The Economist: A closer look at income inequality
Feb. 4, 2012 at midnight
Updated Feb. 3, 2012 at 8:04 p.m.
By Ray Perryman
Income inequality has become a flashpoint, with protestors occupying various locales, campaigners jumping on the bandwagon and pundits spouting statistics.
It's an emotionally charged issue, with the recession and sluggish recovery causing many families intense financial pain.
Taking a step back from the rhetoric and looking at hard facts and real numbers reveals that it's not a simple case of the rich getting richer, while the poor get poorer.
Here are a few patterns that may surprise you.
A long-term perspective shows that, actually, everyone is getting richer.
Business cycles naturally affect incomes, but looking at long-term trends shows that average incomes are rising across the spectrum.
The Congressional Budget Office recently completed a study of average household income over the period from 1979 to 2007; the budget office divided households into quintiles and looked at inflation-adjusted, after-tax incomes.
One of the key findings from the analysis was that incomes rose for all groups over the period: up by 18 percent for those in the lowest 20 percent of households, up 60 percent for those in the 21st through 80th percentiles, and up 65 percent for those in the 81st through 99th percentiles.
Americans across the spectrum are, thus, better off (and typically much better off) in terms of income than they were in 1979 even after accounting for price increases and taxes.
Even with all of this good news, however, the budget office study has been cited by some as evidence of problematic rising income inequality.
In fact, the study does indicate rising inequality thanks to the substantial growth in incomes by the top 1 percent of the population, which were up by 275 percent over the period. (Note that this was just before the recession, when many of the highest earners were hardest hit in terms of percentage drops in income).
Naturally, the rapid growth at the very highest levels tends to skew the picture in that it does mean that the lower income levels have a smaller share of the pie (though they're still better off than they were before, since the pie is so much bigger).
A number of possible explanations for this trend have been explored. One is that changing technology allows "superstars" to generate higher incomes.
For example, a musician or an athlete has a much broader potential audience thanks to all of the media outlets and, therefore, can generate much larger earnings.
Another possibility is that increasingly complex and large corporations lead to larger numbers of very highly compensated chief executive officers.
Financial professionals, lawyers and doctors have been identified as often in this group, which is not hard to believe.
There also have been some tax law changes which could cause income that might formerly have been classified as business or corporate earnings (such as for certain types of small businesses) to show up as individual income.
The favorable treatment of investment income is also advantageous to those who earn their money in this way.
In short, the evolving economy and society have made it possible for the top earners to earn far more than they did before. The interesting point is that this is seen as a bad thing.
As an economist, I see the large potential returns to certain activities (such as owning a successful business or becoming a superstar in some field) as a very good thing - an incentive to do those things that help the economy grow and enhance our wellbeing.
As a consumer, I'm glad that there are huge incentives for the late Steve Jobs and Apple to create iPhones, Bill Gates and the Microsoft crew to bring us Windows, top doctors in the field to keep pushing ahead with new and better ways to save our lives, and the countless entrepreneurs building businesses to do what they do best (and later sell their companies for a fortune if they choose).
I'm all for that 1 percent being able to make the big money; it's good for all of us.
Looking at the other end of the spectrum - the poorest poor - also shows a story not always seen in the headlines.
The U.S. Census Bureau looked at the dynamics of poverty during the 2004-2006 period in a study released in March.
They looked at information collected by a survey, which shows how people transitioned into and out of poverty over a 36-month period.
During that time, 29 percent of people experienced at least one poverty spell lasting at least two months (episodic poverty).
Most poverty spells were short, with almost half ending within four months. Of those in poverty in 2004, almost 42 percent were not in poverty in 2006. Less than 3 percent of people surveyed were in poverty throughout the entire time period.
The bottom line is that people move into and out of poverty due to changing circumstances which are often short-term in nature. Chronic poverty is much less common.
People also move into and out of higher income groups. Tax return data from the IRS shows that in 2007, 392,222 returns were filed with adjusted gross income, adjusted by the IRS for deficits, of $1 million or more, accounting for $1.4 trillion, 16.1 percent, of total adjusted gross income.
In 2008, the number of million-dollar returns stood at 321,295 for total adjusted gross income of less than $1.1 trillion, 13.0 percent of the total.
By 2009, as the recession took its toll, only 236,883 people filed returns with $1 million or more in income for a total of $726.9 billion, 9.5 percent of the total.
Poverty is certainly a difficult problem, and helping those in financial crisis is a worthy societal goal. However, all too often, heated rhetoric obscures the reality of what's going on.
Yes, the recession took a toll on the poor and the middle class, but it also harmed those with high incomes.
Yes, the rich are getting richer, but so are the poor. And those who are poor now are unlikely to stay poor - just as those who are rich now may not stay that way.
The best way to solve the problem lies in greater opportunities for all, rather than inflammatory, divisive battles of often inaccurate words and statistics.
M. Ray Perryman is president and chief executive officer of The Perryman Group, perrymangroup.com. He also serves as Institute Distinguished Professor of Economic Theory and Method at the International Institute for Advanced Studies.