Tuesday, October 06, 2009

Income inequality overstated? 

How often do you hear about rising income inequality in the US? What explains it? Prof. Robert Gordon of Northwestern finds that it's overstated. He accounts for three misperceptions:
  1. If you use household income and compare to productivity, changes in household size will matter. Income and productivity are also deflated using two different deflators, and household income assumes all households consume the same bundle of goods. Correcting for these distinctions, Gordon finds that gap increase between rich and poor is only one-tenth what one finds using conceptually inconsistent measures as most do.
  2. "Second, the increase of inequality is not a steady ongoing process; after widening most rapidly between 1981 and 1993, the growth of inequality reversed itself and became negative during 2000?2007. For instance, a new study that integrates CPS and IRS data and corrects for top?coding using internal Census data, shows that there was no increase of inequality after 1993 in the bottom 99 percent of the population, and the remaining increase of inequality can be entirely explained by the behavior of incomes in the top 1 percent. This paper shows that by several measures, the increase of inequality had already ceased by the early 1990s and by others around 2000, even before the current major recession that has cut incomes at the top more than at the bottom." This puts a big dent in the story that increased use of IT has made the gap between rich and poor higher. This part of the paper was most surprising.
  3. "Third, an emerging literature documents an exaggeration of the rise of inequality due to the use of common price indexes across income groups. Several important recent articles document that prices paid by the rich have been increasing more rapidly than prices paid by the poor." See for example Broda and Romalis [2008] (referred here) to see that trade has helped the poor by making goods cheaper. Because rich people consume services in higher proportion than poor people, and because trade doesn't happen as much for services, the CPI of the two groups has diverged as trade has blossomed around the world.
Diana Furchtgott-Roth believes that some of the acceleration of income inequality in the Reagan period (that Gordon finds) is due to a shift in reporting of income as personal rather than corporate income after the 1986 tax reforms. She also concludes that "the American economy is far more robust and resilient than often viewed. Over long periods of time, it survives the ebb and flow of growth and recession-and governmental policies, the good and the bad-largely intact."