The Income Gap Shrinks with Accurate Accounting

The Income Gap Shrinks with Accurate Accounting


Are the rich getting richer? President Obama thinks so, and has made narrowing the gap between rich and poor a staple of his reelection campaign. Many on the left who decry the exorbitant payouts to CEOs and wickedly low tax rates on billionaires that presumably have led to the widening income gap join him.

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In an effort to bring some facts to the table, Diana Furchtgott-Roth of the Manhattan Institute has published a study debunking the “misguided assumption that income inequality in the U.S. has increased in recent years.” Analyzing spending data from the U.S. Labor Department, she concludes that the gap between the highest and lowest income quintiles has in fact not changed much over the past 25 years.

She says some of the studies that argue otherwise are inaccurate in that they use pretax income for high earners, and do not include transfer payments such as food stamps, Medicaid and housing allowances for low-income earners.  She contends that using spending –an easier number to pin down than income – as a proxy for well-being removes those distortions.

The rise in the number of two-income couples has powerfully influenced the relative wealth of the upper-end.

Furchtgott-Roth also ascribes some of the much-ballyhooed changes in income distribution, mostly measured by household units, to shifting demographics. She notes that top income quintile households typically contain more bread-winners, a number that has grown over time. For instance, in 2010 the lowest income quintile contained only 0.5 earners per household unit, as compared to 2 earners in the highest quintile. That bottom category includes the unemployed, recently graduated and single working persons as well as retirees.  

Data from the Census Bureau shows that the rise in the number of two-income couples has powerfully influenced the relative wealth of the upper-end. In 1990, median income for a family with one earner was roughly $40,000; in 2010 that figure had increased by only 5 percent. However, families with two earners saw their fortunes improve, with income rising from $67,000 to $81,000, up more than 20 percent. The bottom group, by contrast, has seen the number per household shrink, in part due to a rise in single parenting and also the increased longevity of seniors living alone. Single females constituted 46 percent of the lowest income quintile compared to 4 percent of the highest.

The Pass through Tax Loop
Another change that influenced reported income distribution, according to Furchtgott-Roth, was the Tax Reform Act of 1986, which lowered the top income tax rate to 28 percent and the corporate rate to 35 percent, creating an incentive for business owners to file as individuals rather than companies. That flow of income bloated personal income tax filings, pushing up the earnings of the highest categories. 

Because these demographic and tax changes distort comparisons, Furchtgott-Roth turns to spending as a more reliable indicator of how various groups have prospered. She concludes that over the past twenty years there has not been much change in comparative per-person spending between the highest and lowest income categories. Of course, higher earners spend more than those at the bottom of the income ladder – about 2.4 times, to be exact.

That difference has not shifted much over time, suggesting that income comparisons are also steady. In fact, most recently, the numbers suggest a narrowing of the income gap- a change that might also be read as the tendency of wealthier Americans to pull back during the recent recession. With a higher proportion of spending being discretionary, wealthier people have more flexibility to cut outlays in uncertain times.

The emergence of a huge new labor source in China and India has driven down wages for U.S. workers.

Others have presented different data to rebut the narrative that our income gap is due to   misguided domestic policies. A study by Swedish economists Roine and Waldenstron, cited by the Hoover Institution’s Allen Meltzer in a recent Wall Street Journal piece, shows that the share of the pie accruing to the top one percent has ebbed and flowed over time – but not just in the U.S.

In fact, the fortunes of the highest-earning people here have moved in concert with the fluctuations seen in other developed countries with very different tax and wealth distribution models. He notes that the top one percent of earners (as compared to the top 20 percent of households surveyed by Furchtgott-Roth) have indeed seen their share grow in recent years, and attributes that shift to the emergence of a huge new labor source in China and India, which has driven down wages for workers.

This is undoubtedly true. In the language of economists, the “rent” paid to the various components of production shifted over the past several decades, rewarding capital (higher returns and stock prices) and penalizing labor (lower wages). Partly, this stemmed from enormous gains in productivity, as the technology revolution eliminated millions of jobs. It also stemmed from the opening of global markets, which allowed hundreds of millions of low-wage laborers in far-off places to impact our domestic workforce.

President Obama wants to turn the tide, and has proposed giving tax breaks to companies that manufacture in the U.S., and penalizing those that outsource. He wants to single out specific industries for favorable treatment – such as high-tech producers. Such measures might benefit workers but could also distort the flow of capital and, like policies that favored housing, create long-term distortions. This is a discussion we should be having in the U.S. It should be based, though, on fact and not fiction. And perhaps not even politics.