NCPA - National Center for Policy Analysis

The Income-Inequality Myth

January 16, 2012

Much reporting on income inequality in America has suggested that the incomes of the rich have been rising, while incomes for the rest of us have been stagnant or even declining.  But that may represent a significant misreading of the data.  Most studies of inequality, including the recent widely reported study by the Congressional Budget Office, rely on IRS-reported taxable income.  This metric is inaccurate for numerous reasons, including that it fails to account for many forms of income that went unreported in earlier decades, says Michael Tanner, a senior fellow at the Cato Institute.

  • As more businesses have switched from filing under the corporate tax to individual taxes, high-income earners have increased their taxable income.
  • Furthermore, the tendency for executives to switch from accepting stock options taxed as capital gains to nonqualified stock options taxed as salaries has the same effect.
  • Finally, the 1986 decrease in income tax rates saw greater income reporting that the aforementioned studies interpret incorrectly as an increase in wealth.

Additionally, studies that use taxable income as their measure of wealth do not take into account non-salary benefits and payments that the lower and middle classes have increasingly received in recent decades.

  • A recent study by Mark Warshawsky of the Social Security Advisory Board suggests that nearly all of the recent increase in earnings inequality is attributable to rising costs of benefits -- the new implementation of these benefits is most noticeable among the non-wealthy.
  • Similarly, many studies looking at low-income Americans fail to account for non-cash social-welfare benefits such as food stamps, housing subsidies and Medicaid.

When all of these inaccuracies are accounted for, it is likely that income inequality has not increased at all in recent decades.  Furthermore, any increases that researchers do notice have a perfectly plausible explanation that has little to do with wealth-friendly public policy: a gradual transformation of the American economy from manufacturing to service-based industry.  This drastic output change rewards workers with higher levels of education, causing them to earn more.  Therefore, income inequality should not be attributed solely to government policies like the Bush-era tax cuts.

Finally, the presence of income inequality does not mean that someone must inherently earn less so that the wealthy can earn more.  This defies the fact that prosperity is not a fixed value, and that all people have the potential to succeed.

Source: Michael Tanner, "The Income-Inequality Myth," National Review, January 10, 2012.

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