Are the rich getting richer and the poor getting poorer? Stories about inequality typically talk about how the rich, especially the top 1%, are seeing their incomes grow rapidly while people at the bottom are seeing their incomes stagnate and drop. A gap is widening between the top and the bottom. Is that true?
The Federal Reserve Bank of Minneapolis has just published an interesting report that studies the relative income performance of households from 1967-2012. It compares households at the 95th, 50th, and 20th percentiles of the income distribution. The reports distinction between two types of income is revealing: Market income and disposable income.
Market income (pre-tax and pre-transfer income) is what we typically see reported. But when we adjust for taxes (which substantially decreases the income of the wealthy) and add in transfer income like social security, unemployment, and welfare payments (which substantially increases the income of people in poverty) we get disposable income. Disposable income paints a much different picture than market income. Let's look at two important graphs:
The top line in the chart is the ratio of market income (pre-taxes and transfers) of households at the 95th percentile as ratio to households at the 50th percentile. For example, it appears the households at the 95th percentile made 2.7 times as much as those the households at 50th percentile in 1967. By 2012, they were making about 3.6 times as much. The bottom line tells a different story.
Disposable income (after taxes and transfers) follows a similar pattern until about 2000 when the ratio leveled out at just below 3.0, and has remained between 2.9-3.0 ever since. That means that despite market income having risen faster for the 95th percentile compared to the 50th percentile, inequality in terms of what people have to spend at the end of the day hasn't really changed for almost fifteen years.
Then there is this chart:
This chart shows the ratio of the 50th percentile to the 20th percentile. Note the ratio of market income continues to widen with each business cycle. The recessions, shaded gray, result in spikes of unemployment. That expands the ratio and then the ratio contracts a little as employment improves. The sharp jump at the end correlates with very high unemployment and underemployment.
But the striking thing is the disposable income line. It is flat from 1983 onward (until a slight increase since the 2008 financial meltdown.) There has been virtually no change in inequality between the 50th percentile and the 20th percentile for thirty years!
1. The debate raging around inequality typically points to the widening gap in market income between the top and bottom. More transfer of wealth is proposed to balance out the income people receive. Market income and disposable income are conflated. If a household with a market income of $15,000 gets transfers of an additional $15,000, for a total of $30,000 in disposable income, they still have a market income of $15,000! Pointing to market income statistics as an indicator that distribution of income is insufficient is erroneous. By this reasoning, a $15,000 household could get $1,000,000 in transfers but they would still be "living in poverty" because transferred income is not being considered in the income calculation.
2. This analysis focuses only on households at the top 5%, not the top 1%, where so much of the debate has been. For reasons reported in the article, the data did not lend itself to a study of the very top 1% or 0.1%. The ratio of disposable income of the very top to lower percentiles may be increasing. But it is certain that the ratio of disposable income is much lower than market income.
3. This study seems to suggest that public policy has been doing a very good job of preserving disposable income ratios for many years. We may want to debate if these ratios are just but they are not widening.
4. The fact the market income ratio continues to widen, meaning it takes evermore transfers to keep disposable income constant, suggests that low wages and unemployment, not insufficient transfers, are becoming the problem. Left leaning figures like Robert Reich argue that decline of union bargaining and failure to raise the minimum wage are the culprits. Companies aren't paying employees relative to their economic contribution. That leaves taxpayers to subsidize the work that these companies get from low wage workers. Other economists suggest the labor market is more efficient then that and that most employees are being compensated relative to their economic contribution. While very modest minimum wage increases are likely without much impact on the total labor market, substantial jumps in the minimum wage are likely to lead to automation and off-shoring, thus more unemployment and even more need for transfers than the alleged subsidization of low-wage workers today. Who knows exactly where the truth lies.
We do know that technology and the economy is rapidly changing. That means we need a workforce with the human and social capital to take advantage of such changes. Strong families and educational systems are central to developing that capital and we know these institutions have been weakening for some time. That doesn't help the market income challenge.
Bottom line, disposable income inequality is not getting worse for the bottom 95%, and it seems likely that whatever inequality is growing between the top 1% and the rest is substantially less than the market income widely reported. Maybe present distributions of disposable income are unjust. That is worthy of debate. But that is different from saying inequality is growing. Market income inequality continues to rise and what is unclear is if there is a policy fix for this or if this is market income inequality is inherent in a post-industrial and digital economy.