Disagreements on Income Inequality (pt. 1)

Colleagues: There was quite a volume of commentary regarding the first installment of my three part series on income inequality, anemic job creation, and tax policy. With respect to income inequality, about 90% were in agreement and most felt that it was a serious national security issue. The following from a former, very senior Intelligence Official reflected that tenor:

Ty, a thoughtful piece with which I agree. A future problem for those that are rich but turn a blind eye toward the problem is that they assume that their safety and prosperity in an orderly and lawful U.S. will continue unchanged. I believe, however, that they will eventually face a problem like Mexico and other developing countries where they will have to hire private militias for protection and bodyguards to assure that their kids are not kidnapped. A government of law is possible only when everyone believes that he has an obligation and benefits from it. I anticipate that too much inequality and too long a stagnation on jobs and wages will lead to the kind of corruption and lawlessness that we see in most of the developing world.”

Two responses that portrayed a very different interpretation on income differentiation are worth reproducing here. The first is from Reno lawyer Proctor Hug. Proc is from the distinguished Hug family and wants to be sure we know that he is not Judge Proctor Hug, but the Judge’s and who has a somewhat different political perspective. Proc’s submission here is very persuasive and provides a number of links to authoritative studies bolstering his point of view.

The second are a few bullet points in disagreement with my thesis from a good friend (unidentified here) who is currently a senior executive in the aerospace industry. He was formerly an official in the Pentagon and the Department of Veterans’ Affairs. He holds a PhD from MIT, is a graduate of Canoe U (Naval Academy), and was one of the first Afro-American Top Gun pilots.

Enjoy!

Income Inequality: How Much and Does It Matter

By Proctor Hug

My friend Ty Cobb is writing a series on three trends that threaten the fabric of our society. We agree on two out of three, but disagree on the threat posed by the “rapidly growing income inequality in the United States.”

The oft cited statistics regarding “rapidly growing income inequality” distort the real level of inequality and serve little purpose other than to agitate for expanding the welfare state, increasing taxes on the rich, and stoking the flames of class warfare. Income inequality is naturally a favorite of the left. Their utopian view envisions an egalitarian state with an emphasis on equality of outcomes. The left’s remedy for income inequality is redistribution: increasing taxes on the “rich” and expanding taxpayer funded welfare-state benefits to the “poor.”

According to the latest IRS data (2008), the top 1% of taxpayers now pay over 38% of the total federal income tax burden, while the bottom 50% pay less than 3% of total. In 1980 the top 1% paid only 19% of the total federal income tax bill and the bottom 50% paid over 7%. There are now over 70 means-tested welfareprograms that provide cash, food, housing, medical care, and social services to poor and low-income persons. You might ask how, after decades of increasing welfare benefits and the share of taxes paid by the rich, we still have “rapidly growing income inequality?” Ah, behold the wonder of statistics.

Let’s review a few of the problems. First, they use Census data that starts with adjusted gross income. This systematically excludes from income the transfer payments given to middle and lower income households (like TANF, SSI, EITC, WIC, food stamps, and Medicaid, to name a few). Second, they are based on pre-tax income, ignoring the proportionately higher taxes paid by the rich. It is really quite an ingenious propaganda tool. They redistribute massive amounts of wealthwithout any impact on the inequality statistics. Under this methodology you could tax away 100% of the income of the rich, give it to the poor, and the income inequality would be the same.

Next they use “household income” data, not individual income, which fails to account for substantial changes in the composition of households. High income households tend to have married couples with two incomes. Low income households tend to be single-parent households with one income. As more marriages end in divorce, we end up with more households with lower household incomes, even if both parents are still earning the same amount.

The statistics also do not recognize the shift of business income from corporate tax returns to individual tax returns as a result of tax changes encouraging S corporations and LLCs. This has the effect of inflating the income of high earners reporting business income on their individual returns. You get the idea; the statistics are nearly meaningless except as a propaganda tool for the left’s redistribution agenda.

