Yes, Virginia, Income Inequality is Still Rising”

Is Alan Reynolds correct that widening inequality is a myth, or is he standing against a tide of increasingly persuasive evidence to the contrary?

If we were to find, as Reynolds contends, that differences in income and wealth are not as wide as we thought, that would be welcome news. Finding that lower-income individuals are better off than initially reported is preferable to finding they have lower income and wealth levels than we knew about. Unfortunately, a closer look at the evidence does not support Reynolds’ contention that data and measurement problems have produced a misleading picture of inequality in recent decades.

Before looking at some of the specific measurement issues Reynolds identifies, it’s useful to step back and take a broad overview of the research on inequality. There is considerable evidence on the inequality issue, much more than is discussed in Reynolds’ lead essay — it would be impossible to review it all here. But what we know about changes in inequality is summarized well in the speech given by Federal Reserve Chairman Ben Bernanke last week.[1] Chairman Bernanke says:

Although average economic well-being has increased considerably over time, the degree of inequality in economic outcomes has increased as well. Importantly, rising inequality is not a recent development but has been evident for at least three decades, if not longer. The data on the real weekly earnings of full-time wage and salary workers illustrate this pattern…. The long-term trend toward greater inequality … is also evident in broader measures of financial well-being, such as real household income….

He gives quite a bit more detail in the speech. It is worth noting that the view that inequality is increasing is shared widely across political party lines.

Let’s turn next to some of the more specific data issues. In his essay, Reynolds cites two issues repeatedly, the census top-coding issue and the fact that Gini coefficients do not show a rise in inequality.

Let’s take the Gini coefficient issue first. In a paper “Currents and Undercurrents: Changes in the Distribution of Wealth, 1989–2004“[pdf] from January 2006, a paper Reynolds mentions but does not give a full account of, Arthur B. Kennickell, the Senior Economist and Project Director of the Survey of Consumer Finances (i.e. someone who fully understands the data issues), says:

The Gini coefficient shows significant increases in the concentration of wealth in 2004 relative to 1989, 1992, and 1995; but the estimates from the 1998 and 2001 surveys are not significantly different from that from the 2004 survey. On the other hand, estimates of the total amount of wealth held by different subgroups of the wealth distribution show that the share of the least wealthy 50 percent of families fell significantly from … 1992–2001 … to about 2.5 percent of total family wealth in 2004…. Graphical analysis indicates that over the 1989–2004 period, there were statistically significant gains across the wealth distribution and that the level of gains was largest by far for the top few percent of the distribution.

I suppose it would be possible to cherry-pick a few statements from the paper to make a case, but the Gini coefficient evidence is by no means the refutation of rising inequality that Reynolds would have us believe. The write-up to the paper makes this clear.

What about the Census top-coding issue, does Reynolds have a point there? Last month, after Reynolds raised the top-coding issue, Paul Krugman reexamined this point and asked specifically whether top-coding would still matter. Krugman concludes:

The bottom line: top-coding really, truly does matter –- and yes, Virginia, income inequality is still rising.

The technique he uses is rather technical and involves fitting and integrating a Pareto distribution for top incomes and calculating the top-coding effect, but it is clear that the top-coding issue remains important despite Reynolds’ objections.

Let me turn to another place where Reynolds has raised measurement issues regarding inequality data. Recently, in a Wall Street Journal commentary, Alan Reynolds and David Henderson say CBO data on income inequality, which are widely used in inequality research, are misleading because they fail to properly account for interest and dividends earned on deferred income IRA and 401(k) type accounts. According to the commentary, since tax-deferred earnings are not reported, the distribution of interest income from these assets is imputed from reported interest on other assets and this skews the measured distribution of income toward inequality.

Is this an issue? Yes. Should we correct for it if we can? Of course, more precise data are always best. Will correcting the data affect the overall picture? No. In fact, it may even work in the other direction (Gary Burtless makes the same point in his reply).

