Sunday, March 20, 2016

Economists Get Real About Measuring Inequality

Inequality is exceptionally hard to measure: you need lots of data, on lots of different people, in lots of different circumstances, and then a bunch of high level tools to figure it out.

Politicians, bureaucrats, and advocates claims about inequality should probably be dismissed out of hand as not credible.

Having said that, it doesn’t take a rocket scientist to recognize that there’s some.

There’s four big easy ideas, right at the top of the list, that should be grasped by every student at this level.


Income and wealth are not the same. Income is a flow, wealth is a stock. Economists know a lot more about income, because it’s in everyone’s paychecks, and the government keeps tabs on most of us. Economists know a lot less about wealth because it’s harder to value (for example, what your car is actually worth isn’t known until someone buys it from you).

But, what you know about your neighbors is mostly about wealth. You don’t see their paychecks. You don’t know all their sources of income. But their wealth is sitting right there in front of you.

So, we worry about what is mostly wealth inequality, and then politicians, bureaucrats and advocates do bait and switch and tell us they can fix that by going after income. And they do.


What we really want to be more equal is consumption not income (both are flows). We could get a lot less income inequality if we went and punished people for working long hours … you know … go watch more TV or we’ll get the IRS after you. But we don’t do that because it’s dumb. We could also get less income inequality by making sure the poor worked more … you know … no TV for you until you put in more hours. Somehow our society seems to think this one is a little better, but I don’t always agree with it.

Think about it, who bugs you more, the rich person who eats in fancy restaurants, or the rich person who eats at home? It’s not their income that bugs us, it’s what they do with it.

This means we need to be concerned about consumption inequality. So, politicians, bureaucrats, and advocates … focus instead on income. Learn to ask them why. The answers aren’t pretty.


A lot of inequality is between young and old. Some of the poorest zip codes in the country are located in … college towns (because of the low income of most students). Do note that I do not want to diminish the areas of real poverty, I just want to point out that the data isn’t what we think it is. And, a lot of the rich live in coastal Florida, south Texas, Arizona, and southern California. Hmmm … the places that attract retirees.

But the old vote. So the response of politicians, bureaucrats, and advocates has been to shelter a lot of their income (which is often lower because the house is paid off and the kids are done with college anyway) from redistribution. One of the biggest sources of consumption for the old is … Medicare.

BTW: our fiscal problems with Medicare are much larger than those with Social Security (even though that gets more press). The reason is that Medicare is open ended during any given month for senior, while their Social Security checks have known and stable values.


We already do a lot to reduce inequality. We can debate about whether that’s enough or not, but we can’t deny that we’re trying.

This means that if we want to assess whether inequality is getting better or worse, we have to do it after taxes have been collected, and redistributed at transfer payments.

That’s sensible. The only reason to not do that would be that you really don’t want to know the answer.

So what do our politicians, bureaucrats, and advocates do? Base almost all of their discussion and policy prescriptions on pre-tax, pre-transfer, income.


All of that was a preface. There’s a new paper out that does a better job at this. It’s entitled “U.S. Inequality, Fiscal Progressivity, and Work Disincentives: An Intragenerational Accounting ”, and it’s by Alan J. Auerbach Laurence J. Kotlikoff Darryl R. Koehler. It's part of the NBER Working Paper Series: a lot of papers by top economists appear their first before they come out in a formal journal publication.

These guys are not conservatives/Republicans. A more accessible discussion appeared in The New Republic (a liberal/progressive magazine). It’s entitled “We’ve Been Measuring Income Inequality All Wrong” and it’s required.

Let me note that none of this is surprising to economists. It’s just a big job, and holy cow am I glad someone else did the work so that I just have to read it.

Here’s their big findings.


First, spending inequality—what we should really care about—is far smaller than wealth inequality. This is true no matter the age cohort you consider.

… The poorest are able to spend far more than their wealth would imply …

The fact that spending inequality is dramatically smaller than wealth inequality results from our highly progressive fiscal system, as well as the fact that labor income is distributed more equally than wealth.


… U.S. fiscal policy acts as a serious disincentive to work longer hours or harder for more pay.


Our standard means of judging whether a household is rich or poor is based on current income. But this classification can produce huge mistakes.

… Nearly a third of the people we identified as middle income are being mis-classified as either richer or poorer.

And what are their policy recommendations?

Raising taxes and benefits as Democrats advocate will, unless existing tax and benefit systems are properly reformed, come at the cost of even larger work disincentives. Lowering taxes as Republicans advocate—presumably funding this with benefit cuts—will improve work incentives but may exacerbate spending inequality unless the benefit cuts disproportionately hit the rich.

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