Home » CEO Briefing Newsletter » Myths and Misrepresentations About Income Inequality

Myths and Misrepresentations About Income Inequality

One of the main pillars supporting the income inequality debate has been found to be seriously flawed throwing doubt onto the claim that the rich are getting richer. In addition, there is much confusion in the public discourse when politicians talk about the wealthiest Americans. Income is not wealth — and the whole tax controversy is about income taxes.

As early as February 2009 when President Barack Obama issued his first budget, titled “A New Era of Responsibility,” a budget that resulted in a federal deficit of $1.3 trillion. The idea of income inequality—now a central campaign issue in 2012 was launched. There was a section that laid out an argument now familiar to many:

“For the better part of three decades, a disproportionate share of the nation’s wealth has been accumulated by the very wealthy. [Yet] instead of using the tax code to lessen these increasing wage disparities, changes in the tax code over the past eight years exacerbated them. … By 2004, the wealthiest 10 percent of households held 70 percent of total wealth, and the combined net worth of the top 1 percent of families was larger than that of the bottom 9 percent. In fact, the top 1 percent took home more than 22 percent of total national income, up from 10 percent in 1980.”

This section of the budget went on to cite research by economists Thomas Piketty and Emmanuel Saez who had first developed the concept of the “top 1%.” Prior to their research, the convention was to measure income shares in quintiles. The idea of creating a class of 1 percenters distinct from the 99 percenters reached full flower in the Occupy Wall Street (OWS) movement. The notion of the richest 1 percent as a group of plutocrats thwarting the aspirations of everyone else reached an apotheosis in the President’s January 2012 State of the Union address where he said: “We can either settle for a country where a shrinking number of people do really well while a growing number of Americans barely get by, or we can restore an economy where everyone gets a fair shot.” The means to do this, as the president outlined, was to ensure tax increases on those earning more than $250,000 per year, and a guarantee that the effective tax rate of those making $1million per year was at least 30%.

Such a tax, if enacted in the nation’s tax code would have devastating consequences for most business owners, those who report their business income in the individual returns. And since small businesses represent some 60 percent of employment growth the knock-on effects for jobs would be equally troubling.

But are Piketty and Saez correct? If they aren’t or if their work has been misrepresented the intellectual basis for the income redistributionists collapses like a house of cards. Such is the argument advanced by Brian Domitrovic, a Harvard educated economist who chairs the department of history at Sam Houston State University in Houston,TX. Among other criticisms Domitrovic points to research put out by the National Bureau of Economic Research last year, authored principally by Cornell economist Richard V. Burkhauser, titled, “Second Opinion’ on the Economic Health of the American Middle Class.” The premise was simple: measure income conventionally, which means including two things omitted by Piketty and Saez in their calculations. Burkhauser and his team counted in their income measures standard non-reported income, health benefits, and government transfers, which Piketty and Saez had declined to use.

In addition to undercounting of median family income, Domitrovic argues that Piketty and Saeze massaged corporate income statistics, to show that income inequality is higher when tax rates are lowered and increased when personal rates are increased. The fact is the rich have had a fairly consistent slice of wealth over the last century since the income tax was created in 1913. There was no “golden era,” as Piketty and Saeze argue, when the “rich” paid more without consequences to economic growth. The rich have always been raking in about the same proportion of income, Keynesian policy era or not. When faced with high tax rates, the rich re-arrange their affairs to shelter income from government resulting in an “epidemic of underreporting of income.” This, of course, retards economic growth. In fact, there was but one notable boom of the entire high-tax era came in the 1960s, and this came on the heels of a 30% tax cut. Every other boom of the income-tax era in the past century occurred in the context of tax rates that Piketty and Saez found unduly low.

According to the Organization for Economic Cooperation and Development (a consortium of 34 economically developed countries): “In OECD countries today, the average income of the richest 10 percent of the population is about nine times that of the poorest 10 percent.” In the United States, the gap between the top 10 percent and the bottom 10 percent is 14 to one — about the same as the gap between the rich and the poor in Israel and Turkey. For countries like Mexico and Chile, the gap is 27 to one.

True, the wealth gap grew over the last 20 years, but the so-called “Great Recession” was less than kind to the rich. From 2007 to 2009, the top 1 percent’s share of the national income declined from 23.5 percent to 18.12 percent — a drop of 23 percent. Their household wealth fell by 30 percent. Average real income for the top percentile declined 36.3 percent, versus a decline of 11.6 percent for the remaining 99 percent.

Fundamental to the misinformation about this issue in the public discourse is that the people President Obama is talking about are not the wealthiest Americans. Income is not wealth — and the whole tax controversy is about income taxes. Wealth is what you have accumulated, and wealth is not taxed, except when you die and the government collects an inheritance tax from your heirs.

People over 65 years of age have far more wealth than people in their thirties and forties — but lower incomes. If Obama wants to talk about raising income taxes, that’s a legitimate issue for debate, but claiming that he wants to tax “the wealthiest Americans” is a little more than a subterfuge and an emotional distraction.

Read: The Left’s Dubious History of Income Inequality (PDF)

Read: Texas Public Policy Foundation

About ChiefExecutiveNet

Chief Executive magazine provides global economy coverage, business and technology news, information on upcoming events, and executive life.