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Income Inequality: Still Not A Big Deal

Andrew Sullivan, whose blog I’ve just started reading again, points to this Economist piece on income inequality in the United States. While usually a great source for economic reporting, this piece falls into some common traps with welfare analysis and sounds any number of useless alarms.

The common perception is that income inequality in the US is bad and only getting worse, however a closer look at the actual numbers doesn’t paint nearly as bleak a picture as we might be led to believe. The US Census Bureau put out Income Inequality in the United States: 2002, and their most recent data do not seem to indicate a huge leap in income inequality.

The United States Gini coefficient is .0462 according to the above paper in 1979 the US Gini was 0.406*. Like golf, low numbers are preferable from a Normative Economic perspective (more on that later). However, methodological changes make data previous to 1993 not exactly comparable to current data. This is sort of a niggling detail, and a fact largely ignored by pretty much everyone. However, it doesn’t seem like the methodological changes were really large enough to have much of an effect, so I suppose it’s not a big deal to go right ahead and ignore them.

Table 7** from the above report shows that the Gini by quintile for before-tax income is 0.448, slightly but not impressively lower than the above. However, the United States has a fairly progressive taxation structure, and people’s welfare is determined not by their gross income but by their disposable income. The same table shows the Gini for after-tax income to be 0.426, which is significantly lower than 0.462 and lower than the 2001 number of 0.434.

But wait! There’s more! Disposable income is not the only thing that contributes to total welfare, which is really the disparity everyone in the Normative community claims to be interested in, so we’ll have to look at yet a more comprehensive number. Once non-cash transfers and the benefits of employer-subsidized health-care are factored in the Gini drops slightly to 0.421. If you factor in the benefits of Medicare and Medicaid, the Gini drops to 0.405. If the value of home equity returns is considered, the Gini declines to 0.400.

Essentially, the more comprehensive a measure of welfare is used, the less inequality we see. What’s more interesting, and really does expose the lie in “tax cuts for the rich”, is that the top quintile of income earners lost statistically significant shares in all income categories except gross income. Further, while the bottom two quinitiles remained largely unchanged (probably because they really don’t pay taxes at all), the shares of aggregate income in the third and fourth quintiles made statistically significant gains over 2001 in all categories except gross income. What does that mean, kids? That middle class Americans have gained a lot over the last couple of years.

That we have an “inequality crisis” in America is a fallacy. This has been a boilerplate issue for liberals and leftists for a long time now, and is unlikely to go away, but it is important to remember that their claims are not really supported by much in the way of evidence.

Later in the week: Marginal tax rates and government outlays, plus why Normative Economics is fundamentally flawed.

*Table A-3: Share of Aggregate Income Recieved By Each Fifth and Top Five Percent of Households 1967-2002

** Percentage of Aggregate Household Income Recieved By Income Quintiles and Gini Index by Income Definition.

  1. JS says:


    I think you may be confused about the definition of aristocracy. It’s not synonymous with wealthy. As defined by the Merriam Webster Dictionary, aristocracy means 1: government by the best individuals or by a small privileged class3: a governing body or upper class usually made up of an hereditary nobility.

    This is, in large part, what the American Revolution was all about. I would be interested in reading how George Washington and Alexander Hamilton had strong affinities for aristocracy, as you contend. Alexander Hamilton was the illegitimate son of a poor Scottish merchant and an English-French Huguenot mother. He became an important historical figure because of his abilities, not inherited wealth.

    Thomas Jefferson counted the abolition of primogeniturethe legal system under which family wealth was preserved by the exclusive right of the eldest son to inheritamong his greatest accomplishments. He said its abolition was an essential part of “a system by which every fiber would be eradicated of ancient or future aristocracy; and a foundation laid for a government truly republican. The repeal of the laws of entail would prevent the accumulation and perpetuation of wealth in select families, and preserve the soil of the country from being daily more & more absorbed in Mortmain.”

