Incomes and Inequality: What the Numbers Don’t Tell Us
By TYLER COWEN
Published: January 25, 2007
The growing inequality in wealth and income has led many people to question whether the contemporary American economy is rigged in favor of the rich. While there is little doubt that the gap between the wealthy and everybody else has widened in recent years, the situation is not as unfair as some of the numbers seem to imply.
Much of the measured growth in income inequality has resulted from natural demographic trends. In general, there is more income inequality among older populations than among younger populations, if only because older people have had more time to experience rising or falling fortunes.
Furthermore, more-educated groups show greater income inequality than less-educated groups. Uneducated people are more likely to be clustered in a tight range of relatively low incomes. But the educated will include a greater range of highly motivated breadwinners and relaxed bohemians, and a greater range of winning and losing investors. A result is a greater variety of incomes. Since the United States is growing older and also more educated, income inequality will naturally rise.
Thomas Lemieux, professor of economics at the University of British Columbia, estimates that these demographic effects account for about three-quarters of the observed rise in income inequality for men and 69 to 95 percent of the observed rise in income inequality for women (“Increasing Residual Wage Inequality: Composition Effects, Noisy Data, or Rising Demand for Skill?” The American Economic Review, June 2006). In other words, rising income inequality is not just a result of unfairness or bad public policy.
Alan Reynolds, senior fellow at the Cato Institute, goes further in his recent book “Income and Wealth.” Mr. Reynolds argues that many measures of income inequality do not adequately account for government aid to lower-income groups. Furthermore, he says, the rich appear to be getting so much richer because of the tax-induced shifting of income from the corporate sector to the personal sector in the wake of the 1980s tax changes.
He describes the observed rise in income inequality as a statistical illusion. The consensus of professional economists is that Mr. Reynolds goes too far. The long-term trend of rising income inequality is evident in many different studies, including those of executive compensation, even if some estimates are exaggerated.
In any case, as Mr. Reynolds and others point out, income is not the only — or even the most — important measure of inequality. For instance, inequality of consumption — the difference between what the poor consume and what the rich consume — does not show a significant upward trend (Dirk Krueger and Fabrizio Perri, “Does Income Inequality Lead to Consumption Inequality?” The Review of Economic Studies, January 2006)...
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