The Facts About Income Inequality

What Occupy Wall Street gets right-and wrong-about the U.S. economy

The last thing I wish to do is wade into the morass of income statistics to ascertain if the rich are really getting richer while the rest of us are getting poorer. We've all heard the line about "lies, damned lies, and statistics" (though we don't know who first said it), and we've been warned that "if you torture the data enough, they will confess anything."

The point is that there are many pitfalls in the income stats if you don't know to look for them. For example, people often unknowingly compare apples and oranges, say, household income in two different periods with average households of different sizes. If single-earner households take the place of two-earner households, an unadjusted comparison could be highly misleading. (The growth in the number of households has been outpacing population growth.)

Or take median and average income: It's easy to be misled, as Donald Boudreaux shows:

Imagine what the average or median income would be in a room occupied only by Bill Gates, Warren Buffet, and Bono. Now imagine that I enter the room and accept their offer to become their full-time shoe-shiner at an annual salary of $500,000.  Because this income is higher than I earned before entering the room, I'm richer. And because my entering the room does not lower their annual incomes, none of them is poorer. But my presence in the room (with my new income still far below that of each of these men) dramatically lowers the room's average income, and pretty significantly lowers its median income, even if the income of each of these men rises during the current year.

Everyone is richer, yet average and median incomes are lower.

Economic Mobility

Even without those problems, we'd have to factor in mobility. People move up and down the income structure. Studies that follow individuals who start on the lowest rung (typically younger people) find that a good share of them move up within several years. So it's misleading to compare the lowest 20 percent of 40 years ago with the lowest 20 percent today as though they were the same people. The influx of low-skilled, uneducated (so-called illegal) immigrants would depress the average income of the lowest 20 percent—although they believe they are better off here than where they originated. (See more about the problems of income analysis in this Robert Samuelson column.)

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Many people nevertheless insist that the income gap is growing. How do they know? Apparently the most popular indicator is the Gini Coefficient, which is said to prove that the gap has been growing dramatically in the new century.

But does it really? Not according to the Census Bureau. As summarized by Mark Perry:

According to three different Census Bureau measures [including two that use the Gini Coefficient], income inequality in America increased only gradually from the 1960s through the mid-1990s, but since then has remained relatively constant. Therefore, the factual record of income data in the United States certainly doesn't support the claims that income inequality has "exploded" recently. A more accurate description of income inequality over the last several decades would be to say that it "flat-lined" starting in about 1994. [Emphasis added.]

This is the opposite of the standard story in which incomes were more equal until the new century. (See graph above and another here. Also see this graph showing that income inequality for individuals is less pronounced than for households and families. Alan Reynolds discusses the 1 percent's share of wealth here.)

No Stagnation

As for stagnating middle-class incomes, Terry J. Fitzgerald, senior economist of the Federal Reserve Bank of Minneapolis, presents data showing this is not the case. "[T]he economic compensation for work for middle Americans has risen significantly over the past 30 years," Fitzgerald wrote in 2007. (Effects from the Great Recession would be cyclical not secular and would not count against Fitzgerald's conclusion.)

I could also add that what matters is not one's position relative to the richest, but one's absolute position and its improvement year to year. Studies demonstrate that for decades the time it takes the average worker to earn the money to buy any given consumer good has been shrinking. (And the goods are often of much better quality.)
This statistical picture seems well confirmed by observation. Any baby-boomer should be able to attest that living standards across the board in America have palpably improved over the decades. Today low-income people have things the middle class didn't dream of 40 years ago—and even some things the rich couldn't have had at any price because they hadn't been invented yet. And this is not primarily due to consumer debt.

So when advocates of increased government intervention invoke the alleged growing income gap—a rallying cry for Occupy Wall Street—we libertarians certainly should correct them if for no other reason than that we should demand intellectual accuracy and integrity from everyone, including ourselves. (I live in fear of "confirmation bias." If I've gone wrong here, show me.)

But here is what we should not do: We should not react as though an actual growing income gap today would indicate a moral flaw in the libertarian desideratum: a social system based on mutuality, consent, and free exchange. Too many market advocates react defensively to the inequality charge—as if someone just insulted their mothers. They seem to be saying, "Don't you dare talk about my beloved economic system that way!"

Not What We Want

Need I point out that the current corporatist system is a far cry from what libertarians say they want? In the response to OWS I find a disturbing preponderance of what Roderick Long calls "right-conflationism" (or for Kevin Carson, "vulgar libertarianism"): "the error of treating the virtues of a freed market as though they constituted a justification of the evils of existing corporatist capitalism." In this case, those who routinely criticize "crony capitalism" respond to allegations about growing income inequality as though the charge were being made against laissez faire. To be sure, some OWS protesters think they are doing that. But libertarians should know better, and it is their responsibility to point that out.

I'm of course not suggesting that no income inequality would exist in a freed market, though I am suggesting that the political means to gaining mega-wealth (the vast array of anti-competitive measures including intellectual "property" laws) would not exist.

That the wealth of the nonrich grows is no reason to be complacent about corporatism. It simply shows that something less than complete freedom goes a long way. I suspect that in a freed market, many of the super rich would be much less rich, while most people of modest means would be wealthier. I await the empirical evidence.

Finally, a word to the OWS protesters: Don't base your complaint against the current corporatist system on false grounds. There are plenty of legitimate grievances. A straw man will only give observers reason to dismiss you.

Sheldon Richman is editor of The Freeman, where this column originally appeared.