Economics, U.S. Economy

7 reasons why Obama is wrong on income inequality

As if ordered up directly by the Obama White House and Occupy Wall Street, the Congressional Budget Office has produced a timely report looking at income inequality. The CBO found that between between 1979 and 2007, average real after-tax household income grew by 275 percent for the top 1 percent of households, 65 percent for the next 19 percent, just under 40 percent for the next 60 percent, and 18 percent for the bottom 20 percent.

Blogger Derek Thompson of  TheAtlantic.com, always worth reading, draws this conclusion from the CBO study:

This is complicated stuff, and I’d be lying to you if I said I understood all of it. But let’s all agree about square one. Income inequality is not a myth, so what do we think we should do about it? If we can’t agree on the question, we’ll never find an answer.

Like Obama and OWS, Thompson is worried. I am far less so. Here’s why:

1. Liberals frequently claim the average American family has been losing ground for the past three decades—or at least since Ronald Reagan took the presidential oath in January 1981. (As if the 1970s with its sky-high Misery Index was a great economic time.) The CBO refutes this. Its data show real median after-tax household income (half of all households have income below the median, and half have income above it) grew by 35 percent over the past three decades.

Indeed, look at this chart from Jim Sullivan of Notre Dame and and Bruce Meyer of the University of Chicago (via recent presentation at AEI):

2. The CBO fails to factor in that American households in the top income quintile have, on average, almost five times more family members working than the lowest quintile. (Analysis by AEI blogger Mark Perry.) Those folks are also far more likely, as Perry notes, than lower-income households to be well-educated, married, and working full-time in their prime earning years. Perry also notes that “individuals are not stuck forever in a single income quintile but instead move up and down the income quintiles over their lifetimes.” (Indeed, a Treasury study on income mobility found that starting in 1996, half of taxpayers who started in the bottom 20 percent had moved to a higher income group by 2005.)

3. Price indexes for the poor rise more slowly than for the rich, causing most empirical measures of inequality to overstate the growth of real income of the rich vs. the poor.

4. Apples-and-oranges kinds of issues—such a differences in household size and inflation indexes—has led highly respected Northwestern University professor Robert Gordon to conclude that the “rise in American inequality has been exaggerated both in magnitude and timing.”

5. The Minneapolis Federal Reserve concluded—after taking into account household size and differing price indexes—median household income for most household types increased by 44 percent to 62 percent from 1976 to 2006. In addition, its research shows that median hourly wages (including fringe benefits) rose by 28 percent from 1975 to 2005.

6. As technological change accelerates and becomes more pervasive, the market will reward workers with more education and skills. As CBO notes: “Numerous researchers have concluded that, on balance, the technological changes of the past several decades—and perhaps the entire past century—increased employers’ demand for workers with higher skills and more education. That increase, along with a smaller increase in  the supply of workers with higher skills and more education, generated substantial gains in the relative wages of  more-educated worker. In the past decades, inequality has been going up everywhere.” It is a global phenomenon.

7. And why did the top 1 percent do particularly well? One potential  explanation from CBO:  “The compensation of ‘superstars’ (such as actors, athletes, and musicians) may be especially  sensitive to technological changes. Unique characteristics of that labor market mean that technical innovations,  such as cheap mass media, have made it possible for entertainers to reach much wider audiences. That increased exposure, in turn, has led to a manyfold  increase in income for such people.” The CBO also mentioned “changes in the governance and structure of executive compensation, increases in firms’ size and complexity, and the increasing scale of financial-sector activities” as possibilities.

My bottom line: a) income inequality has increased somewhat in recent decades, but not exploded; b) that increase is natural given technology and globalization; c) incomes could have risen faster with a better educated workforce (that also didn’t have to compete with an influx of workers from Asia), but did O.K.; d) we need to boost education to keep up with advancing technology and productivity; e) the past decade was one of slow growth followed by a nasty recession. No argument there. Looking forward, America will need a pro-growth tax system, smarter regulation and far better human capital (helped by higher teacher pay in exchange for eliminating tenure, more skilled immigration, etc.). That way, incomes won’t just be more equal, they’ll be growing.

49 thoughts on “7 reasons why Obama is wrong on income inequality

  1. Nice try. But more people are coming to realize that few of the 1% earned their fortunes do anything productive, most became rich mainly by moving money around. Ever heard of a derivative? Of those running productive enterprises, the outrageous salaries come from sitting on chummy boards. For every Steve Jobs or Bill Gates there’s 100 champion butt-kissers flying around in private jets.

    • Where do you think that money that is being moved around is going? I would be willing to bet most of their earning is provided from equity. That money is investing directly into businesses, which provides jobs and products that directly improve social and consumer welfare. Stifling investment at the top means stifling the economy as a whole. Steve jobs and Bill Gates did not get where they were and are without plenty of capital provided by investors.

    • Simplifying the work banks do with the phrase “moving money around” shows how little you know about finance.

      Do you have a pension, 401(k), or own equities of any kind? When your paycheck deduction hits every two weeks, it has to be directed to purchase a certain type of stock, bond, or treasury note.

      Do you fly to Chicago or New York, walk onto the exchange, find a willing buyer and complete the transaction? Do you monitor stock prices day-in and day-out to come up with the data you need on what is a smart purchase? There is much more to it than attempting to dumb the whole thing down by saying it’s just “moving money around.”

      I challenge you to retire successfully without utilizing the services of any bankers, stock brokers, financiers, etc.

  2. That’s not the point. The point is that these people are not the creators. They are not the innovators. They do not MAKE anything. They provide a valuable service, yes, but if you look at the rise in the financial sector as part of the economy as a whole, it has gone from less the 20% of domestic corporate profits in the 80′s to more than 40% now, and accounts for twice as much of the GDP. There are several factors that contribute to this, and I’m not saying the growth is all bad…what I am saying though is that their value was falsely inflated (mortgage-backed securities, CDS, other bookkeeping tricks), and those sorts of numbers are unsustainable and indicate a larger problem in the economy…and yes, there were certainly people out there making a tidy profit off that stuff with no thought to who they might be screwing or that it could blow up the entire economy.

  3. If inflation average 3% per year, then after thirty years, that’s 90% of inflation. So if the median income started at 37k in 1980, then, in order to keep up with inflation, thirty years later in 2010, median wage would need to be 70.3K. Compared to inflation, median wages are down. That said, median income earners did not beat inflation and the 1% did. This is bad for business, if the median income earners can only buy inferior goods and can’t afford much else, then how do entrepreneurs sell normal goods? The middle class is simply stagnated and going into debt.

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