Why Income Inequality Has Not Increased In America

This post is based on two reports of income inequality studies entitled - The Myth of Increasing Income Inequality & Income Inequality In America – Fact & Fiction - that were sent to me by Diana Furchtgott-Roth of the Manhattan Institute.  Diana wrote the first report in its entirety & contributed to the monograph in the second report.  You can use this information in conjunction with the September 8 post regarding income mobility.  I know many subscribers to RTE, like our Wall Street Finance VP, will pour over these reports.

 

The studies conclude that there has been no increased inequality in America from 1987 to 2012 when measured by real spending per person by income quintile – the best measure of a person's financial well being.

 

How can that be true since we all have heard that the average CEO used to make 20 to 30 times the income of the average worker & lately that ratio has been reported to be more like hundreds of times more.  The conclusion seems even more improbable when you consider the dreadful economy of the past six years with its high degrees of unemployment & underemployment, the number of previously unemployed people who found work but only @ a fraction of what they used to make, the labor force participation rate of prime-age workers (ages 25 to 54) is still 2 points below its pre-recession level, the median inflation adjusted household income dropped 5% between 2010 & 2013, the poor education provided by government schools that leaves graduates (& drop outs) ill prepared to find work in the global economy, employers are still concerned about the shortage of qualified workers in engineering, construction, & information technology which they say is both intensifying & broadening across skills & occupations, the Fed's manipulated zero-level interest rates that leave CD interest income virtually non-existent, & statistics abound that the top ten percent now takes in 45% of the nation's income instead of one third.

 

We know all of the above maladies are facts that would @ least imply growth in income inequality over time.  But why then don't we see people dying of starvation in the streets?  Could it be that inequality is not growing? – i.e., the rich are not getting richer especially @ the expense of the poor.  In fact it is pretty close to just the other way around.

 

For perspective it is important to understand that the average poor American in the bottom income quintile has more living space than the average individual living in Paris, London, Vienna, Athens, and other cities throughout Europe.  These comparisons are to the average citizens in foreign countries, not to those classified as poor. Source – Robert Rector of the Heritage Foundation. 

 

The problem with the emotional excitable claims made by BO that the income gap between America's rich and poor is the "defining challenge of our time" is that the claimed increasing income inequality in most studies is based on pretax income, does not include any of the 126 anti-poverty federal government programs whose benefits & existence has been documented by the Cato Institute such as food stamps, housing allowances, unemployment benefits, & Medicaid, does not include demographic changes to households that have occurred over time, & does not include the effect of the Tax Reform Act of 1986 which resulted in some small businesses filing their income taxes in the late 1980s & 1990s under the 28 percent individual rate rather than the 34 percent corporate rate, later increased in 1993 to its current level of 35 percent – as long as the top individual rate is less than the corporate rate small business owners will follow this practice.

 

The Manhattan Institute studies address faulty methodology used in other studies by concentrating

directly on the amount of money people have available for spending using the government's own published consumer expenditure data.  It is from this analysis that you see that there has been no widening inequality for the last 25 years.  The impact of the Tax Reform Act of 1986 makes comparisons of incomes or spending prior to 1987 pointless as explained above.

 

Below is a table from the Manhattan Institute studies that show the remarkable consistency from 1987 to 2012 in the ratio of real expenditures per person of the top income quintile to the bottom income quintile based on the BLS Consumer Expenditure Survey. 

 

click on table to enlarge

 

The information in the table is not based on the spending of CEOs of the Fortune 500 companies (i.e., 500 people), the handful of professional athletes who have tremendous incomes for a few years, or the even smaller handful of successful Hollywood stars who may never have another hit movie or TV show again.  It is based on an analysis of the 120 million households in America broken down into quintiles & then each quintile is analyzed to show real inflation adjusted spending per person per quintile for the selected years between 1987 & 2012.

 

Increasing inequality was shown to be a myth by the Manhattan Institute when they analyzed the government's own published consumer spending data from the government's Consumer Expenditure Survey. 

 

In essence the spending data can be derived by adding disposable income (adjusted for a small savings rate – i.e., people spend most of their disposable income) plus government transfers like those listed in the table below.  It is this balance that tells the tale of why income inequality has not increased over the years.

 

Income taxes (federal, & if any state & local) coupled with Medicare & Social Security payroll taxes reduce the pre-tax income of people in the higher quintiles while none of these taxes are paid to any significant degree by people in the lower quintiles.  Over the years Congress & our state elected representatives have done a masterful job of distributing a portion of the aforementioned tax revenues to people in the lower quintiles so that the ratio of the top to the bottom quintiles remained constant as shown in the above graphic.  This consistency of income redistribution shows the precision with which the politicians controlled tax revenues even before

BO told Joe the Plumber he wanted to spread the wealth around.

 

Our elected representatives have found the monetary redistribution formula to keep the domestic peace so that the half of the population with poor education & limited job skills is not @ the throats of the productive half – everyone has some money jingling in their pockets.  Of course this makes the U.S. a mixed economy – somewhere between a totally free market (pure capitalism) & a government directed one (socialism).  In 1996, just ten years into the 25 years covered by the Manhattan Institute's studies, Professor Friedman said "We're more than 50 percent socialist.  And I don't think we're getting our money's worth." 

 

   click on graphics to enlarge

 

The above table shows where some of the money goes & the above right graph indicates that government dependence spending is now higher than disposable income.  Both of these graphics are from IBD.  The first graph on left is from the Cato Institute & is for 2011.

 

The above table does not include 3 million people who have signed up for Medicaid under ObamaCare.  The Cato Institute has determined that a family can get government benefits equivalent to a $35,000 a year job in 11 states & in Hawaii such benefits are equivalent to a $60,000 a year job.  The programs do not require work; in fact people lose benefits if they become employed.  There is no one working in half of the bottom quintile households.

 

But we have to be careful of his intentions because BO does not always distinguish in his remarks between income inequality & growing income inequality - in fact he rarely if ever does.  In BO's defining challenge of our time quotation above he was referring to just the gap between the rich & poor (not the growing gap) meaning he favors socialism - for starters.  BO prefers the methods that show there is growing income inequality (disproved by the Manhattan Institute studies presented herein) & he also tries to convey the idea that the people in the bottom quintile are always the same people (disproved in the September 8 post regarding income mobility).

 

Scott Hodge, President of the Tax Foundation, calculated that the top two quintiles currently pay $1.5 trillion in taxes that go to the bottom three quintiles (yes, this means even an average middle quintile family – i.e., middle class - receives over $7,000 more in benefits than they pay in federal taxes each year) – this represents 21% of the top quintile's income.  Mr. Hodge calculates that in order to bring every family in America to average would require the people in the top two quintiles to pay higher taxes than they currently do with people in the top quintile paying the vast majority of an additional $2.4 trillion per year in federal taxes or 74% of their income. 

 

So now we know BO's target.

 

In mid-August a report came out that statewide 64.2 percent of New York students are not proficient in math and 68.6 percent are not proficient in English.  These appalling results, typical throughout the U.S., take the subject of income inequality to another level by revealing a problem much greater than the false and misleading claims of income inequality.  They clearly show how someone becomes so ill-prepared to support themselves that they will be competing for jobs with third world people who make pennies a day.