To look at this, I used the Survey of Consumer Finances data shown in Tables 1 and 5 in “Recent Changes in U.S. Family Finances: Evidence from the 2001 and 2004 Survey of Consumer Finances,” by Brian K. Bucks, Arthur B. Kennickell, and Kevin B. Moore of the Federal Reserve Board’s Division of Research and Statistics.

This report shows that the median value of retirement assets for the bottom 90% of the income distribution was approximately $13,000 in 2001 and $15,400 in 2004, while the median value of retirement assets of the top 10% was approximately $138,500 in 2001 and $182,700 in 2004 (all values are expressed in 2004 dollars). If we assume a 5% rate of return, then the median lower 90% household would have earned around $770 in interest income. Presumably the CBO allocates some interest income to the lower 90% group. After all, they do have financial assets and report interest income to the government. However, even if we assume that no interest income at all is allocated to the bottom 90%, this correction would only raise their incomes by around $770, not enough to matter, especially when compared to the rise in incomes in the top 10% from sources other than the potential mismeasurement of capital income. The basic point is that most Americans have so little capital income that exactly how you count it is not an important issue.

One final point on this. When you examine the distribution of financial assets in the Survey, you see that the distribution of retirement assets rises more steeply with income than do other categories of financial assets such as stocks and bonds. Thus, if interest income is distributed by the CBO according to the distribution of reported interest income, this works in the opposite direction from what Reynolds claims since too little rather than too much interest income will be allocated to upper-income taxpayers.

I chose these examples because they are indicative of Reynolds’ analysis generally. When we examine the points he makes, we find that they are either too inconsequential to change the inequality picture, that they are an incomplete presentation of the evidence, or rebutted by other work. As conservative economist Bruce Bartlett says:

Even accounting for the factors Reynolds cites, there are too many different sources all showing a rise in income inequality… No matter how you slice it, the distribution of income has become more unequal over the last 20 years or so.

As another example, consider Reynolds’ criticisms of Siketty and Paez’s work in his lead essay and in this editorial from the WSJ. In response to Reynolds’ criticisms, Thomas Piketty and Emmanuel Saez have posted a detailed rebuttal[pdf] on Emmanuel Saez’s web site. Here are a few selections:

In his … article, … Alan Reynolds casts doubts on … our results showing that the share of income going to the top 1% families has doubled from 8% in 1980 to 16% in 2004. In this response, we want to outline why his critiques do not invalidate our findings and contain serious misunderstandings on our academic work. …

Alan Reynolds points out that reported incomes may not reflect true incomes because of tax evasion or tax avoidance. This is a legitimate concern and we, along with a number of colleagues, have actually spent substantial time investigating this issue. Alan Reynolds has picked some of the facts in order to provide a very skewed view. …

Even the small point on 401(k)s is conceptually mistaken… In sum, our work has shown the top 1% income share has increased dramatically in recent decades… The reduction in taxes at the top since 2001 has mechanically exacerbated the discrepancy in disposable income…

Moving to a final issue, one that Gary Burtless raises as well, there are potential measurement issues that work in both directions –- some adjustments to income and wealth work against inequality and some work for it -– and a fair presentation of the evidence would note both sides. But that is not what we have. Only those adjustments that favor the proposition that rising inequality is a myth are presented favorably by Reynolds. For example, we didn’t hear about this:

There is evidence, however, that because of the way the G.D.P. is calculated, the actual shift [in inequality] is much more pronounced. “We know that income inequality is quite substantial,” said Harry J. Holzer, a labor economist at Georgetown University, “and this new evidence suggests that it is worse than we thought.”

The Bureau of Economic Analysis, which issues the G.D.P. reports each quarter, is on the case. So are two prominent economists at the Federal Reserve. … If these [adjustments] … were incorporated into G.D.P. …, labor’s share of national income would decline from a fairly steady 65 percent in the 1950′s, 60′s and 70′s to less than 60 percent today.

