The Myth of Increasing Income Inequality

President Obama’s new fiscal year 2013 budget, with its proposed tax-rate hikes, reflects the misguided assumption that income inequality in the U.S. has increased in recent years. Populist cries for redistribution as a means to remedy this purported inequality have gained currency in both the press and in the public imagination.[1] This paper, based on an original analysis of U.S. Labor Department data, concludes that inequality as measured by per capita spending is no greater today than in it was in the 1980s.

Below, I examine in more detail the following topics:

• Problems with current measures of inequality
• Accounting for changes in demographic patterns over time
• Using spending to measure inequality

I conclude that the increase in income has been exaggerated. Published government spending data by income quintile show that the ratio of per person spending between the top and bottom 20 percent has essentially not changed between 1985 and 2010. In terms of total spending, inequality has diminished slightly, rather than increased.

Why do other measures show increasing inequality? First, many studies use measures of income before taxes are paid and before transfers, such as food stamps, Medicaid, and housing allowances. Including these transfers reduces inequality.

Second, many studies do not take into account demographic changes in the composition of households over the past 30 years. These changes include more two-earner households at the top of the income scale and more one-person households at the bottom. Studies that show increasing inequality are capturing these demographic changes.

Third, some of this increase in measured inequality is due to the Tax Reform Act of 1986, which lowered top individual income-tax rates from 50 percent to 28 percent, leading more small businesses to file taxes under individual, rather than corporate, tax schedules.[2]

A superior measure of well-being that avoids these pitfalls is spending per person by income quintile. Spending power shows how individuals are doing over time relative to those in other income groups. These data can be calculated from published consumer expenditure data from the government’s Consumer Expenditure Survey. An examination of these data from 1985 through 2010 shows that inequality has declined rather than increased.

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