Carpe Diem

Inequality Myth: Political Rhetoric v. Econ. Facts

Political Rhetoric: Class warfare is once again a campaign theme. The Democratic candidates are railing against the “tax cuts for the rich,” lamenting the stagnation of middle-class incomes, and decrying the deepening woes of the poor.

Both candidates portray America as a nation where the fruits of economic progress have been usurped by corporate CEOs, equity-fund managers, inside traders and international speculators. Main Street has floundered, while Wall Street has flourished.

Economic Reality: The median household income in 2006 was $48,201, just a trifle ahead of its 1998 level ($48,034). That seems to confirm middle-class stagnation, but demographic changes in the size and composition of U.S. households have distorted the statistics in important ways.

1. The share of the pie consumed by the poorest 20% has been shrinking (from 4.1% in 1970 to 3.4% in 2006), but the “pie” has grown enormously. This year’s real GDP of $14 trillion is three times that of 1970. So the absolute size of the slice received by the bottom 20% has increased from $181 billion to $476 billion. Allowing for population growth shows that the average income of the bottom quintile has risen 36%. They’re not rich, but they’re certainly not poorer. In reality, economic growth has raised incomes across the board.

2. We track “household income” of the “typical” (median) household over time, but the “typical” household keeps changing. Since 1970 there has been a dramatic rise in divorced, never-married and single-person households. Back in 1970, 71% of all U.S. households were two-parent families. Now the ratio is only 51%. In the process of this social revolution, the average household size has shrunk from 3.14 to 2.57 persons — a drop of 18%. The meaning? Even a “stagnant” average household income implies a higher standard of living for the average household member.

3. A closer look at household trends reveals that the percentage of one-person households has jumped from 17% to 27%. That’s right: More than one out of four U.S. households now has only one occupant. Who are these people? Overwhelmingly, they are Generation Xers whose good jobs and high pay have permitted them to move out of their parental homes and establish their own residences. The rest are largely seniors who have enough savings and income to escape from their grandchildren and enjoy the serenity of an independent household. Both transitions are evidence of rising affluence, not increasing hardship. Yet this splintering of the extended family exerts strong downward statistical pressure on the average income of U.S. households. Had the Generation Xers and their affluent grandparents all stayed under the same roof the average household income would be higher, but most of us would be worse off.

4. The supposed decline of the poor and middle class is exaggerated even more by the dynamics of population growth. When people look at the “poor” in any two years, they think they’re looking at the same people. That’s rarely true, especially over longer periods of time. Since 1998, the U.S. population has increased by over 20 million. Nearly half of that growth has come from immigration, legal and illegal. Overwhelmingly, these immigrants enter at the lowest rungs on the income ladder. Statistically, this immigrant surge not only reduces the income of the “average” household, but also changes the occupants of the lowest income classes.

5. To understand what’s happening here, envision a line of people queued up for March Madness tickets. Individuals move up the line as tickets are purchased. But new people keep coming. So the line never gets shorter, even though individuals are advancing.

Something similar happens with the distribution of income. People keep entering the distribution line from the bottom. Even though individuals are moving up the line, the middle of the line never seems to move. Hence, an unchanged — or even receding — median marker could co-exist with individual advancement. The people who were at the middle marker before have moved up the distribution line. This is the kind of income mobility that has long characterized U.S. income dynamics.

From today’s WSJ editorial “The Inequality Myth,” by economist Brad Schiller

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