Live After Quit

The Truth about American Inequality

Economist and Mises Institute Associated Scholar Robert Ekelund recently teamed up with former US Senator Phil Gramm and John Early to write The Myth of American Inequality: How Gernment Biases Policy Debate.  The book was released this month by Rowman and Littlefield Publishers.

In it, the authors explore some of the many ways that the debate over inequality in the United States is based on bad research, bad data, and a variety of other misconceptions. I recently asked Prof. Ekelund about some of the ways these errors affect our thinking on US inequality versus the rest of the world.   

Ryan McMaken: For many years, we’ve been hearing about how the United States is unique among industrialized nations in that it has unusually high levels of inequality. But this conclusion relies on a small number of reports from a few organizations. What are these sources, and are they reliable?

Robert Ekelund: The United States is not unique among industrialized economies with high levels of income inequality, but inequality is vastly overstated when a proper accounting for all income transfers and taxes paid are considered. The US does have relatively large numbers of high income and high wealth households, but the most unequal nations are typically those where markets are restricted or less developed.

A major part of our book is dedicated to getting the “numbers” correct and letting the chips fall where they may. The important numbers that we have found come from our own Bureau of Labor Statistics (BLS) and the Census Bureau, as well as from international institutions such as the Organization for Economic Co-Operation and Development (OECD).  These organizations are “reliable” as far as bureaucracies are concerned, but they have not corrected their reporting for obvious inaccuracies. The Census Bureau, for example, leaves out about two-thirds of transfer payments.

Our team of authors are all economists, but we have a diverse experience in government (Gramm), within the statistical bureaucracy (Early), and academia (myself), and even the private sector. We also have benefitted from the work and input of others, especially your own Mark Thornton. We wanted to rebuild a factual account of income distribution in comparison to the somewhat mythical account that currently dominates public discourse in the popular press.

A central part of our book has been to include the many sources of income transfers received, mostly government, and taxes paid and recalculating the 5 income quintiles for the US. The bureaucracies do not count all or even most of the transfers and taxes. In other words, instead of looking at earned income and only accounting for some transfers and taxes, we take all taxes and income transfers into account and look at a household’s total consumption possibilities. We find that when a more accurate accounting of these taxes and transfers are included, income distribution in the US is about the same or better over the last half century. In international comparisons, when corrected for obvious oversights, the US is in the middle of the pack of high income developed countries. Most of what people have read about that status of income distribution in the US is largely a statistical fabrication. When all transfers and taxes are taken into consideration, our calculations shows that the average income in the highest quintile is only four times the lowest quintile, rather than the 16-to-1 ratio that is often reported in the press. 

Additionally, our measures of poverty are essentially the same as the government’s until Johnson’s “War on Poverty” began in the mid-1960s. While the official measure of poverty stopped falling and began to stagnate well above 10% to the present day, our adjusted measure shows that the poverty rate has decreased to about 2.5% when the “missing transfers” are added to the calculation. 

RM: You note that in many of the international rankings of national levels of inequality, researchers don’t even include huge American social programs like Social Security and Medicare? How does this affect the rankings?

RE: In terms of international rankings, you must realize that the European nations are more homogeneous with respect to taxes and transfers and the US is more unique in terms of policy and statistics. For example, they have large Value Added Taxes and National Healthcare Services and we do not.

Social Security and Medicare are huge programs and most people feel they have bought and paid for the benefits received. However, they are actually tax and spend programs, there is no real Trust Fund, and they both represent a large transfer from high income earners to low-income earners. When we include this data, it tips the income distribution in favor of low earning households and those are among the many things not included in the statistics and reports you read about in the popular press. 

RM: Part of the reason for all this is the enduring myth that the United States has virtually no welfare state and that it is “laissez-faire.” From what I’ve seen, the US spends on social benefits programs at least as much as many European countries. 

RE: The US welfare state has grown enormously over the last century and might be the most generous in the world. Our welfare spending is probably the highest in the world. It is only “laissez-faire” in the sense that we have a very complex system at the federal, state, and local levels, and a very large charitable sector as well. Our statistical accounts are complex and comparisons are difficult. We found over 100 income transfer programs, not including “public goods” programs, that are mostly unaccounted for in the income distribution statistics. When fully included, these programs, large and small, tip the distribution scales strongly in favor of low earning households.

RM:  Europe relies heavily on sales taxes, which are regressive taxes. What effect does this have on relative incomes?

RE: European countries rely very heavily on the Value Added Tax which is a type of sales tax levied at each stage of production so that when a consumer buys a good there is in effect a huge sales tax imposed and sales taxes are considered “regressive” in that the overall tax is a higher percentage of a low-income person compared to a high-income person. Sales taxes are regressive and relatively hurt the poor, which is why there are sometimes sales tax exemption for necessities like food and medicine or sales tax holidays for back-to-school products, such as clothes, shoes, and school supplies.

At the same time, we already “soak the rich” more than other countries. The top two quintiles (top two 20% groupings of the income distribution) pay the vast majority of the US income tax and our income tax is more progressive than in most European countries.

RM: Embedded in a lot of the discussion over inequality is the assumption that it’s markets that are the primary cause of inequality. But aren’t government policies often a big driver of inequality where it exists?

RE:  Historically, the emergence of markets is what reduced economic and political inequality while at the same time increasing the standard of living and life expectancy. Non-market societies, in contrast, are typically hierarchical in some important respects which implies inequality and unfortunately, relatively stagnant or even declining standards of living. Some writers simply want to throw money at the problem and this can help to a certain extent. The US and other countries have gone beyond this tact and adopted a generous welfare system, along with large public education and regulatory systems.  As a result, we have effectively captured a large part of the population on welfare, with over 40% (the bottom two quintiles) receiving significant income transfers while simultaneously being dependent public schools and law enforcement, unable to afford private schools and protection.

RM: What promarket changes could be made to address inequality?

RE: Well, there are many reforms that could increase earned income across the board, some that would help low earning households, and still others that might further compress the distribution. 

Starting from the bottom, public schools and law enforcement seem to be a disservice to the poor but do a better job in higher income areas. Both are in need of systemic reform and more competition, in other words, the government seems to work against the poor in the basic needs that drive economic performance–property rights and education.

Government also has established a labyrinth of regulations and barriers to entry, much of it at the state and local levels, that benefits the well-established and hurt people trying to climb the economic ladder. Land use regulations, licensing requirements, and various federal, state and local monopoly privileges are examples of government tipping the scale against the poor.  In each case, government restrictions hurt the poor with reduced opportunities, lower wages, and higher prices while simultaneously helping the wealthy with economic privileges, such as higher wages and higher prices for the things they sell, compared to more competitive markets.

Reducing government intervention would level the playing field and enhance economic opportunity and mobility. Freedom and unrestricted mobility are the force behind classic “rags-to-riches” stories, and it still occurs all the time. Many people are only “rich” for a few years of their lives. The individuals in the Forbes 400 frequently change. Over time, people drop off and are added en masse. Mobility is the key for enhancing prosperity and for making distribution equitable. The primary purpose of the book is not to provide specific, suggested reforms, but we do suggest that there is much to be done to improve opportunities for the poor and to avoid protectionism for the rich.