    In Common Sense, Thomas Paine wrote, But it is not so much the absurdity as the evil of hereditary succession which concerns mankind. Did it ensure a race of good and wise men it would have the seal of divine authority, but as it opens a door to the foolish, the wicked, and the improper, it hath in it the nature of oppression. Men who look upon themselves born to reign, and others to obey, soon grow insolent; selected from the rest of mankind their minds are early poisoned by importance; and the world they act in differs so materially from the world at large, that they have but little opportunity of knowing its true interests, and when they succeed to the government are frequently the most ignorant and unfit of any throughout the dominions.

    The Founding Fathers were not aristocrats, as you contend, although many (but not all) had some amount of wealth. More still, like Alexander Hamilton, were self-made men. Very few were the products of great inheritances.

    After great fortunes were made during industrialization Theodore Roosevelt and the Progressives re-established the Estate Tax in an attempt to keep America from going the way the Founding Fathers so despised in the English: a rich aristocracy sustained on inherited wealth instead of work; a place where the class system created the very conditions that led Americans to revolt.

    The progressive income tax and estate taxes have attempted to level the playing field. It’s bad public policy to actively encourage the creation of an aristocracy of privilege and inherited wealth, especially in a high-tech, integrated global economy that values meritocracy, entrepreneurship, and human capitalAmerica’s richest man in 1918 was John D. Rockefeller who owned 0.54% of the nation’s total net worth. In sharp comparison, at the peak of the stock market boom in 2000 it took the combined fortunes of Bill Gates, Larry Ellison, Paul Allen, and one-third of Warren Buffett to equal 0.52% of net worth, according to the scholars.

    These progressive, field-leveling, anti-aristocracy policies have come under attack by many Republicans (and even some Democrats). And although the Estate Tax, for example, could have been improved, it was wrong to repeal it.

  2. JS says:

    Interesting article. Yet it doesn’t answer any of the questions I asked with all sincerity. And it completely avoids the issue, brought up in the Economist article, of the lack of upward mobility among those born into families with lower incomes. That American ideal of being able to go from rags to riches is basically a sham these days.

  3. Timothy says:

    Law prof, excuse me.

  4. Timothy says:

    As usual, an econ prof from GMU says it better than I could have.

  5. Tyler says:

    “Since industrialization there has been a growing aristocratic class in the United States that the Founding Fathers would’ve objected to in their own time.”

    You’re joking, right? Both George Washington and Alexander Hamilton had strong affinities for aristocrats. The Founding Fathers were aristocrats, for fuck’s sake. Who fought for the right for ordinary citizens (read: non landowners) to vote? Andrew Jackson, who was a generation removed from the Founding Fathers. And golly gee, his Presidency corresponds rather nicely with the industrial revolution.

    But I digress. This had been a riveting discussion of economics before I butted in.

  6. JS says:

    You started out addressing income inequality. Now you’re addressing the “distribution of total welfare”. We could move on to discuss wealth inequality:

    The top 1% of households own almost 40% of the nation’s wealth.
    The top 10% of Americans own over 70% of nation’s wealth.
    The top 20% of the nation’s households own 85% of the nation’s total wealth.
    The top 60% of households own almost 100%, or 99.8%, of the nation’s wealth.

    It’s the discussion of wealth inequality where the easily understood (and very striking) statistics speak more to “fairness issues”. Since industrialization there has been a growing aristocratic class in the United States that the Founding Fathers would’ve objected to in their own time. The policies of the Bush Administration (repeal of the Estate Tax, for example) contribute significantly to this.

  7. JS says:

    Hi, yeah, linking to a 34 page Census Bureau document as a supplement to a 500 word post isn’t too helpful if you’re trying to stimulate some sort of discussion–one of the main purposes of the blog, right?

    Perhaps I should’ve just asked what “common traps with welfare analysis” the Economist fell into.

