Shelton and McKenzie on measured Inequality

Here is the link:  http://www.ncpa.org/pub/st358

From Kathryn M. Shelton and Richard B. McKenzie, Why the "Rich" Can Get Richer Faster than the "Poor" NCPA Economic Study #358, July 10, 2014

President Barack Obama has tagged the growing inequality of income over the past three or four decades as "the defining challenge of our time," an often-repeated claim recently echoed by economist Thomas Piketty in Capital in the Twenty-First Century. Numerous social and economic factors explain why the income and wealth gaps have grown, from the rise in family breakdown to the incentives embedded in government welfare programs.

However, there are reasons for the gaps that have gone largely, if not completely, unrecognized. These explanations make the relative growth in the income (and wealth) of the rich practically inevitable - at least as officially measured.

According to official measures, the average and total income of people at the top of the income distribution is growing relative to the incomes of lower income groups. From 1979 to 2007, the inflation-adjusted income of the top 1 percent of households grew 275 percent, while the bottom fifth's income grew only 18 percent. However, if the incomes of household members are combined, if household income is adjusted to reflect reductions in tax rates and increases in government transfers and if household income is further adjusted to account for the declining number of people in the average household over nearly three decades, the 3.2 percent increase in median taxpayer earnings over the period rises to nearly 37 percent.

Much of the income inequality debate in the United States has focused on "fifths," "tenths" or "the top 1 percent" of households. Such divisions give the appearance of inequality, but there are far more people and workers in the top income brackets than in the lower ones. Indeed, there are 82 percent more people in the top fifth of households than in the bottom fifth. In 2006, 81 percent of households in the top quintile had two or more workers; but only 13 percent of households in the bottom fifth had two or more workers. In nearly 40 percent of these households, no one was working.

Further, people in different income divisions do not remain at those income levels throughout their lives. The Federal Reserve Bank of San Francisco found that absolute mobility - that is, the extent to which children earn more than their parents - is high:

Of all U.S. adults, 67 percent had higher incomes than their parents; and among those born into the lowest income bracket, 83 percent exceeded their parents' income.

About 40 percent of people in the lowest fifth of income earners in 1986 moved to a higher income bracket by 1996, and roughly half the people in the lowest income quintile in 1996 had moved to a higher income bracket by 2005.

Indeed, one study found that a majority of Americans reach the upper income brackets at some point during their lives. Over a 44-year period, 12 percent of 25- to 60-year-olds moved into the top 1 percent for at least one year; 39 percent reached the top 5 percent; over half reached the top 10 percent; and nearly three-fourths were in the top fifth of the income distribution.

Moreover, Americans are moving to the top of the income ladder without inheritances. Thus, an investigation into the 2013 Forbes list of the 400 wealthiest Americans found:

More than two-thirds (68 percent) of the billionaires were "self-made," which means they built their fortunes without the help of inheritance.

Furthermore, according to the Internal Revenue Service, between 1992 and 2009, only 2 percent of the people on the Forbes 400 list were on it for 10 or more consecutive years.

The success of people at the bottom of the income distribution can increase inequality, because their newfound success does not improve the average incomes of the lower income brackets they left behind; rather, their economic gains are treated as gains to the higher income and wealth brackets they reach.

An analysis of portfolio investment over time reveals an unheralded reason the "rich" have become richer absolutely and relative to the "poor." The top 1 percent of households hold over a third of the country's total wealth, while the bottom two quintiles hold a fraction of that wealth. As such, the rich are able to develop and maintain highly diversified portfolios of investments, including stocks, bonds, derivatives, insurance, precious metals, degrees, multiple homes and other real estate holdings. The ability of the rich to safely diversity their portfolios allows them to take on riskier investments without incurring the hazards associated with the far less diverse portfolios of lower income individuals.

Moreover, pundits often fail to appreciate the direct and indirect ties between the Federal Reserve's monetary policy and the distribution of wealth and income.

When the Great Recession emerged with force in 2007, the Federal Reserve pushed down interest rates drastically with the expectation of stimulating the economy. The drop in interest rates negatively affected many low-income people who relied on their small amount of interest income earned from bank savings accounts. At the same time, the Fed padded the pockets of firms deemed "too big to fail," giving the privileged firms a form of government-backed insurance for their future profit streams and adding upward pressure on stock prices. As a consequence, the wealth of rich people has escalated over the last several years.

Finally, family breakdown is a large contributor to poverty. Households in the top income brackets are far more likely to be married, stay married and have children after marriage, while households in the bottom income brackets are far more likely to be single-parent households. Wealth taxes, such as those proposed by Piketty, can retard the future accumulation of wealth, with negative consequences for people down the income ladder who depend on capital accumulation for growth in the number of income-producing jobs.    

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