US Inequality Is Not At All Like You Think It Is


By: Tim Worstall
May 6, 2014

Nor, more importantly, is US inequality like what we're all being told it is. No, not even by the latest rock star economist, Thomas Piketty and his acolytes.

The problem comes from something that has been dubbed the Worstall Fallacy. No, I assure you, I didn't call it that but it came from people noting that I continually make this point. You cannot go around trying to decide on how much we must do to solve some problem unless we take account of what we already do to try and solve that problem. To give a concrete example in US economic statistics, we cannot look at the number below the poverty line and then immediately assume that we must increase the EITC, SNAP and Section 8 programs. For we don't include the effects of those programs when we calculate the number below the poverty line. In order to decide whether we must do more, or anything at all, we need to look at the number still in poverty after the EITC, SNAP and Section 8 programs: only when we see how much poverty there is left after what we already do can we even consider what we must do next.

So it is with inequality. All of the numbers that are being thrown around are the inequality of market incomes. Yes, even the US Census calculation of the Gini index is about market incomes, before the influence of the taxation system and most of the welfare and benefits system. It's worth noting here that almost every other country reports theirs after the influence of those two systems. The US is more unequal than most countries but not by as much as the officially reported figures would lead you to believe.

The real importance here is that of course the most obvious way of reducing inequality is to tax those rich people more and give the money to the poor. But if we're measuring everything by market, before tax and redistribution policies, incomes then we're committing Worstall's Fallacy. We're trying to decide what we should do without taking account of what we're already doing.

Which leads us to this lovely report from the Minneapolis Fed. Have a look at these two charts:

But note some fascinating things. Market income is what people earn (or get paid if you think the two sums are likely to be different). Disposable income is what people have left after the influence of the tax and benefits/welfare system. Between the top and the middle market income inequality has roared away, yes it has. But disposable income inequality has been pretty much flat since 1996. This isn't evidence of some great plague of inequality infecting our society. Rather, it's pretty good evidence that the tax and benefits system is ameliorating rather successfully the increase in market income inequality.

The second chart is showing the same for the bottom to the middle. And there again market income inequality has been rising while disposable income inequality has been nearly flat since 1983. Clearly, our welfare system is doing something right in dampening down the inequalities being caused in that market.

And that's really not something you hear people saying currently is it? That while it is true that the US is more unequal than many other countries, that while market income inequality has been rising, the past couple of decades really haven't seen much change in disposable income inequality because the tax and benefit system removes a lot of that inequality. Already removes a lot of that inequality.

As a note I checked with the authors of the study and their figures for low income earners actually overstate that disposable income inequality. They have included the effects of the EITC but not the effects of SNAP (aka food stamps), Section 8 vouchers, Medicaid and any other form of aid to the poor that comes as benefits in kind rather than in cash. Thus these charts overstate disposable income, or consumption income inequality and they're really the only forms of inequality that we could possibly worry about.

The story of inequality in America really isn't the one we're all being told in the usual media.

About this Entry

This page contains a single entry by CFED published on May 9, 2014 4:36 PM.

How We Should Talk About Inequality was the previous entry in this blog.

Barriers to opportunity is the next entry in this blog.

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