    How is the following frivolous?
    “…the lowest fifth (the bottom 20% of earners) grew by 6.4%, while that of households in the top fifth grew by 70%.” The rate of growth for the top fifth was more than 10 times greater than the rate of growth for the bottom fifth. Simple math indicates that this cannot lead to anything but a massive (and rapidly growing) inequality between the top and bottom fifths.

    And income inequality isn’t just a “fairness” issue. According to the John D. and Catherine T. MacArthur Research Network on Socioeconomic Status and Health, income inequality correlates to the health of the population in question.

    “Recent research suggests that the degree of income inequality in society may be related to the health status of a population. Greater income inequality has been linked to lower life expectancy in cross-national comparisons (Wilkinson, 1996); higher mortality rates (Kaplan et al. 1996; Kennedy et al. 1996) and worse self-rated health (Kennedy et al. 1998) at the U.S. state level; higher mortality at the U.S. metropolitan level (Lynch et al. 1998)…”

    There’s a table at the link you provided for the Gini coefficient that lists the Gini for several countries.

    Australia: 0.352
    China: 0.447
    France: 0.327
    Germany: 0.283
    India: 0.325
    Japan: 0.249
    Mexico: 0.546
    UK: 0.360
    USA: 0.408

    The only countries with a worse Gini than the US on this list are China and Mexico.

    Check out this “World Atlas of Income Inequality (gini coefficients)” to see how the US ranks among industrial democracies (it’s not good).

    Perhaps the Gini coefficient is really more instructive with the added context of other nations?

  8. Timothy says:

    Anyway, the point is that looking at shares of aggregate income (either gross or net) is not a very good way to determine the distribution of total welfare. There are other benefits that aren’t counted in the income calculations (welfare, employer-subsidized healthcare, medicare/medicaid, and other government transfer programs) and taking those factors into account paint a very different picture than looking at shares of aggregate income.

  9. Timothy says:

    Hi, yeah, did you even read the bit about the Gini coefficient? Did you bother looking at the US Census Bureau paper?

    My point isn’t that the numbers in the Economist piece are wrong, but that they’re essentially frivolous. It should also be noted that the primary source, EPI, is an advocacy group for low and middle-income workers so they’re going to make a big deal out of income shares.

    The Gini coefficient is a way to determine how far from perfect income equality an economy is, a Gini of 0 means that everyone gets exactly the same income, a Gini of 1 means that one guy gets all of the income. So, in looking at that (generally considered a much better measure if income inequality than simple gross wage shares), there doesn’t seem to be the same sort of severe increase in inequality that the alarmists are yelling about.

    If you would like to learn a little more about Normative analysis, I highly recomend either taking a class from Peter J. Lambert in the UO department (sorry, but 300-level theory is required) or just read his book which is really the authoratative source for Normative Economics as it pertains to income. The first parts are very accessible, but you will need to know how to integrate by parts.

    There are reasons that I don’t find the Normative approach to be very satisfactory, or even particularly useful, but I will cover those in a later post.

  10. JS says:

    Rather than explain what’s wrong with the Economist piece by using a completely different methodology, it would help those of us with little training in economics (me) if you could reference the stats and methodology of the article.

    The meat of the Economist article seems to be the following:

    “The Economic Policy Institute, a Washington think-tank, argues that between 1979 and 2000 the real income of households in the lowest fifth (the bottom 20% of earners) grew by 6.4%, while that of households in the top fifth grew by 70%. The family income of the top 1% grew by 184%and that of the top 0.1% or 0.01% grew even faster. Back in 1979 the average income of the top 1% was 133 times that of the bottom 20%; by 2000 the income of the top 1% had risen to 189 times that of the bottom fifth.”

    What’s wrong with these numbers? What numbers do you come up with using your methodology?

    And your post doesn’t really address the following:

    “Thirty years ago the average real annual compensation of the top 100 chief executives was $1.3m: 39 times the pay of the average worker. Today it is $37.5m: over 1,000 times the pay of the average worker. In 2001 the top 1% of households earned 20% of all income and held 33.4% of all net worth. Not since pre-Depression days has the top 1% taken such a big whack.”

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