Don’t Believe Obama on Income Inequality

Economic analysis of income inequality shows the middle class have experienced healthy growth.

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You've heard it a thousand times at least. The incomes of middle class Americans have stagnated in recent decades. Those of the rich—the 1 percent—have soared. It is a very compelling, very troubling, and very widely believed observation and, according to three economists from Cornell and Indiana universities, not true. If they are right—and their analysis is extremely thorough—the economic argument of the entire Obama presidential campaign is founded on an untruth.

First, the origin of the "middle class incomes are stagnating" theory: As The New York Times reported recently, it started with "two academically revered, if publicly obscure, left-leaning French economists whose work is the subtext for the battle over tax fairness." 

Emmanuel Saez of the University of California, Berkeley and Thomas Piketty of the Paris School of Economics have spent the last two decades mapping income data in numerous nations. In studying the United States, they laboriously assembled and processed vast volumes of IRS data going back to 1913.  By their numbers, first published in 2003 and unchallenged until the last couple of months, the median income American taxpayer (meaning the taxpayer in the middle, with as many taxpayers reporting more income as reporting less) has seen virtually no change in his or her income in decades. Meanwhile in the first seven years of the past decade, the top 0.1 percent of taxpayers boasted a boost of an astonishing 94 percent. 

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In this election year, these findings have become a key evidence point in the Obama administration's argument for raising taxes on "the rich," however the administration defines that group.

But now, after an equally arduous examination of far more comprehensive U.S. income data, the Cornell-Indiana team—Richard V. Burkhauser, Jeff Larrimore, and Kosali Simon—have shouted, "Not so fast."

Burkhauser and his colleagues started with Census Bureau data, which includes the IRS information that Saez and Piketty examined and more. Then they worked for years to conform the dead numbers to the living reality of American life.

Some of their adjustments were obvious. Saez and Piletty compared pretax incomes. Using the National Bureau of Economic Research's tax simulator, Burkhauser et. al adjusted for the differences in taxes of all kinds paid—state and local sales taxes, federal, state and local income taxes, payroll taxes—to determine post-tax income. They also adjusted for changes in government income transfer policies, including but not confined to Medicare, Medicaid, and Social Security. Those two adjustments alone nearly tripled the increase in the median taxpayer's income over those 28 years from 1979 to 2007 to 9.5 percent.

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What's more, the Burkhauser team noticed—as apparently Saez and Piketty did not—that increasing portions of American income derive from noncash benefits, that is from benefits for which your employer pays, not you, such as the employer provided portion of health insurance. Add benefits to the impact of taxes and transfers, and the median taxpayer's 28-year income growth jumped from 9.5 percent to 18.2 percent, a near doubling.

And there was more.

As our friends on the left never tire of reminding us, America includes many kinds of household arrangements, all of which should be honored. And if they should all be honored, should they not also all be counted?

But because of limits to IRS data, Saez and Piketty could not distinguish among household arrangements, but Burkhauser and his colleagues could. It turns out that increasing numbers of American households include multiple tax filers. On the other hand, if you are unmarried, over 20 years old, and don't file a tax return, it doesn't mean that you live in destitution, with no means of support—as Saez and Piketty assumed.

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So you see, the difference between household and individual income is critical in numerous ways, including that there are efficiencies to living with others, not alone. Economists have studied these efficiencies. A family of four with a combined annual income of $100,000 a year lives at the same level as four individuals each with a $50,000 income do separately, not like four people making $25,000 a year each.  Burkhauser et. al made that fix among others.

And they looked into anomalies in both the IRS and Census databases. For example, the 1986 tax act reduced personal tax rates below corporate rates, leading many investors and entrepreneurs—including, I'm guessing, Mitt Romney—to change the legal organization of their holdings. The result in the tax and census rolls was a big increase in the personal income of the wealthy, whereas the truth was that only the way the income was reported for tax purposes had changed. They corrected their data accordingly.

I could go on, but you get the idea.

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When they added it all up, the Burkhauser team found that the median American's income between 1979 had risen a healthy 36.7 percent, a far cry from stagnation. Their conclusion: Income inequality in the United States, as Burkhauser put it in a recent interview, "hasn't increased very much since 1993."

That's a problem for the president's campaign

Here is a link to a page at the Library of Economics and Liberty. There you will find both the Burkhauser, Larrimore, and Simon study and the Piketty and Saez one.  Also, you will find a transcript of and link to a podcast with Professor Burkhauser.

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