Tuesday, October 20

Setting the Record Straight on Income Inequality

by Eben Macdonald

Much Progressive thought is based on the theory of power structures. It states that all disparities, inequalities and differences in economic and cultural power in society must inevitably be attributed to innate discriminatory forces within that system. This idea originates from Karl Marx’s theory of Surplus Value: it states that an employer making profit is inherently a form of worker exploitation.

This explains the Left’s utter obsession with income inequality: the gap between what an Indian farmer and Bill Gates earn. The growing concern about income inequality rests on three premises: first, that it has risen substantially in recent decades (and that it is as bad as the public perceives it to be). Second, that it can be explained as the rich exploiting the poor. Third, that relative disparities in wealth and income are more important than the absolute living standards of the poorest. Let’s examine each in turn.

You’ve all heard Bernie Sanders or AOC rant on about the proportion of capital which the richest 1% in society own. The assumption amongst many is that this share of wealth has been increasing since the 1970s. Whilst it is easy for politicians and media figures to blurt out statistics along these lines, the truth is that the measurement of income inequality is much more complicated than it looks. There is a great number of factors one must consider when measuring such: are you looking at government transfers? Are you looking at peoples’ incomes before or after tax? Are you including income from capital gains? And if you are, then are those gains at accrual , or having been realized ? Are you considering the friction between public assets and private assets? Because welfare transfers discourage people from saving and investing in private assets, like pensions, or saving accounts. Are you taking into account family size, which, having been reduced, increases the incomes of the poorest? Are you considering that a lot of income is underreported, which is why many economists prefer consumption data to income data when measuring peoples’ living standards. And perhaps most significantly, age must be considered. Age and income correlate very well – so as societies age, a greater share of the population will be dominated by those who get high incomes from pensions and other assets they’ve invested in over time. When one includes all these factors, studies have repeatedly shown that there has been no increase in income inequality since 1970, or if there has, it has been much more moderated than public perception. When one takes into account the accrual of capital gains, Armour et al. (2014 ) demonstrate the exaggeration of the increase in inequality. When you examine consumption data, instead of just income data, a 2001 study came to a similar conclusion. When you look at tax records, instead of simply reported income, the same shocking truth is discovered . No, I’m kidding, tax records are really more reliable . When changes in labour market and household composition (like family size) are adjusted for, one finds something similar . Most interestingly, however, age plays an important role in income inequality, as verified by a 2017 Fraser Institutestudy , which estimated that up to 80% of all inequality in Canada can be explained by an ageing population.

The record on income inequality was set straight by a 2014 Cato Institute book Anti-Picketty: Capital in the 21st Century, in response to Thomas Picketty’s famous book which hypothesised a dramatic increase in inequality (and consequently became the new Das Kapital). It refuted all the arguments it put forward, as well as debunk the alarm surrounding inequality. (For further reference, you can read another paper published by the same think-tank, which did something similar).

So, is income inequality rising at dramatic rates, while the rich get richer and the poor become increasingly more impoverished? No.

The second premise of the inequality brigade is that income disparities can only be explained by the rich exploiting the poor. This is patently wrong. The causes of poverty I addressed in my previous article for the Mises Institute. However, to review again, the strongest predictor of poverty in the United States is single motherhood, confirmed by CDC statistics . As it is written on page 275 of Robert Bartley’s book Seven Fat Years [i] :

“ ….Data from the CPS show that about one half of all families with a female householder, no husband present were in the lowest income quintile. The increase in this type of family would cause an increase in measured income inequality ”.

Single motherhood is the best predictor of poverty in the US. There are also high housing costs, which may well be a strong cause of inequality – whether it has increased dramatically, increased moderately, or even plateaued. High housing costs (as well as smaller houses) are a result of government regulations which restrict supply. High regulations also restrict the spaciousness of housing. It’s why countries with lower housing regulations tend to have larger houses (just look at Canada, America, Australia New Zealand, countries with low housing regulations, in comparison to most European countries, which have the opposite).

The third premise of the inequality alarmists is that disparities between the rich and poor seem to matter more than the absolute living standards of the poorest. In response to this, I always give this thought-experiment. Where would you rather live? A society where the richest 10% earn 11 times more than the bottom 10%, but where the poor are on incomes of $40,000 a year and have access to high quality goods and services. Or, would you want to live in a society where there is complete income equality, but where everyone is on an annual income of $10,000. Now, obviously I’m committing a false dichotomy here. However, if you prefer equality to absolute prosperity, then you ought to be more inclined to answer ‘the latter’. Income inequality is essentially a useless measure of living standards. Whilst societies in which the poor are poor may have high levels of inequality, it does not follow that all societies with high/rising inequality have an impoverished poor, or that societies with low/dropping inequality have a rich poor. For instance, the country with the lowest inequality on earth is Ukraine – with a Gini coefficient of just 25. A country with much higher inequality is Australia – with a Gini coefficient of 35.8, nearly 11 points higher than Ukraine’s. Yet Australia’s living standards are clearly much higher than Ukraine’s. Rising inequality does not mean declining living standards – whilst declining inequality does not mean rising living standards.

Since the 1990’s, income inequality has risen in China. Yet is this of any moral relevance? During that time, hundreds of millions of people have been lifted out of poverty.

Another good example of this ethical problem is the economic record of the British Prime Minister, Margaret Thatcher (1979-1990), who famously liberalised Britain’s economy and fought the trade unions. During her premiership, income inequality increased dramatically – causing a rise in the number of people living on relatively low incomes (incomes relative to higher ones) – yet, this did not mean that the poor suffered under her. Quite to the contrary . The percentage of Brits living on absolute low incomes declined from 60% in 1979 to just over 40% in 1990 (and around 35% in 1997, when her Conservative government was finally voted out of office). This can be found on page 12 of a 2010 ONS report .

With all this in mind, consider that forcing inequality to drop may (for certain) involve suppressing people’s freedoms. Making people completely equal – or, at least, approaching completely equal – could involve the expropriation of wealth and property, which people won’t agree to easily. Freedom is much, much more desirable than equality. Freedom is contingent on the supreme rational faculties of the human being – and thus, the freedom of the individual, and the freedom of a society, are a reflection and an exercise of those innate human capacities. Income equality has no moral basis: there is no ethical reason why people ought to earn exactly the same, especially when the productivity and importance of different forms of labour vary. Thankfully, the American people agree with me. It’s why an overwhelming 77% of them value freedom over equality.

[i] Page 275, Chapter Seventeen, Seven Fat Years, by Robert L. Bartley

Posted with permission from the Mises Institute.

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