Thursday, March 23, 2006

Income Inequality: Is It Overstated?

We hear the constant drumbeat from government interventionists railing against rising income inequality in the U.S. and calling for “big” government remedies. However, it is abundantly clear that these individuals, pundits and economists have overstated the problem and advocated policy solutions that will undermine the long term growth of the U.S. economy.

It is true that over the past two decades the share of income going to the lowest quintile of workers in the U.S. declined by approximately 1%, while the proportion going to highest quintile of workers rose by almost 5%. However the raw income numbers fail to consider factors that undermine this result.

First, the data do not consider government subsidies for which low income workers qualify. For example in 2000, families having more than one child and earning less than $31,152 received a credit, or earned income tax credit (EITC) of up to $3,888. Caring for a child who was formally placed by an authorized placement agency may also qualify a worker for the EITC.

Second, the measured inequality does not consider the impact of taxes. The most recent IRS data show that the top 1% of taxpayers pay 29% of all taxes and the top 5% of taxpayers pay 50% of all taxes. The lowest 20% of U.S. income earners pay virtually none of the federal income tax burden. In fact, IRS data show that the top quintile of income earners pay 79% of federal income taxes, and the bottom quintile of job holders pay -2% of federal income taxes. A high share of the low income earners instead of paying taxes actually received a net tax “refund” or EITC.

Third, it does not recognize the aging of the U.S. workforce. Workers in the age bracket 45 to 54 are the highest income earners in the nation. Over these two decades, the share of the workforce in this age bracket has grown by 3% to 5%. Thus, one would expect the highest quintile of workers share of income to grow simply because the quintile is older.

After adjusting for these factors, one concludes that the U.S. earnings differences between the “haves” and “have nots” is not nearly as dramatic as presented by the alarmists.


Ankur said...

but the gap is indeed widening? which is a proven (sad) consequence of capitalism. now what i want to ask is if there have been any studies which relate to the following: "a govt. intervention in form of subsidies to the poor might reduce the future growth rate."



Anonymous said...

Thanks for your comment Ankur.

There are many studies that show that increasing subsidies to the poor via increasing marginal tax rates does reduce GDP growth. Furthermore subsidies that increase the cost of working (reduce the cost of leisure)to the poor (and rich) do reduce GDP growth.
Ernie Goss

Ankur said...

thx! :). will stay tuned for more..