Red Jahncke (Photo courtesy of the author)

Opinion: The Surprising Income Equality in America

in Columns

This is a column about a column.

On November 4, 2019, the Wall Street Journal published a column entitled “The Truth About Income Inequality,” by Phil Gramm, former U.S. Senator from Texas, and John Early, twice Assistant Commissioner of the U.S. Bureau of Labor Statistics.

The column makes a convincing case that the U.S. enjoys remarkable income equality –  not inequality.

This reality flies in the face of the almost universal belief that the U.S. suffers from gross income inequality, which notion serves as the foundation of all the extravagant proposals from one side of the political spectrum, ranging from free college and Medicare for All to the wealth tax that Elizabeth Warren and Bernie Sanders advocate.

If the income distribution is only modestly upward sloping from bottom to top, namely those at the bottom have substantially more resources, and those at the top substantially fewer, than previously thought, two natural questions arise. First, can those at the top afford these extreme proposals, and, second, do those at the bottom need them?

Public notions of income inequality range as high as a factor of 60 (income at the top being 60 times that at the bottom). That’s wildly unequal and would be genuinely alarming.

The column authors find a drastically lower differential – a roughly four-times multiple between top and bottom quintiles, a level of relative income equality befitting a free enterprise system, in which achievement is rewarded.

Courtesy of Cato Institute

How do analysts arrive at such different results?

We don’t need Sherlock Holmes to solve this mystery. Most conventional measures of income exclude taxes, so income at the top is significantly inflated. The upper fifth pays taxes equal to about one-third of its income. Indeed, it pays more than 80% of all federal income taxes.

At the bottom, most measures ignore a large portion of the safety net which supplements meager income in the lowest quintile. Various official income measures exclude all in-kind transfers, such as the major health care benefit programs Medicare (depressing the measured income of the elderly poor) and Medicaid (reducing the income tally of the poor of all ages) and the $70 billion food stamp program (aka supplemental nutritional assistance program, or SNAP).

Gramm and Early start their analysis with earned income, i.e. wages and salaries (including self-employment), employer-paid benefits, and earnings from savings and investing. The latest year for which comprehensive data is available is 2017, when average household earned income was $296,000 in the top quintile and $4,900 in the bottom quintile. Thus, the 60:1 income differential cited above.

Adjusting the top quintile for $110,000 in taxes paid (federal, state and local taxes of various kinds) leaves after tax income of about $186,000.

The bottom quintile paid virtually no income taxes. Actually, these households received cash from the IRS in the form of the “refundable” Earned Income Tax Credit (EITC). The column’s co-author John Early provided me data showing that the IRS paid an average of $1,900 to each of the 25 million households at the bottom. This offsets most of the bottom quintile’s payment of roughly $2,700 in other taxes, including $1,100 in property taxes and $1,000 in sales and excise taxes.

Clearly, it is impossible to live on after-tax income of less than $5,000. That’s why we have government social welfare programs, aka government transfers plans.

Gramm and Early find about $45,000 in government transfers to the average household in the bottom quintile ($43,100 excluding the EITC which the authors treat as a transfer rather than a tax adjustment). In aggregate, that’s about $1.1 trillion going each year to the 25 million households in the bottom fifth.

So, those at the bottom have about $47,200 in available annual resources to meet their needs – and then some.  

Thus, the column authors conclude that the real income differential ratio is about 4 to 1.

Nevertheless, as Gramm and Early say in their column “The published census data for 2017 portray the top quintile of households as having almost 17 times as much income as the bottom quintile.”

Really? Why is that?

The overall reason is that we are still using official data sets and analytics created a half century ago in the 1960s, when government programs and political issues were vastly different. At that time, the focus was on the War on Poverty then being launched.

Then and now, taxes don’t matter much in analyzing income near and below the poverty line. As outlined above, the poor and near-poor don’t pay significant taxes.

In analyzing income disparity, today’s hot issue, taxes are critically important.

Now, why are in-kind transfers not counted? Because, as John Early explained to me, “Before the War on Poverty, most government transfers were paid in cash. So it wasn’t deemed worthwhile to tally and include minor in-kind transfers.”

Non-inclusion has persisted to the present, despite that in-kind transfers now total over a trillion dollars annually. Ironically, the first shot fired in the War on Poverty was not counted. In 1964, in-kind food stamps were introduced to eliminate hunger, the worst symptom of poverty – and weren’t counted, and still aren’t.

This is not simply a saga about statistics gone awry. As the Gramm-Early column warns, the faulty information fueling the hue and cry about supposed income inequality could wind up altering the very foundations of our economic and political system.