Income Inequality in America: Is It Rising and Is It Bad| | 07.14.14

For anyone following the media just now, it is hard to get through a week without hearing about income inequality in America. In case you missed it, it’s gone up in the last few decades and this, we are told, is a bad thing. On both accounts, I wonder.

The recent flurry of interest follows the publication of Capital in the 21st Century, by French economist Thomas Piketty. After laying out his data, Piketty calls for a cure of, yes, higher taxes and a variety of familiar left-wing policy elixirs. Paul Krugman loves him.

Maybe Mr. Krugman shouldn’t have chortled so quickly. A couple of years ago a team of economists led by Richard Burkhauser of Cornell University pretty much demolished Piketty’s work on the stagnation of American middle class income (summary here,  interview and academic paper here). They used far more comprehensive income data than had Piketty, adjusting it for the full range of taxes as taxes changed over time. They added in the value of non-cash benefits and transformations in household composition. Results? Piketty was flat out wrong. The median American income had not stagnated between 1979 and 2007, despite Piketty’s insistence otherwise. It had, in fact, increased by 36.9%. U.S. income inequality was little changed from 1993.

But whether it has grown or not, is the income inequality we in fact have a bad thing?

In June, James Bullard, president of the Federal Reserve Bank of St. Louis, a research powerhouse in the Federal Reserve System, addressed the source of U.S. income inequality in a lecture at the Council on Foreign Relations.

Bullard used what is called a life-cycle analysis of incomes. All of us – or at least most of us – are minimally productive in our early years, gain in productivity as we age, peak in our 50s and become steadily less productive until our final years. According to the St. Louis Fed’s analysis as told by Bullard, that normal cycle of life accounts for three quarters of the income disparity in the U.S.

By almost universal agreement among American economists, most of the remaining spread has to do with education. Higher education makes for higher earning, and the value of good degrees has gone up significantly over time. I say good degrees to allow for the apparent degradation of aspects of higher education in recent years, which is another matter for another column.

Does anything else explain U.S. income differences? Let me suggest a couple.

The first has to do with how people report their income, which is really about how they adjust to tax laws. Some years ago (this is a true story) a multiply married Hollywood mogul bought his new wife a home on New York’s Upper East Side. Among the women’s friends, the purchase was taken to indicate the power of her charms over him. Homes for prior wives had been rented or belonged to the studio. But it turned out that he bought the new property not long after the Reagan tax cuts went into effect. In other words, once tax rates dropped, he stopped concealing his compensation as non-taxable business expenses (like a movie-studio-rented Fifth Avenue apartment) and started taking it as ordinary taxable income, from which he bought that residence. This shift likely accounts for a fair amount of the remaining growth (after the life cycle and education effects) in upper income earnings between the 1950s and 60s on one hand and the 1980s through today.

Another part of the change likely has to do with how those incomes are made.

For beginning in the 1970s and growing explosively from the 1980s until the tax and regulatory hikes of the Obama years, new business creation and growth have been the engines of the American economy. But while entrepreneurs may make significant income in good years, they are more likely to lose significant amounts in bad ones, as when their ventures fail or they face new business challenges. If you were building a regression analysis of their collective earnings, you would see growing volatility over the decades, what is called a high beta.

Here is my concern. It is a value judgment. For a variety of reasons, not all of them economic, I feel that having low barriers to entrepreneurship is a good thing for a free society. Much of the attack on American income inequality looks to me like a cover for attacking the nation’s entrepreneurial flowering, with anti-entrepreneurial potions like Picketty’s always following. Such critics see no difference between the rock solid earnings of a civil servant or a tenured professor and those of a young man or woman rolling the dice on a high tech start-up.

So here is my question. To the extent that increases in high incomes are a result of variations in time of life productivity, education, the candor with which incomes are reported and increases in American entrepreneurship, isn’t income inequality a good thing?

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