Forget About Income Inequality

Opening more economic opportunities will help the poor, not eradicating inequalities.

This article is part of What to Do about Inequality, a Boston Review forum on correcting gross inequities in pre-tax income

Reading David Grusky's essay is a strange experience: with the wrong diagnosis, he gets half of the right cure.

Grusky maintains that the central problem confronting America is income inequality. He argues that the root cause of this malady lies in how rich people acquire their pre-tax income—by rigging the rules of the market to extract illicit "rents." In other words, the economic system, not the tax system, is unfair. Therefore, he argues, redistributive taxation—the remedy of choice for progressives—targets the symptom not the cause.

Grusky's claims about rising income inequality are seriously overblown. But even if they weren't, it wouldn't automatically follow that we should care given that the material well being of Americans has not only been improving, but even equalizing across classes. Still, Grusky's therapies—reforming the higher education industry and doing "something" about obscene CEO salaries—might be desirable if aimed at maximizing opportunities rather than equalizing incomes, which is, at best, a distraction.

Grusky points out, "The share of pre-tax income flowing to the top 1 percent of households increased from less than 10 percent in 1975 to more than 20 percent now." The implication is that greedy CEOs are gobbling up a greater share of the national wealth, leaving less for everybody else.

But if Grusky wants to measure market-generated income inequality, household income is not the proper metric; individual income is. That's because market rewards—paychecks, capital gains, and dividends—go to individuals, not households. Gini coefficients, which measure inequality, decreased slightly for individuals between 1994 and 2010, while showing a modest uptick for households, meaning that individuals became more equal and households less so. The uptick in household inequality might be unrelated to the economy. For example, if rich individuals marry other rich individuals and the poor marry poor—as is increasingly the case—household income disparities will increase even though individual incomes remain unchanged. Similarly, a higher divorce rate among the poor would diminish their relative household income even if all individual earnings remain the same. Equalizing incomes across households then would require addressing segregation and family breakdown, not reinventing the economy.

Furthermore, any indictment of capitalism worth its salt has to show not just that the rich are getting richer, but that they do so by making the poor poorer. There is no evidence of that. Facebook recently floated an IPO making Mark Zuckerberg the richest 27-year-old in America. I didn't notice my bank balance dip.

Many progressives paraded the October Congressional Budget Office finding that between 1979 and 2007 after-tax income of the top 1 percent of households grew 275 percent. They failed to mention that the same study also found a 65 percent income gain in households in the top quintile; for those in the 21st through 80th range, 40 percent; and the bottom quintile, 18 percent. In short, no group lost ground.

Wealth might have been even more evenly distributed in a truly competitive market undistorted by corporate subsidies, onerous regulations that discriminate against smaller players, and barriers to entry that protect incumbents in labor markets and industry. Or not. More open immigration policies, for example, might have allowed more prospective gazillionaires such as Sun Microsystems' Vinod Khosla and Google's Sergey Brin into the country, skewing income distribution even further. We'll never know. We do know that market distortions diminish economic opportunities and are therefore more urgent candidates for reform than out-of-whack CEO salaries, Grusky's bête noire.

But, despite such opportunity-restricting distortions, America has done a remarkable job of closing the only gap that matters: the personal well-being gap. As economist Tyler Cowen has described, the difference between the basic goods available to average Americans and mega-rich folks such as Bill Gates has steadily decreased. Gates might have personal jets and private gardens. But thanks to technology-driven productivity increases and lowered trade barriers, almost every American can afford bypass surgeries, laptops with Internet access, cars, TVs, and occasional air travel.

What's more, America remains a highly income-mobile society where poverty is a stage of life, not a way of life. There is no permanent underclass here. A study by Thomas Garrett of the St. Louis Federal Reserve recently found that between 1996 and 2005—nine short years—roughly half of taxpayers who began in the bottom income quintile moved up to a higher one.

To be sure, Americans might be able to scale the income-mobility ladder faster and higher if there were even more opportunities for education and entrepreneurship. That's why Grusky is right to draw attention to America's highly cartelized higher-education industry, which has created an artificial scarcity of college slots. Strict accreditation requirements—written by the colleges themselves—have made it very difficult for competitors to set up shop, causing college tuition to shoot up four times more than general inflation in four decades, with no appreciable increase in quality—the exact opposite of the rest of the economy. Breaking this cartel should be a top priority of lawmakers, second only to reforming the K–12 system.

But that requires a commitment to maximizing opportunities and not getting distracted by red herrings such as income inequality.

Shikha Dalmia is a Reason Foundation senior analyst.