Most are young people who live in middle income households. For example, the economists estimate that if the federal minimum wage were increased to $9.50 per hour:

  • Only 11.3 percent of workers who would gain from the increase live in households officially defined as poor.
  • A whopping 63.2 percent of workers who would gain are second or even third earners living in households with incomes equal to twice the poverty line or more.
  • Some 42.3 percent of workers who would gain are second or even third earners who live in households that have incomes equal to three times the poverty line or more.

Myth No. 5: Income is the best measure of wellbeing.

Why are we talking about income? The implicit assumption is that income limits our ability to enjoy life. But that turns out not to be true. One study found that consumption by those in the lower fourth of the income distribution was almost twice their money income. Moreover, consumption inequality is much less than income inequality. A Bureau of Labor Statistics study found that

…in 2001, the Gini coefficient for consumption was only .280 (almost 30 percent lower than the Gini for comprehensive income, and about 40 percent lower than the Gini for money income), indicating that inequality with respect to this most meaningful measure of living standards is relatively modest. Moreover, according to the BLS, during the fifteen-year period between 1986 and 2001, consumption inequality went down slightly; from a Gini of .283 to a Gini of .280.

Bottom line: the next time you hear someone complain about inequality, make sure they are not repeating these five myths.

Comments (26)

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  1. Eric S. Graber says:

    John,
    Thank you for helpful analysis and commentary

  2. Brent James says:

    John,

    Last December former Senator Bob Bennett published an article in which he argued:

    “These statistics come from Diane Furchtgott-Roth, former chief economist of the US Department of Labor. The average number of people per household is greater in the top quintile, at 3.1, than in the bottom, where it is 1.7. At the same time, the percentage of people who live in homes without a mortgage is greater in the bottom quintile than the top.

    “These facts reflect the fact that a higher percentage of Americans are living in retirement than ever before. Their incomes have gone down, but so have their needs. The kids are out of college and the mortgage has been paid off. I am not suggesting that the lower quintile does not contain people in real need and is made up entirely of retirees, but there are enough of them in it to skew the statistical case …”

    I did not see that in your analysis. Thoughts? Does the retirement community skew the income disparity statistics?

    thx,

    brent

  3. Charles S. says:

    Myths 3 and 4 are the most harmful and the ones that impact the economy the most. These are programs that are accepted by the general population because they are believed to be helpful. Yet, this is not always the case. Economic theory states that the higher the incentives to be unemployed, the higher the unemployment will be. The benefits given by these programs are inviting people to stay unemployed as long as they can. Some even argue that the main cause of the crises in the PIGS countries were these government programs.

    • Thomas says:

      Exactly, increasing government aid to the unemployed will only incentivize them to continue to be unemployed.

  4. Andrew says:

    “Families at the top tend to be married and both partners work. Families at the bottom often have only one adult in the household and that person either works part-time or not at all.”

    An increase of employment and improvement to lifestyle changes to the poorer side of the distribution would only improve inequality. Becoming a welfare state to bring the bottom of the distribution up isn’t an economically sound solution.

    • Matthew says:

      I remember when I was a student and working at the grocery store and a middle aged couple paid for their groceries with food stamps. Then as I helped them out to their car, I proceeded to load their groceries into the back of their Cadillac Escalade. It was just amazing how people can live off an income in the lower quintile while enjoying the lifestyle of the higher quintile.

      • Jay says:

        Well looks like we will continue to be a nation that lives in debt, consume excessively and expect to be taken care of.

  5. Greg Scandlen says:

    As suggested by your fifth point, there is a vast underground economy of cash and barter that no one can measure.

  6. Roger Waters says:

    Thank you for your insughts

  7. Chase J. says:

    It is easy to manipulate statistics. Governments do it all the time to keep the population happy even if reality is different. That is why it is important to have independent researchers that let the population know that not all what the government is telling them is correct.

    • Andrew says:

      Most of the population remains rationally ignorant until we can see the truth and how it actually affects us.

  8. Matthew says:

    “Only 11.3 percent of workers who would gain from the increase live in households officially defined as poor.”

    Raising minimum wage is a terrible solution. This causes workers to become more costly and likely increase the scarcity of jobs. Not to mention the ones who benefit the most are not the head of a household, but likely young adults who live with their parents and have obligations like higher education.

    • Walter R. says:

      It is disheartening to hear that an economist believes the solution to income inequality is to increase minimum wage.

  9. Charlie Bond says:

    Hi John,
    The great equalizer is health care–everyone will need it sooner or later, but not all can get the health care they need. (I presume this is why your are talking about economic inequality.)
    This should not be an economic question, but a question addressed to our core values.
    Human suffering is different than material wealth. Human suffering is not measured by income, although lower income levels may be a predictor of poorer health conditions. Health care addresses human suffering, and thus should be measured by the depth of our compassion, not the depth of our pocketbook.
    Regardless of religious belief, the parable of the Good Samaritan was a pretty succinct articulation of the right health policy. It concludes with the directive, “Go thou and do likewise.” We have a moral imperative to take of ourselves and to take care of others.America has the resources to provide care to those in need. Shame on us for not doing so.
    The inequailities in health care can be addressed by more efficient design of health care delivery, including tapping into the great reserve of volunteerism, and by incentivizing savings (e.g. through gainsharing contracts) and by addressing care for the 5% of the population that drives 90% of our costs.We do not need to reform 100% of health care or health care financing to take care of a 5% problem.
    We need simply use our resources wisely to distribute care more efficiently to those in need.
    Let’s worry more about doctors than dollars and health more than wealth.
    Cheers,
    Charlie Bond

    • Frank M. says:

      I agree with you. The Health Care system needs to be overhauled. It is unbelievable that one of the countries that spend the most on health services is one that provides one of the worst coverage, among the top countries. We need a comprehensive reform that benefits the entire population. I do not know what the solution is, but, I don’t think Obamacare is the solution the country needs. In my opinion Obamacare was done without a throughout analysis, it is a rash measure with political intentions more than an act of compassion for the benefit of Americas.

