Income Inequality - I'm a Skeptic

A couple of weeks ago, I cited an article that reported new disclosure requirements that help identify the level of income inequality within firms. I should admit, I'm not even sure I believe that increasing income inequality actually exists. A year or two ago, a book by a French economist became highly publicized:

Admittedly, I haven't read the book, but I have listened carefully to several talks by Piketty and the moral of the story is twofold. First, income inequality (or the amount of income earned by the richest group of individuals) has been increasing over the last 50 or so years. And second, the reason is because the rate of return on capital is greater than the growth in income. The book is primarily a culmination of his academic research. Related to his first point, Piketty and Saez (2003 and 2007) show that, from 1960 to 2005, the share of income earned by the top 10% increased from 32% to 44% while the share of income earned by the top 1% increased from 8% to 17% over the same time period.

If you were to ask, "Why should income inequality matter?", I would answer by saying, "great question!". I'm not sure that I know. Economic theory suggests that wages should equal workers' marginal product and discrepancies in this equality may result in inefficiency. However, theory is agnostic to the idea that inequality may produce social and political uncertainty as policy makers attempt to respond to cries from the Occupy Wall Street Movement that inequality is unfair. In my opinion, this is the most persuasive argument against income inequality given that regulatory uncertainty can influence the investment decisions of both firms and individuals, which will no doubt affect economic outcomes.  But what if the statistics do not tell the full picture and the uncertainty caused by inequality is generated by policy makers instead of the current economic system?

Here's where I begin to question the idea that rising inequality even exists... Two studies by the U.S. Department of the Treasury shed light on movement within the income distribution across time. It is this movement from, say 1960 to 2005, that seems to be more important than simply looking at the tails of the distribution in 1960 and then again in 2005 and trying to draw conclusions about fairness. Said differently, we shouldn't care that much about statistical groups or categories, per se. We should be more interested in "flesh and blood people". At least, this is the argument of economist Thomas Sowell. It's possible, and indeed likely, that individuals in the bottom part of the income distribution in 1960 actually moved to the top part of the income distribution by 2005. Therefore, we should be more concerned with income mobility than with income inequality.

Turns out, that in the United States, there is much more mobility than inequality - at least this is what the two studies from the Treasury Department seem to indicate. Both studies track earnings of individuals across 10 year periods using Tax Return data. The first time period is between 1979 to 1988 while the second period is from 1996 to 2005. Here is the first table from the first of these studies:

Table 1
Percentage Distribution Across Income
Quintiles in 1988 of Taxpayers Grouped by
Their Income Quintiles in 1979 /1/
(Quintiles defined for all taxpayers)
Quintile in 1988
Quintile in 1979	First	Second	Third	Fourth	Fifth
First	14%	21	25	25	15
Second	11	29	30	20	11
Third	6	14	33	32	15
Fourth	3	9	15	38	35
Fifth	1	4	9	20	65
/1/ Reproduced from Table 1 in 'Household Mobility During the 1980s: A Statistical Assessment Based on Tax Return Data,' U.S. Department of the Treasury,, Office of Tax Analysis,, June 1,, 1992. The results are striking. Look at upper left part of the table. Only 14% of individuals that were in the lowest quintile of the income distribution in 1979 remained in the lowest quintile by 1988. In fact, 15% of individuals in the lowest quintile made it to the highest quintile by 1988. 86% of individuals moved out of the bottom quintile during this 10 year period. 35% of individuals dropped out of the top quintile by the end of this period.  Fortunately, this level of mobility is not unusual. Here is the first table from the second Treasury study: Table 1: More than 50 percent of taxpayers in the bottom quintile moved to a higher quintile within ten years Income Mobility Relative to the Total Tax Filing Population 2005 Income Quintile 1996 Income Quintile Lowest Second Middle Fourth Highest Lowest 42.4 28.6 13.9 9.9 5.3 Second 17.0 33.3 26.7 15.1 7.9 Middle 7.1 17.5 33.3 29.6 12.5 Fourth 4.1 7.3 18.3 40.2 30.2 Highest 2.6 3.2 7.1 17.8 69.4 Notes: The rows sum to 100 percent across the five quintiles in the first five columns. The table uses the tax returns of primary and secondary non-dependent taxpayers who were age 25 or over in 1996 and filed for both 1996 and 2005. Income breaks for the quintiles and top percentiles are based on the full cross-sections of tax returns for each year, where the taxpayer is age 25 and over. Income is cash income in 2005 dollars as defined in the Technical Appendix. Source: Tabulations by the U.S. Department of the Treasury, Office of Tax Analysis, using data from IRS Statistics of Income, Individual Income Tax Files for tax years 1996 and 2005.

It should be noted that we observe less mobility from 1996 to 2005 than from 1979 to 1988, but the level of mobility is still higher than some policy makers would like to think. For instance, about 58% of individuals moved up from the bottom quintile of the income distribution during this 10 year period while slightly more than 30% of individuals dropped out of the top quintile.

While Piketty has become famous for reiterating the notion that the gap between the rich and the poor has been widening, the analysis conducted by the U.S. Treasury Department suggests that, in general, those who start out rich and those who start out poor typically meet in the middle. Although not reported in this post, the latter of the Treasury studies further reports that nearly 50% of individuals in the bottom quintile had their incomes increase more than 100% during the 10 year period while only about 8% of the individuals in the top quintile had their incomes increase more than 100%. Piketty figuratively trademarked the idea that r > g  - i.e., the rate of return on capital is greater than growth in income.  I would submit that the data from the Treasury suggests that p > r - i.e., the growth in income of the poor p is greater than the growth in income of the rich r.

What is most disturbing about this entire discussion is that the most negative externality associated with income inequality is being observed in our society without the absolute presence of rising inequality. In other words, we get to experience political and social uncertainty without experiencing the thing that caused it.