Workers & Economic Inequality

Graph: Redefining Income Inequality Won’t Make It Go Away

Post by: Benjamin Landy , on July 2, 2013

Income inequality hasn't grown at all over the last two decades. At least, that's the argument advanced by conservative economist Richard Burkhauser (along with co-authors Philip Armour and Jeff Larrimore), who claims in a new paper that it is the fortunes of those at the bottom, not the top of the income distribution, that have grown the most since 1989.

That may come as a surprise to America's struggling poor and middle class. Yet as it turns out, it's relatively easy to come to this conclusion: All you have to do is change everything about how "income" is actually defined.

The New York Times' Tom Edsall has already done a fine job summarizing some of the many objections to Burkhauser's paper; Dean Baker and Jared Bernstein, too, pen excellent responses. But, as Baker points out, such a "peculiar and counter-intuitive" methodology demands repeat deconstruction and debunking to prevent its adoption by right-wing talking heads. (Already, Reihan Salam at the National Review is floating Burkhauser's research as evidence that 'the science isn't settled' on income inequality.)

To understand how Burkhauser's methodology diverges from the traditional view, it helps to first look at how the nonpartisan Congressional Budget Office measures inequality. In its most recent report, the CBO constructs a definition of market income that takes into account regular income like wages and other compensation (retirement plans, employer-sponsored health insurance premiums, the employer's share of Social Security and Medicare); subtracts federal taxes (including negative taxes like the Earned Income Tax Credit); and then adds government transfers (Social Security, unemployment insurance, housing assistance, food stamps, and so on). Finally, the CBO adjusts income for inflation and household size. 

With this comprehensive definition of "income" in hand, the CBO finds that inequality surged between 1979 and 2007, with the vast majority of growth happening at the very top of the income distribution.

You've probably seen some version of this graph before:  

For his own inequality measure, Burkhauser keeps most of the CBO's methodology in place, but with one major difference. Where the CBO uses tax data that includes realized capital gains (the profit made by the sale of stock or some other financial asset), Burkhauser et al. include unrealized capital gains—that is, the fluctuating value of assets whether or not they're sold—such that the growth in asset values appear as a series of incremental annual income gains.

For example: Let's say I received a $50,000 salary in 2005, and own a $200,000 apartment. The next year my salary stays the same—$50,000—but property values in my neighborhood rise 5 percent, meaning my apartment is now worth $210,000. Even though my standard of living is exactly the same, Burkhauser would say my "income" in 2006 was actually $60,000—a $50,000 salary plus $10,000 in unrealized capital gains—a 20 percent annual increase.

Calculating income in this manner may have some merit, according to Baker, since the decision of when to sell an asset is both arbitrary and highly dependent on current tax rates. Realized gains do not necessarily reflect when the gain actually took place, and evidence suggests that households change their spending behavior in response to rising wealth regardless of whether that wealth is realized. 

This "wealth effect" is very real, and helps explain why consumer debt and spending soared during the mid-2000s, as home values grew between 10 percent and 20 percent year-over-year. But it also helps explain why the U.S. economy sank quickly into recession when the housing bubble popped in late 2006. 

In other words, if you're going to to include unrealized capital gains as yearly-accrued income in a study of inequality, you better be really careful about which years you pick as your starting and ending points. And this is where it becomes obvious that Burkhauser's claims cannot be taken seriously.

Burkhauser sets his base year as 1989, just a few years before the housing bubble began to take off, and ends in 2007, just as housing values are beginning to fall. As a result, he includes a massive build-up in illusory, speculative housing wealth—the only asset class held overwhelmingly by middle-class families—and counts that towards their twenty-year income gains. Middle class incomes are further inflated by Burkhauser's inclusion of "imputed rent," which means he adds the rental value of housing to homeowners' income, as if people paid themselves to live in their own homes.

Burkhauser is similarly misleading by starting in 1989, a year in which the S&P 500 rose by more than 27 percent. As Jared Bernstein notes, this allows him to lower the top quintile's stock market gains going forward. "By contrast, if Burkhauser had chosen 1987, when the S&P fell more than 6 percent, he would have a much lower base. This would make the growth in income for the top quintile appear much larger."

Of course, the year that Burkhauser stops measuring bubble-fueled "income" is the same year that the housing market collapsed, wiping out nearly half of the middle class's net worth.

This does not figure in his calculations. Neither does the subsequent stock market rebound that began in 2009, sending the ratio of top 1 percent wealth to median wealth from 181:1 to 288:1, a staggering 60 percent rise in inequality.

  

There are a number of other problems with Burkhauser's research that should discredit his results. He doesn't account for the switch from defined benefit pensions to defined contribution (401k) plans, which has the effect of artificially inflating middle-class wages. He assumes that everyone receives the same returns on their investments, artificially depressing the gains of the top of the income spectrum relative to everyone else. And he diverges from the CBO's practice of counting only the fungible value of government health benefits, instead attributing the full cost of Medicare, Medicaid, and Children’s Health Insurance Program (CHIP) benefits to the poorest two quintiles as if they were cash-in-hand.

This distinction is particularly significant for the United States, where the cost of Medicare for a couple is nearly $25,000. Since low-income people would not otherwise purchase health insurance, government-provided care cannot reasonably be counted as a cash substitute, as employer-sponsored insurance can for higher-income individuals. Low-income families in particular do not experience a higher standard of living when their health benefits become more expensive. On the contrary, the only people who benefit are health care providers.

Still, these are minor points next to the overarching intellectual dishonesty of Burkhauser et al.'s 1989-2007 time frame, which, in combination with the inclusion of yearly-accrued unrealized capital gains, can only be interpreted as having been selected to elicit their intended result. (Whether they were driven by ideology or heterodoxy is beyond me.)

The study of income inequality is meaningful only to the extent that it measures real differences in Americans' standard of living, relative to themselves and to their neighbors. Redefining income as some kind of theoretical accounting construct will not make those differences go away.

Tags: income inequality, burkhauser

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