SOCIAL INDICATORS 2006
Economic Status (Part 2)
The Gini Index is a measure of income inequality. The index ranks income distributions from 0 to 1 where 0 equals equality and 1 equals inequality. Gini indexes had been calcualted for families from 1947 to present in the US. However, household income is now the preferred indicator and that data is available from 1967 to present.
The Gini Index declined slowly over the 1950s and 1960s until it reached a low of .388 in 1968. Based on earlier data for the entire century, I suspect 1968 was the low point of the century. Over the past four decades the rate has climbed to .466 in 2004. That is an increase of 20%. Is that significant? Yes.
The following is a chart that shows the percentage of income earned by the top 1% of taxpayers from 1913-1998.
The Gini Index growth rate flattened out in 2000 and I suspect this chart would show a similar leveling or decline if extended five more years. The percentages preceding 1913 were likely higher than the 1913 percentage. This indicates that income distribution in the 1950s through 1970s may have been an aberration and not the norm.
Many attribute the rising inequality to the tax cuts implemented by Ronald Reagan in 1981. However, the rise in the Gini index began earlier:
Some estimates suggest the rate of poverty in the United States in 1939 was more than 40%. This would certainly have given a high Gini Index. We also know that the Gini Index fell rather steadily from the end of World War II until 1968. The Gini index fluctuated near the 1968 level until 1974. The rate began to grow in 1975 and continued at a very steady pace until early 1992, set back only by the 1980 and 1990 recessions. If not for the recession and economic woes of the mid-1970s, the orgin of the increase might have been as far back as 1968. The calculation methods for the Gini Index were revised in 1993 and indexes after that date are not strictly comparable with previous years. The period of 1993-2000 shows slower growth and 2001-2004 shows virtually no change.
So why did the Gini Index contract and then grow? Frankly, I don’t think anyone knows with certainty. It appears that changes in taxation were not a primary factor.
- After the 1964 Kennedy tax cut, inequality continued to decline for the next four years before leveling off in following years.
- Ronald Regan cut taxes in 1981 and the inequality kept increasing through the 1980s at or above the same rate it started in 1975.
- Bill Clinton raised taxes and inequality kept growing, although at a slower rate.
- George W. Bush cut taxes and inequality stayed constant.
There is no doubt that taxation has an impact on distributive inequality but is also clear that a host of other factors are involved as well.
Is unequal distribution a problem and, if so, why? Here is a bell curve graph that shows the median household income for each fifth of the US population in 1968 and 2004 (the lowest and highest points of income inequality in the last fifty years respectively.) The “2004” line shows the distribution of median incomes for each fifth of American society in 2004. The “1968 Adjusted” line shows how 2004 income would have been distributed if the 1968 distribution had held constant.
The chart shows that the poorest fifth would have received $5,000 more and the wealthiest fifth would have received $32,500 less if the 1968 distribution of income had remained constant. Or does it? We know that the wealthiest among us are more likely to save and invest each succeeding dollar than the rest of us are. If the money that went to the wealthiest fifth had not gone to them, would it have been saved and invested in the same way? Might the poorest fifth have become even poorer? Should we try to reduce economic inequality?
Some economists say no. The growing inequality sends signals through the market place. For instance, if a gap comes between high school and college graduates, it motivates more people to pursue greater education, thus improving the workforce. It reduces the amount of unskilled laborers causing the wages for unskilled laborers to go higher. Also, why does it matter that some are becoming very wealthy if everyone is getting better off with rising inequality?
On the other hand, Charles Wheelan in his book Naked Economics tells of a study done by economist Robert Frank. Frank offered people an option of living in one of two worlds: (A) You earn $110,000 a year and everyone else earns $200,000 a year, or (B) you earn $100,000 a year and everyone else earns $85,000 a year. Which would you pick? A majority of Americans picked option B. Relative status is more important than absolute status to much of the population. Great inequality will lead to higher levels of dissatisfaction in the culture.
Furthermore, inequality could reach such high levels that significant numbers of people are discouraged from work and achievement. They would no longer feel they have ownership in the institutions of society and cease to respect them. Maintaining order would begin to become costly, crippling a productive economy.
It appears that too little inequality could hamstring economic growth by diverting wealth from those most likely to save and invest in productive economic efforts. Too much inequality could lead to a breakdown in respect for social order, which would also hamstring the economy. There are dangers either direction. However, at present, I do not believe that we are near either extreme and our economy continues to grow at healthy rates. Most European democracies with more equality have sluggish economies, higher unemployment and find themselves confronting hard decisions about reductions in government welfare programs. For these reasons I do not necessarily view our present levels of income inequality as a pure negative.
- Unemployment and inflation rates have been hovering below are just barely above thirty year lows.
- Median household income has grown by 30% since 1967.
- Since the mid 1990s the poverty rate has fluctuated in the 11.5-13.5% range. Just slightly above the historic lows of the early 1970s.
- The percentage of Seniors living in poverty has dropped below 10% but poverty for children is at nearly 18%.
- Since 1967, the Gini Index of income inequality has risen by 20% while median household income has risen over 30%.
The overall economic picture is one of improvement, though it may be less than we might wish. The economic indicators suggest an overall improvement in quality of life.