    • Jim Dillon says:

      Inequalities in the burden of illness are easy to show. Poor people are sicker, on average, than rich people. Inequality in the distribution of health services, however, is another kettle altogether. Consider, for example, the following: “…the poorest decile of Medicare beneficiaries spends 30-40 percent more than the wealthiest; overall hospital utilization rates in large urban areas are 25-35 percent more than in their wealthiest Zip codes; and hospital readmissions are most prevalent from poor neighborhoods and in safety-net hospitals.”(Cooper, 2013, at http://healthaffairs.org/blog/2013/10/09/inequality-is-at-the-core-of-high-health-care-spending-a-view-from-the-oecd/). Furthermore, it is well known that Medicaid recipients rely excessively on expensive ED services that are often unnecessary. Sometimes this is attributable to absence of primary care providers in the community or transportation (the ambulance is always available for a trip to the ED), but often it is just a matter of personal convenience.

      Not only do the poor use more health resources, in some instances they have preferential access to superior resources. For example, a Medicaid recipient in Michigan may have access to the best available psychiatric inpatient care (eg, the University of Michigan) that the civil servant, who issued the Medicaid card, cannot obtain through the mental health carve-out in her state-sponsored employee plan. In the same state, by statute, Medicaid patients are guaranteed access to expensive psychotropic medications that may be unavailable or difficult to obtain through private insurances. If this is happening now, a fortiori it is sure to happen under the insurance exchanges.

      The inequities cut across economic lines in strange and unexpected ways, reflecting the chaos into which our system has descended. I would still prefer to be rich, but it is hardly for lack of spending (or charity) that we have huge disparities in health per se.

      I hope you were not proposing that the government be the “good Samaritan.” The Good Samaritan was “good” precisely because he was the natural enemy of the Jew upon whom he bestowed mercy (and medical care). In other words, he did not have to help the injured man and nobody would have expected him to do so. Today’s government is not a good candidate to replace the Good Samaritan; rather, it is much more like the thieves who robbed the Jew, making him sick and poor in the process.

      I agree–”We need simply use our resources wisely to distribute care more efficiently to those in need” — that the problem is not in the volume of resources but in their distribution, though experience tells us that the “wisdom” of government, which does nothing “simply,” will not bring us a solution.

    • Peter Ferrara says:

      Mr. Bond, The crucial point that this comment exposes is that the real issue is addressing human suffering and deprivation. Once the poor are taken care of, there is no further issue of “inequality.” How much anyone earns or how high their income gets is not anyone’s business and is not even a moral issue once the poor are taken care of through safety net programs. The concept of inequality is distinct from safety nets taking care of the poor.

  10. James Martin says:

    The McDonald’s employee’s demand of a $15 dollar hourly wage is a great case to explain the problems with increasing minimum wage.
    Working as a cook in McDonald’s is a job that doesn’t require advanced skills; almost everybody can do it. If that simple job is paid at $15 an hour, any other job that requires more skill would have to pay more than that to be competitive. Companies would have to pay more to its workers and the additional cost, of doing so, will be passed on to consumers. Consequently, prices will rise accordingly. There would be inflation and unemployment. And the economy would be worse off.
    Raising the minimum wage is hardly an effective solution to the problems of the economy.

  11. Al Baun says:

    One can rationalize the perceptions of inequality all day long but things normally get dicey when the ‘cake’ runs low.

  12. Devon Herrick says:

    Recently I’ve heard more about inequity than in the previous five years. Purportedly, democracies cannot long survive a unequal distribution of wealth that allows billionaires traveling in private jets to coexist with the working poor, who can barely keep tires on a 20-year old car.

    Someone commenting on Slate.com even went so far as to posit the question: with the low price of bullets, how long can the rich expect this to go on?

    However, what passes for informed debate is more about the politics of envy. Moreover, countries that want to restrict inequity have to restrict wealth building. That does little more than guarantee a greater proportion of the populations will be part of the working poor.

    • John says:

      Devon – tell the people over at slate that there is roughly 1,500 billionaires in the world. Out of over 7 billion people in the world.

      The money Mitt Romney made a year puts him in the Richest 7,500 people in the U.S. Out of 140 Million tax units.

      Pretty exclusive class….DON’T YOU THINK

    • Peter Ferrara says:

      Once the poor are taken care of with safety net programs, “inequality” is just a rallying cry for organized crime, or gang warfare. E.g. the Democrat Party.

  13. BHS says:

    From 3.2% to 36.7%…that’s a huge difference!

  14. Floccina says:

    One thing that I seldom see acknowledged about minimum wage is that many people end up working for below minim wage. My son once worked for below minim wage delivering phone-books and it turn out that he netted out about $2.00/hour. Also next to my is office is an office for Vector Marketing they have streams of people coming in to work for them, most of them end up working for no money at all. Most of the people sucked into those types of jobs would gladly work for a sure $4.00/hour. So does minimum wage push people into such schemes? I would guess that it does.

    https://www.google.com/search?q=evector+marketing&rlz=1C1CHYD_enUS571&oq=evector+marketing&aqs=chrome..69i57j0l5.7928j0j7&sourceid=chrome&espv=210&es_sm=122&ie=UTF-8#q=vector+marketing&spell=1

  15. Ian Random says:

    If the minimum wage is so effective, why are the Demoncrats fretting over the food stamp cut?