The Myth of Income Inequality

January 13, 2012 By David Milstein 8 Comments

By David A. Milstein, TheCollegeConservative.com

January 13, 2012

For years, the Left led by President Obama and aided by the robots in the media have continued to say there is a growing income gap in America. They say the rich are getting richer and the poor are being left behind. President Obama recently stated in his weekend address to the nation, “Over the past three decades, the middle class has lost ground while the wealthiest few have become even wealthier.” The recent flurry of news stories came as a result of a new Congressional Budget Office (CBO) report that concluded: “From 1979 to 2007, real (inflation-adjusted) average household income… for households at the higher end of the income scale rose much more rapidly than income for households in the middle or at the lower end of the income scale.”Not surprisingly, the Left jumped all over the airwaves to promote the report and argued for the need for higher taxes and redistribution. Yet some of the conclusions from studies like the CBO report can be extremely misleading and perpetuate fallacies about income and upward mobility in America.

First, the broad claims are true that categorically the top 1% continue to have higher income. The top 1%, like all levels, will continue to grow with technology, innovation and investment. We should be very worried if the opposite happened. Yet the problem with studies like the CBO report is they only take statistical, bracket snapshots of household income and fail to follow the growth of individual income over that same period of time, let alone measure the constant individual movement between the brackets. As pointed out by renowned economist Thomas Sowell in his must-read new book Economic Facts and Fallacies; there is a huge difference between measuring household, individual and categorical data and our focus should instead be on the movement of individuals, not bracket growth.

Here is what he means. Despite the conventional wisdom, a 2007 IRS, Treasury report studied individual tax returns rather than income brackets. It found between the years 1996 and 2005, those individuals whose income were in the top 1% and 5% in 1996 actually saw a decline in their income by 2005. On the flip side, the IRS and Treasury found that the individual income for those in the bottom 20% in 1996 had an average income increase of 91% by 2005, almost doubling their income. They also found “roughly half of taxpayers who began in the bottom income quintile in 1996 moved up to a higher income group by 2005.”

The difference in conclusions is simple: individuals move between income categories all the time. If someone who makes $70,000 a year and sells their $200,000 house in a given year, the snapshot of that given year will show much higher income. The same goes for a wealthy investor whose income could drop after losing a large investment. These categories create the illusion that those who fill each bracket actually remain fixed there each year.

Second, it is very misleading to use household income levels as a way to measure the income gap. Today, fewer people live in the average household. As a result, total household income has decreased. In fact, the latest 2010 Census report actually found there are almost five times more earners among wealthier households than those at the bottom, and those at the top are usually more educated and married. Quite logically, those at the bottom are usually single-family households, young adults and less educated. As you can see, it is easy for the household data to paint the wrong picture of income in America.

And finally, there is a major difference between income and wealth. Seniors rely on Social Security or dividend payments from their stocks for much of their income once they retire. But the decrease in their income doesn’t mean they are now categorically poor. In fact in a 17-page rebuke of the CBO report, Rep. Paul Ryan noted that much of these studies don’t account for transfer payments. It also ignores the wealth that seniors have accumulated throughout their lives.

If I wanted to use Obama’s argument, a recent Census Bureau report highlighted by Investors Business Daily shows the greatest average household income gap in the last thirty years actually occurred under President Clinton and those at the very top actually lost income under President Bush. But it is extremely misleading. It only shows a snapshot of the distribution of income during specific years. Instead we should focus on the individual income and recognize people move between multiple income levels throughout their lifetime. Upward mobility, or even a loss of income is the essence of risk, reward, success and failure that happens within a capitalistic, opportunity society. The Left has successfully created many economic fallacies like this one to promote their redistribution plans of taking more from the rich to give to the poor. In reality, it will simply lead to a contraction in the private sector and everyone financially worse off. Rather than pushing for equal outcome that would only punish the more successful, we should instead promote equal opportunity to ensure greater upward mobility. This is the principle that makes us an exceptional nation.