7 Problems With The Way We Think About Income Inequality
Cost of living is one of many neglected challenges facing lower-income Americans.
Many people believe that the biggest policy problem in America is income inequality. But the American discussion of income inequality is wholly inadequate to the real challenges facing those most in need of economic opportunity.
There are seven basic problems with using income inequality as our lens for thinking about expanding economic opportunity:
1. Gross income is not the same thing as disposable income
Most people who talk about income inequality do so by looking at the size of someone’s paycheck. But a $30,000 paycheck can be a living wage in, say, Kansas in a way it can’t be in San Francisco. Disparities in the cost of living are a material source of economic inequality. NIMBY zoning laws that restrict growth in housing supply, for example, make housing unaffordable for those with below-median incomes. Rising consumer debt levels — a big problem for those with student loans — is another factor that reduces disposable income. The high cost of living in California is why it’s the state with the highest poverty rate in the country, as measured by the Census Bureau’s Supplemental Poverty Measure.
2. Inflation disproportionately harms the poor
Inflation is conventionally described by economists and journalists as a phenomenon that affects everyone equally. But high earners are better able to endure higher consumer prices, because they have higher disposable income. Not so for low- and middle-earners, who have no cushion with which to absorb higher prices. As a result, agressively low interest rates—a policy especially favored by progressives—significantly increases inequality. Even modest inflation over time worsens inequality.
3. Taxes and transfers exist
The U.S. has the most progressive tax code in the developed world. In 2019, the bottom 40% of earners paid 3% of federal taxes, whereas the top 40% of earners paid 87%. According to the Organisation for Economic Co-operation and Development, only Denmark depends more on personal income taxes than the U.S. to fill its coffers. In most other advanced countries, the tax burden is shared more broadly through value-added taxes (VAT) and other consumption and payroll taxes.
As the below chart using U.S. Congressional Budget Office data describes, the vast majority of taxes are paid by those with above-median incomes; the beneficiaries of those transfers — particularly, the financial value of Medicaid and other health care subsidies — are those with below-median incomes. A discussion of income inequality that excludes a consideration of what we already do to redistribute income is, obviously, inadequate.
As Phil Gramm, Robert Ekelund, and John Early have documented, U.S. income data produced by the Census Bureau — which economists and policymakers rely on for their analyses — fails to account for the impact of nearly 80% of the redistribution that the U.S. undertakes via means-tested transfers and tax credits.
Indeed, on a per-capita basis, Americans in the second-lowest quintile actually earn less after taxes and transfers than do those in the bottom quintile, despite the fact that 85% of people in the second quintile are employed, compared to only 36% of those in the bottom quintile.
4. Income is not the same thing as wealth
A focus on income leads us away from appreciating that income is not the same thing as wealth. A retired banker with a paid-off 5 million dollar house may have no wage income. But he has a considerable financial cushion. A young medical school graduate may have the opportunity to make six figures someday, but in the meantime he may have also accumulated $300,000 in student debt and live in a high-cost city. Compared to a one-year snapshot of someone’s income, net worth and lifetime earnings give us a better picture of the distribution of economic opportunity.
5. Single parenthood is highly correlated to poverty
There is a wealth of empirical research indicating a strong correlation between poverty and growing up with a single parent — especially a single mother. As the below chart from the OECD illustrates, this correlation is true across the industrialized world. In every OECD country, households with a single parent have a significantly higher poverty rate than those with two parents or more. For reasons both cultural and practical, we have not been comfortable confronting this problem.
6. Absolute income is more important than relative income
Our disproportionate focus on relative income — measured by things like the Gini coefficient — tells us little about the actual economic status of those below the median. Do lower-income Americans have basic access to food, shelter, health care, education, and work? Relative inequality is far less problematic if those near the bottom have the resources and opportunities they need to get ahead. Another way to think of this is global: the income of someone we’d consider poor in America would represent the income of someone in the middle class in many parts of the world. The countries with the lowest income inequality, as measured by Gini coefficient, are Slovakia, Slovenia, Belarus, and Armenia. Those countries, however, rank 47th, 33rd, 71st, and 90th, respectively, in GDP per capita.
7. Future opportunity is more important than past income
We can’t do anything to change the income someone has earned in the past. But public policy can help expand the opportunities people have in the future. For example, tax and regulatory reform can drive economic growth, and expand the demand for labor. Increased competition for workers, in turn, can lead to higher wages. We can also make it easier for individuals to become qualified for better-paying jobs through education and job training. And, as we saw during the COVID-19 pandemic, if we remove incentives for individuals not to seek work, we lift constraints on their ability to rise out of poverty.
So, that’s a long list of factors that a simplistic discussion about income inequality fails to capture. But it represents the kind of research we are doing at FREOPP. It’s our hope that, by broadening the discussion on inequality, we can unite progressives and free-marketeers around a shared equal opportunity agenda.
