Official government measures greatly exaggerate income inequality by ignoring taxation and noncash sources of income.
iStock (The Hill)
According to Mark Twain, “It ain’t what you don’t know that gets you into trouble. It’s what you know that ain’t so.” “The Myth of American Inequality,” by Phil Gramm, Robert Ekelund and John Early, quotes that wisdom, then offers 250 pages of analysis proving it.
Before reading the book, you should ask a few questions to test the authors’ hypothesis that misleading government statistics have led many Americans to misperceive the prevalence of poverty, the degree of inequality, and the changes in these measures in recent decades. Has the average standard of living grown substantially since the 1960s? Has inequality shrunk over that period? Did post-1960 redistributive policies reduce the percentage of families living in poverty?
Media commentators and politicians seem to believe that little progress has been made in raising average American living standards since the 1960s; that poverty has not been substantially reduced over the period; that the median household’s standard of living has not increased in recent years and inequality is currently high and rising (“a truth universally acknowledged,” according to the Economist magazine in 2020).
The authors—a former chairman of the Senate banking committee, a professor of economics at Auburn University and a former economist at the Bureau for Labor Statistics—show that these beliefs are false. Average living standards have improved dramatically. Real income of the bottom quintile, the authors write, grew more than 681% from 1967 to 2017. The percentage of people living in poverty fell from 32% in 1947 to 15% in 1967 to only 1.1% in 2017. Opportunities created by economic growth, and government-sponsored social programs funded by that growth, produced broadly shared prosperity: 94% of households in 2017 would have been at least as well off as the top quintile in 1967. Bottom-quintile households enjoy the same living standards as middle-quintile households, and on a per capita basis the bottom quintile has a 3% higher income. Top-quintile households receive income equal to roughly four times the bottom (and only 2.2 times the lowest on a per capita basis), not the 16.7 proportion popularly reported.
What explains the disconnect between reality and belief? Government statistical reports exclude “noncash” sources of income, which excludes most transfers from social programs. Taxes (paid disproportionately by high earners) are also ignored in official calculations. Furthermore, even the government’s “cash” income numbers are reported in a way that understates improvements in real (inflation-adjusted) income over time because government inflation measures fail to use the appropriate chained price indexes or take account of new products and services.
Increased earned-income inequality is the natural consequence of redistributive policies: if one can enjoy median household consumption without earning any income, the incentive to work is substantially diminished. This largely explains the growing distance between earned and total income for poor households (transfers to those households have gone up dramatically). Ironically, it is the very success of redistribution in reducing poverty and inequality that has led mismeasurement to create the false perception of increasing inequality.
The equality of consumption between the bottom quintile (in which only 36% of prime-age persons work) and the middle quintile (in which 92% of prime-age persons work) is a striking finding. As the authors note: “It is hard to see how a middle-income family with two adults both working would not resent the fact that other prime work-age people who are not working at all are just about as well off as they are.”
Most of the facts documented in this book will not shock economists who specialize in studying poverty and inequality. The formal studies of these topics published in professional journals, however, tend to focus on short periods of time and narrowly defined questions, not broad issues of measurement. What makes this book an invaluable new resource for public policy and economic education is its focus on how the experiences of Americans of different living standards evolved over time and how earned income and consumption diverged for the poorest households. It traces improvements in the living standards of the poor to transfer programs, shows how taxation of the rich has flattened the distribution of consumption across households, and documents how measurement errors have distorted general beliefs about economic inequality.
But that’s not all. This book is written in straightforward American English, not in economic think-tank jargon. It shows clearly how each element of the analysis (taxation, transfers, inflation adjustment) contributes to its conclusions. Graphs and tables are comprehensive and comprehensible. The style is lively and lucid. On two occasions I read passages aloud to my wife, who then raised questions that were addressed by the authors in the next few paragraphs.
The analysis probes deeply to demonstrate the robustness of its conclusions. For example, it measures not only differences in consumption by households across quintiles, but also the more meaningful per capita consumption across quintiles, and adjusts those per capita calculations to capture consumption synergies within households using standard methods.
Most important, the authors don’t clutter their analysis with contentious approaches to measurement, and they limit their policy recommendations to those that flow self-evidently from the facts they document. It is encouraging that three disparate economists can together write an objective book about the measurement of living standards, poverty and inequality without engaging in partisan advocacy that undermines their findings. (“While we each have our opinions and political views,” writes Mr. Gramm in a preface, “we share a desire to get the facts straight.”)
“The Myth of American Inequality” will have a positive effect on the quality of policy discussions, and may well achieve its objective of changing the ways in which government agencies report information about American household income and consumption. At a time when partisan tribalism makes serious discussion almost impossible in Washington, this book shows that economics is still a powerful tool kit for informing and disciplining our thinking across the partisan divide.
This piece was originally published in The Wall Street Journal