In a new book, The Myth of American Inequality: How Government Biases Policy Debate, three economists, John Early, Phil Gramm, and Robert Ekelund, assess, using detailed data, whether income inequality in America is as great as everybody thinks it is. They conclude that, by a wide margin, it is not, for surprising reasons.
If you are suspicious (in light of Gramm’s well-known conservative leanings and the anti-government intimations of the book’s title) that this is a biased conclusion based on a selective reading of the data, that suspicion was shattered, at least for me, not only by my reading the book and interviewing Gramm, but by stumbling two days later on a New York Times “The Daily” podcast that concluded the exact same thing.
An honest effort to set the facts straight
Phil Gramm was a U.S. senator from Texas in 1980. He was a Democrat, but right of center and an admirer of President Reagan. He was one of the shapers of the bipartisan1 economic agenda later known as “Reaganomics.” Reaganomics cut government spending – even eliminating some Social Security benefits – and reduced taxes. Gramm switched parties and ran as a Republican in 1984, serving three more terms in the Senate after that. In 1996 he ran for the Republican nomination for president, but was defeated by Bob Dole.
Gramm is an engaging, courtly man, with a refined Southern accent. When I spoke to him, he assured me that the book he co-authored had no partisan agenda and no ideology. It was merely trying to get the facts straight so that debates over wealth transfers from the rich to the poor could be held on a sound basis.
An objective reading of the book confirms that assurance. There is no hint of a partisan or ideological agenda. One of Gramm’s co-authors formerly worked for George McGovern, the liberal Democrat who ran for president against Richard Nixon in 1972. When I interviewed Gramm he mentioned that the co-authors came from different parts of the political spectrum.
Furthermore, when I read the book I sensed no deliberate bending or shading of the data to make an ideological, political or predetermined point. The data are, of course, presented in an organized manner to create and back up the book’s conclusions, but they didn’t seem cherry-picked from among a plethora of data, some of which might contradict the conclusion.
Failing to count everything that counts
The result of the book’s investigations is that income inequality (and, in the case of The Daily’s podcast, poverty) in the U.S. are substantially less than is usually believed and reported, because the data that are reported leave out important details.
To put it simply, income inequality and poverty are measured and reported before most redistributions – transfers – from the well-off to the poor. But those transfers are large and have become much larger over the last 55 years. Failing to measure and report incomes after most of those transfers, while reporting them only before those transfers, is like only reporting investment performance before fees and taxes.
It is well known – or believed – that inequality in the Scandinavian countries and other Western European countries is much less than in the U.S. The reason for this difference, we assume, is that government redistributes wealth in those countries from the rich to the poor to a much greater extent than the U.S. does.
But suppose it was discovered that there is just as much, or nearly as much redistribution in the U.S., but it is not reported and recorded in incomes. This, in essence, is the message of The Myth of American Inequality.
Income transfers that are not in cash
The core argument of the book is this:
In 2017, the average household with earned income in the bottom 20 percent of all households received more than $45,000 in government transfer payments; yet, remarkably, Census failed to count nearly $32,000 of those transfers as income to the recipients. This substantial omission has caused the Census calculations of income inequality and the poverty rate to be seriously overstated. In addition, the expanding number and size of these transfer payments has caused the overstatement of inequality and poverty to grow over time.
How could so much income – $32,000 a year – fail to be recorded in the income data?
The explanation is this:
Because in 1947 over 90 percent of all employment compensation and government assistance was received in cash payments and it was difficult to measure the value of noncash payments, the decision was made to define income simply as the total of all cash payments received. At the time, cash payments received were reasonable approximations of total income.
Thus, since then, U.S. Census data on household income has not included non-cash payments, which are many, and add up to $32,000 a year on average for the lowest 20% of pre-transfer income earners.
Those non-cash payments include food stamps, Medicare, Medicaid, housing subsidies, and numerous other government benefits to the poorer sector of the population that have not been classified as cash payments. They are not the same as cash payments, of course; food stamps cannot be used to buy whatever the recipient wants to buy, and the same is true of Medicare and Medicaid and other benefits. Nevertheless, they substitute for what otherwise would be a need to spend out of other income, for food, for medical care, for housing, and therefore are as good as cash payments for cash-strapped recipients.
Meanwhile, say Early, Gramm, and Ekelund, households in the top fifth of the income scale lose 35.2 percent of their pretax income to taxes, including federal, state, local, and sales taxes. But this income is reported by the Census before taxes.
In short, there is a massive transfer from the incomes of the higher earners to the incomes of the lower earners, but most of those transfers are not reported in income figures by the U.S. Census.
Corroborating evidence
This result was so counter to what I thought I knew about income inequality in the United States that I sought corroborating or contradictory evidence.
The first piece of corroborating evidence fell in my lap almost immediately after my interview with Gramm, in the form of “The Daily” podcast that I mentioned earlier. In that podcast, “The Daily” interviewer Sabrina Tabernise interviews New York Times journalist Jason DeParle.
DeParle begins with this headline revelation:
Over the course of a generation, child poverty fell 59 percent. The share of children in poverty went from more than one in four back in 1993 to about one in 10 today.
