Opposite the Headlines, Income Inequality has Gone Down over the Last Two Decades

September 13, 2013

The story of increasing income inequality is shaping up to be more a statistical fabrication than anything else. This week there have been lots of headlines about the “rich taking a bigger slice of income than ever before,” based on new data from Emmanuel Saez. Meanwhile, Richard Burkhauser and other researchers at Cornell have been explaining why the data used by Saez and others is inadequate to make such claims about increasing income inequality. First, in a 2011 paper, Burkhauser and others explain what is not counted in the income measures used by Saez, namely government transfers and fringe benefits and changing household structures, and how this overstates income inequality:

Researchers considering levels and trends in the resources available to the middle class traditionally measure the pre-tax cash income of either tax units or households. In this paper, we demonstrate that this choice carries significant implications for assessing income trends. Focusing on tax units rather than households greatly reduces measured growth in middle class income. Furthermore, excluding the effect of taxes and the value of in-kind benefits further reduces observed improvements in the resources of the middle class. Finally, we show how these distinctions change the observed distribution of benefits from the tax exclusion of employer provided health insurance.

Second, in a paper from earlier this year and published in the American Economic Review, Burkhauser and others explain what is miscounted in the income measures used by Saez, namely capital gains, and how this overstates income inequality. Saez’s income inequality result is driven by measures of taxable realized capital gains, but capital gains should be measured on an accrual basis. When this is done correctly, income inequality has gone down over the last two decades:

Recent research on United States levels and trends in income inequality vary substantially in how they measure income. Piketty and Saez (2003) examine market income of tax units based on IRS tax return data, DeNavas-Walt, Proctor, and Smith (2012) and most CPS-based research uses pre-tax, post-transfer cash income of households, while the CBO (2012) uses both data sets and focuses on household size-adjusted comprehensive income of persons, including taxable realized capital gains. This paper provides a crosswalk of income growth across these common income measures using a unified data set. It then uses a more consistent Haig-Simons income definition approach to comprehensive income by incorporating yearly-accrued capital gains to measure yearly changes in wealth rather than focusing solely on the realized taxable capital gains that appear in IRS tax return data. Doing so dramatically reduces the observed growth in income inequality across the distribution, but most especially the rise in top-end income since 1989.

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