Tuesday, March 20, 2012

Measuring Inequality

I recently saw an article in Slate which was fine as far as it went, but which prompted me to deliver a bit of a rant at Hacker News about how we talk about income inequality in America, which I've cleaned up a bit and am also posting here.

The first thing that annoys me about how most people talk about inequality in America is that people often just use one metric, and ignore all the others.  You could talk about:

  1. Total Compensation - including untaxed things like health insurance as well as paychecks and capital gains.
  2. Taxed income - which the SSA confusingly refers to as "Total Compensation", which is income plus capital gains and bonuses but not things you don't pay taxes on.
  3. Pure income - your paycheck.
  4. Wealth -  how much you have in your bank account plus how much your house is worth.
  5. Private consumption - how much you spend each year on stuff for yourself, rent and food and fun things.
  6. Total consumption - private consumption plus whatever goods and services the government provides for you.
I always tend to prefer to look at consumption, because that is the metric that effects how people live.  Lets say the government passed some new law that said that all income from whatever source was going to be taxed at 100% and redistributed equally among all Americans.  That, I think, would be a pretty egalitarian society but it wouldn't change the US income statistics one iota.  It would, however, show up in the US consumption statistics.  Wealth is an even worse measure, since even in a perfect Utopia where everyone received the same paycheck each year the people who are just retiring are going to be much, much wealthier than the people who are just getting out of college.  

Also, its important to distinguish between statistics that are computed at a household level and statistics that are computed at an individual level.  Poorer households tend to have more children, but that effect is smaller than the extent to which higher income households are likely to have two adults and to be older and thus more likely to be married or have more children.

Another problem with the graph in the linked article is that it treats income before and after 1986 the same way, and doesn't even mention the huge discontinuity in the data that happens in 1986. The 1986 tax reform act strongly incentivised rich people to report things as income which they had previously claimed were business expenses. That does mean that the numbers after 1986 are more comparable to the numbers from before people started feeling the need to claim that things were business expenses, but it does mean that the numbers from 1988 aren't really comparable to the numbers from 1982. And its hard to compare across countries since AFAIK most of Europe is closer to the pre-1986 US system than the post-1986 US system.

And speaking of Europe, its important to remember than income inequality has been rising at more or less the same rate everywhere in the industrialized world (baring the US's 1986 jump). See pretty graphs here.  Now, I should point out that many other countries do more income redistribution than the US does, so similar share of income by the top 1% don't necessarily mean the same thing in different countries, but that's just another reason to look at consumption inequality instead.

Now, its true that the link in the last paragraph only talks about pure income, and doesn't deal with capital gains and such.  As far as I know other countries are broadly similar to the US in how they deal with this issue, but it would still be really nice to change the US tax code to make capital gains as progressive as income, either through a Friedmanequse system or through a consumption tax.  

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