When Tavernise asks how that happened, DeParle responds:
One thing that happened was that the census bureau changed the way it was measuring poverty. Traditionally the government measured child poverty while leaving out the impact of most safety net programs. So, the government delivers tens of billions of dollars a year in wage subsidies through tax credits, in nutritional aid through food stamps, in housing assistance through programs like Section 8 in public housing; the old way of measuring poverty ignores all that aid. So, the government could spend and spend and spend and seem to make no difference because it simply wasn’t measuring the impact of that aid. But in 2009 the government began using a new poverty measure which does take into effect the impact of government aid, and once you take that into account you start to see that child poverty rates are going down, significantly.
Thus, the government did correct for the non-cash transfer payments in its measurement of poverty, starting in 2009, but apparently it hasn’t yet corrected for them when measuring income.
But even this wasn’t enough for me to fully believe what Early, Gramm, and Ekelund were saying. I knew for example that Thomas Piketty and Emmanuel Saez had written a widely cited paper concluding that top wage shares “are now higher than before World War II.”
I searched some more, and came upon this March, 2018 article by the Public Broadcasting System’s (PBS’s) outstanding economics reporter Paul Solman.
In Solman’s news item, he cited a 2018 paper (which has since been updated) by Gerald Auten and David Splinter, which concluded, “Since the early 1960s, increasing government transfers and tax progressivity have resulted in little change in after-tax top income shares.”
In the course of his investigations to see if he could validate the conclusions of Auten’s and Splinter’s paper, Solman noted as follows:
One tax professor friend considered the question so politically sensitive that he asked not to be quoted by name after having put it to me this way in an email when I asked if the research held up:
“There is a widespread public perception that the distribution of income and wealth has become so much more unequal, a consensus so strong that no one is really allowed to question it in public.”
It would appear, therefore, that this has been known for at least two and a half years among economists, but the popular perception was too entrenched for it to be overcome, or even for the truth to be spoken.
There’s more…
As if Early, Gramm, and Ekelund’s revelations recounted above were not enough, there is much more, and just as surprising. I can only assume that these facts are correct, though I do not have the means to check them, at least not easily. They all contribute to making income inequality out to be less than we thought it was.
One fact they reveal that I did not know (and perhaps should have known), but presumably can be easily checked, is this: “Social Security retirement benefits, relative to Social Security taxes paid, are five times greater for low earners than for high earners.” Assuming this is true, it is obviously yet another redistributional benefit for low earners.
And as for the presumption that taxes are higher in Western European countries than they are in the U.S. and therefore they can redistribute more income than we do, there is this:
The top 10 percent of households in the United States earn about 33.5 percent of all income, but they pay 45.1 percent of income-related taxes, including Social Security and Medicare taxes. In other words, their share of all income-related taxes is 1.35 times larger than their share of income. That is the most progressive income tax share of any OECD nation. In Germany, the top 10 percent earn 29.2 percent of the income and pay 31.2 percent of income-related taxes, 1.07 times their share of income. The French top 10 percent earn 25.5 percent of the income and pay 28.0 percent of the income taxes, 1.10 times their share of income.
My immediate knee-jerk response to this was, “Say what … ??” But I find it hard to believe the authors would lie about this or say it if it was a major mistake.
Furthermore, the authors note that at the lower end of the household income scale in the United States, household sizes are smaller than at the upper end; in fact, household size increases steadily with income quintile: “The bottom quintile has on average only 1.69 people living in each household. The higher quintiles have 2.23, 2.51, 2.81, and 3.10, respectively.” Hence, if household income is converted to per capita income, individual income inequality is even less than it is for household incomes.
What about inflation-adjusted income’s failure to increase over time for poorer quintiles?
One of the author’s responses to this question addresses the knotty problem of measuring inflation, something we do not think about nearly enough.
In principle, inflation is supposed to be measured by the change in the dollar value of a basket of goods and services over time.
But what if the quality, and therefore the value of the items in that basket increases immeasurably over time?
At almost all times in the past 80 years, that basket would have contained a phone, a radio, and a television. Now, a phone may cost a bit more, but it is also a radio so there is no need for one, and even a television to boot, and it performs an almost uncountable number of other useful services as well. How is it possible to say that inflation-adjusted incomes for the lowest quintiles have been level, when inflation is so well-nigh unmeasurable and products and services have increased and transformed by so much in their useful value?
What is the right amount of redistribution of income?
This is the question that the authors do not address. They do not even hint at an answer. Their stated aim is only to provide authentic and factual data that may be used to help address questions like this one.
As to that goal, they have succeeded brilliantly. It now remains to contemplate and debate the big question, armed with a much-improved knowledge of the data.
Economist and mathematician Michael Edesess is adjunct associate professor and visiting faculty at the Hong Kong University of Science and Technology, managing partner and special advisor at M1K LLC, and a research associate of the Edhec-Risk Institute. In 2007, he authored a book about the investment services industry titled The Big Investment Lie, published by Berrett-Koehler. His new book, The Three Simple Rules of Investing, co-authored with Kwok L. Tsui, Carol Fabbri and George Peacock, was published by Berrett-Koehler in June 2014.
1Those were the days.
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