The Mismeasure of Inequality

August 6, 2012

In October 2011, the Congressional Budget Office (CBO) published a report, "Trends in the Distribution of Household Income between 1979 and 2007," showing that, during the period studied, aggregate income (as defined by the CBO) in the highest income quintiles grew more rapidly than income in the lower quintiles, say Kip Hagopian and Lee Ohanian of the Hoover Institution.

While this report has since galvanized the Left's campaign against the supposedly enormous level of income inequality, it is largely misleading and fails to present a comprehensive picture. In making the claim that income inequality has increased, many emphasize gradual increases in a common metric, the Gini coefficient. However, this measure is incomplete.

  • The U.S. Gini coefficient cited here comes from an annual report of the U.S. Census Bureau, which uses what it calls "money income" in its measurement of income inequality.
  • Money income in this context consists of cash income only, does not subtract taxes, and excludes the value of noncash transfer payments (such as nutritional assistance, Medicare, Medicaid and public housing), as well as many other components of income.
  • In addition to transfer payments, which are a substantial portion of income at the low end of the income scale, some of the other missing components of income are: employer-provided fringe benefits, capital gains and increases in the value of home equity.

A more holistic metric produced by the Census Bureau incorporates much of this data, allowing for a more precise understanding of income inequality. What Hagopian and Ohanian found is that the level of inequality drops dramatically when these factors are taken into account, and that inequality has actually decreased over time.

Moreover, the entire idea of income inequality is misleading. There is a clear consensus among economists that the best measure of living standards over the long term is not income, but consumption.

  • There is a body of research indicating that consumption inequality is not only substantially lower than income inequality, but has been declining in recent years.
  • The Gini coefficient for consumption inequality was roughly 40 percent lower than the coefficient for income inequality.
  • Further, this metric also decreased over the course of the last couple of decades.

Source: Kip Hagopian and Lee Ohanian, "The Mismeasure of Inequality," Hoover Institution, August 1, 2012.

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