When consumption is measured as opposed to income you see a much narrower gap among the income groups. The inequality statistics imply that the top income earners are a never changing aristocracy when in fact the data shows an amazing amount of income mobility. A Treasury Department Study titled “Income Mobility in the United States from 1996 to 2005” showed taxpayers whose incomes were in the bottom 20% in 1996 had a 91% increase in incomes by 2005. On the other hand, taxpayers in the top one-hundredth of one percent had their incomes drop by 26% over those very same years. The study also showed rising incomes for most taxpayers with median incomes increasing by 24% after adjusting for inflation. The real incomes of two-thirds of all taxpayers increased over this period and the median incomes of those initially in the lower income groups increased more than the median incomes of those initially in the higher income groups. But you won’t hear those statistics from the class warriors.

Finally, even if income inequality were rapidly increasing why should we care when living standards are increasing? The fact that Microsoft co-founders Bill Gates and Paul Allen became multi-billionaires did not negatively impact low income individuals. It is now possible for 38% of the “poor” to own a personal computer. “Poor” Americans today are better housed and fed than the average US citizen throughout most of the 20th century. The Heritage Foundation’s recent study found that in 2005 the typical household defined as poor by the government had a car, air conditioning, two color televisions, cable or satellite TV, a DVD player, a refrigerator, an oven and stove, a microwave, a clothes washer and dryer, a cordless phone, a coffee maker, and lots more. Their home had more living space than the average European and was in good repair.

Don’t be caught by the politics of envy and the statistical tricks on income inequality. The remarkable American standards of living were made possible by individual liberty, equality of opportunity, and free market principals, not class warfare and redistribution of the income earned by others.[i]

[1] Sources and recommended reading:  Alan Reynolds book Income and Wealth and 2007 CATO paper; Heritage Backgrounder #2575, What is Poverty in the United States Today?BLSConsumer Expenditure Survey, 2009; Tax Foundation Summary of Latest Federal Individual Income Tax Data (see Table 6); Heritage reports, Why Does Income Inequality Matter? andIncome Inequality: How Census Data Misrepresent Income Distribution; Department of Treasury Report: Income Mobility in the U.S. from 1996 to 2005; Thomas Sowell’s books: Economic Facts and Fallacies and Intellectuals and Society.

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And this by my friend in the Aerospace industry.

Ty – some observations:

1. To decipher what’s happened you have to look at the period from 1945-70/75 as a complete anomaly. The other concentrations of industrialization and wealth were shattered: western Europe, NE Asia, and the British Empire. The US was 50% of global GDP at the beginning of that period. This was clearly unsustainable.

2. As the article points out, US laborers face competition from lower priced alternatives worldwide. Those who benefit from financial gain are able to take advantage of opportunities around the world. I think that explains a lot of the difference in the returns to the two groups in the last two decades.

3. The primary underlying failure here is educational. The K-12 system in the US is not equipping potential US workers with the skills to be high-productivity workers in a leading edge economy. But, our colleges and grad schools are the envy of the world. The difference is competition: K-12 is a monopoly whereas higher education is a free market. Look at the results and draw your own implications.

4. I do not think simply an income disparity is the total picture. What’s happened to poverty rates in this period? Is it the case that the globally-opportunistic are getting rich at the expense of the common man (seems the implication) or are they taking advantage of global opportunities unavailable to the ‘common man’? If they are, but the ‘common man’ is still holding his own relative to poverty rates, then what is the issue aside from envy? Said simply – if the gain of the rich isn’t at the expense of the bottom 90%….is there really a problem in societal terms?

5. The real enemy – as the Brazilian example makes plain – is poverty. If poverty rates aren’t moving together with income disparity, then I’m not sure there is a societal problem.

6. The fact is that the US tax code, at least federal income taxes, is already skewed to redistribution. Fully 51% of wage earners pay NO federal income tax, and in 2007, 40% of income taxes were paid by the top 1% (up from 24% in 1987). Also, the tax payments of the top 1% exceed those of the bottom 95%. If any move is made to be more redistributionist because of income disparity, then there should be some move to broaden the tax base. Not that the poor should pay at the same rate, but they should pay SOMETHING.

As you can tell, I think income disparity – especially viewed outside historical context or without respect to the sources of the rich’s income – is a bit of a red herring. We already have a redistributionist mechanism in the tax code. If you want to address the real problem – making US workers more able to command the wages that go to highly productive workers (e.g Germany) thenFIX K-12 EDUCATION and focus it on the demands of the labor marketplace. I remember going all the way to Minnesota from Texas to recruit machinists for $20/hr unionized jobs – good jobs – because many US schools had de-emphasized shop classes.

This is the wrong problem inaccurately phrased.

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