The issue is whether R&D should be counted as an investment or an expense. If it is counted as an investment, and there are good reasons to do so, the picture changes dramatically. This change alone would dwarf the kinds of adjustments Reynolds discusses.

As I said at the start, I would be very pleased to find out that growing inequality is not a problem. However, despite the attempts of Alan Reynolds and a few others to argue otherwise, the preponderance of evidence and of professional opinion clearly indicates that inequality has been rising since 1988, and that the trend toward widening inequality has been present for much longer than that. The question is what, if anything, to do about it. If we can get past the attempts to cloud the issue, perhaps we can proceed to more important discussions.

Notes

[1] Janet Yellen, president of the San Francisco Fed, also has a very nice summary of the inequality evidence. See “Economic Inequality in the United States.”

Also from This Issue

Lead Essay

  • Income Distribution Heresies by Alan Reynolds

    A headline in today’s Wall Street Journal reads “Fed Chief Warns of Widening Inequality.” Bernanke worries that inequality erodes tolerance of the “dynamism” that lays the golden eggs of “economic progress.” But is inequality widening at all? Cato Institute senior fellow Alan Reynolds has his doubts. Following up his own controversial Wall Street Journal op-ed, a Cato Institute policy forum, and a new Cato policy paper, Reynolds in this month’s lead essay digs yet deeper into the mysteries of the official numbers and comes up with … not much: “If there were any [good] data showing a significant and sustained increase in the inequality of disposable income, consumption, wages, or wealth since 1988,” Reynolds concludes, “I suspect someone would have shared it with us by now.”

Response Essays

  • Ben Bernanke is Right by Gary Burtless

    Gary Burtless agrees that analysts of the American income distribution should “take seriously some of Reynolds’s criticisms of the data on income disparities.” “Reynolds points to some serious problems,” Burtless concedes, “and in many cases fair-minded experts will agree with him.” Nevertheless, Burtless dissents sharply from Reynolds’s larger claim that inequality apparently stopped increasing in the late 1980s. “Income inequality was higher at the end of the 1980s than it was in the beginning of that decade,” he states, “and it was higher in 2005 than it was in 1989.” According to Burtless, Reynolds can reach his unorthodox conclusion only by manipulating the evidence. “The problem is,” Burtless charges, “he is harshly critical of data series that do not support his views, while he is usually silent about equal or more serious problems with data sets that show little change in inequality.”

  • Measuring Economic Well-Being: What, How and Why by Richard Burkhauser

    Invoking Kurosawa and Derrida, Richard Burkhauser dives into the contested complexities of the Current Population Survey data on household income. His conclusion: “Over the 1990s business cycle the entire distribution moved to the right with little or no change in income inequality. Since 1989 household income inequality has risen very little and much less than in the previous decade. This is very good news that matters.” Burkhauser admits that the CPS data are not well suited to tracking trends for the top 1 percent of earners. “But does this really matter?” he asks. “Our economy is not a zero sum game. My gain does not mean your loss or vice-versa. I know of no evidence that increases in the incomes of the top 1 percent of our population are the root cause of the challenges faced by those at the other end of the distribution.”

  • Inequality in What? by Dirk Krueger and Fabrizio Perri

    Dirk Krueger and Fabrizio Perri suggest that we shift our attention away from inequality in current incomes. “[I]f one is ultimately interested in the distribution of well-being across U.S. households,” they write, “the object of study ought to be the joint distribution of lifetime consumption and leisure across them.” Unfortunately, good data on lifetime consumption are not available. However, citing Milton Friedman and Franco Modigliani, Krueger and Perri contend that “if households can borrow and lend on financial markets, then there is a strong link between the lifetime resources of a household (sometimes also called its permanent income) and its current consumption.” And the trends in current consumption data show that “the increase in income inequality in the U.S. has been much more pronounced than the corresponding increase in consumption inequality.”

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