Income Inequality: The Complete Picture and Its Implications


Recently, we reviewed the records of the last eight presidents on income growth and inequality. Reagan, Clinton and Nixon/Ford had the best overall records and Obama the worst. Income inequality increased most under Obama and least for George W. Bush.

But what does income inequality really mean?

Its standard measure is the Gini coefficient, named for Corrado Gini, the Italian statistician who invented it 100 years ago. The Gini coefficient is a value between 0 and 1, showing how balanced the income distribution is across the population. Zero means everyone has the same income and 1 means one person gets everything. The higher the coefficient, the more unequal are incomes; the lower its value, the more equal they are.

This number has risen in the United States since the 1970s. The Gini approach, however, misses a key point: Real incomes of low-earner households have remained steady over time, but incomes have grown for high earners. So, contrary to the notion that economics is a zero-sum deal, high incomes of the well-off are not achieved at the expense of the poor.

Also, there are many points of subjectivity and ambiguity about Gini scores.

First, two nations could have vastly different income distributions and still have identical Gini scores – for example, an oligarchy and a real market economy with great income variation.

Second, the Gini coefficient is calculated using the data source most easily available: household income on a pretax basis, as reported by income-tax filers. But pretax income levels mean little in real life, since those aren't the amounts households actually spend.

In 2015, federal transfer payments – government payments to people, usually those with lower incomes -- totaled $1960 billion, up from $773 billion in 2000 and just $56 billion in 1970. Combined with progressive tax rates, this growth in transfer payments has almost completely offset the impact of rising pretax income inequality. So, we should compare households' consumption rather than their pretax income.

The Bureau of Labor Statistics conducts household expenditure surveys. In 1984, the first year for which data is available, average consumption by households in the top income quintile was 3.84 times that of households in the bottom quintile and 2.15 times that of households in the middle quintile. By 2014, those ratios had increased only slightly, to 4.40 and 2.30, respectively. So, taxes paid by high-income households funded subsidies that significantly increased low-income households' consumption, even though pretax inequality increased.

Third, changes in the characteristics and composition of households affect Gini scores over time, causing them to misrepresent trends in the actual well-being of individuals. For instance, more people are living alone, and this growth of single-person tax-filers is unsurprisingly concentrated in lower household income brackets. In 1999, 57.2 percent of the lowest quintile were single persons, rising to 61.0 percent by 2013.

Filers in the bottom quintile are also increasingly less likely to hold a job. In 1999, 53.8 percent of those households had no income earners. By 2013, that ratio grew to 61.5 percent. By contrast, 77.7 percent of households in the top quintile had multiple earners in 1999, which fell only to 76.0 percent by 2013. As more people live alone or remain jobless, Gini scores rise.

Understanding these limitations of this measure of inequality is vital in drawing policy lessons. Leftists wrongly use pretax Gini scores to infer rising inequality that they try to address with wage controls and other regulations. They ignore the equalizing force taxes and transfers already play and they overlook that part of the increase is explained by people's decisions about living arrangements and their work status.

Even more fundamental is the role of income mobility. Most people and households move from one quintile to another over time. As we noted previously, income mobility in the United States is not only robust, but increasing.

Considering all this, we still believe the primary public policy goal should be to facilitate a dynamic and growing economy in which individuals are freely mobile. This means no price or wage controls, fewer regulations that suppress entrepreneurship, and no special deals for cronies.

Human wellbeing is best promoted through individual liberty and free enterprise, plus helping folks who are not productive become so.

Ron Knecht is Nevada State Controller. Geoffrey Lawrence is Assistant Controller