Income Inequality: Why It’s Not as Bad as the Media Thinks, and Why the Numbers Are Misleading

A famous phrase — often but uncertainly attributed to Mark Twain — refers to the increasing evils of “lies, damned lies, and statistics.”

No matter who said it first, it’s true that numbers are used, misused, and abused, especially in political debates. In the early twenty-first century in the United States, debates about the nature, existence, and extent of so-called “income inequality” have made generous use of statistics.

These numbers demand examination. How does one quantify income? There are numerous ways. But income is not the only way to measure economic well-being, and perhaps not the most accurate way. Some economists point out that measuring consumption, as opposed to income, is a truer measure of one’s standard of living. Edward Conard writes:

Consumption is a more relevant measure of poverty, prosperity, and inequality. University of Chicago economist Bruce Meyer and the University of Notre Dame economist James Sullivan, leading researchers in the measurement of consumption, find that consumption has grown faster than income, faster still among the poor, and that inequality is substantially less than it appears to be.

Consumption is, after all, a measure of the items which constitute a standard of living: clothing, food, housing, transportation, etc.

Income and consumption are two variables which can increase or decrease independently of each other, as Edward Conard notes:

Measures of consumption paint a more robust picture of growth than proper measures of income.

Misleading income measures assume tax returns — including pass-through tax entities — represent households. They exclude faster-growing healthcare and other nontaxed benefits. They fail to account for shrinking family sizes, where an increasing number of taxpayers file individual returns. They don’t separate retirees from workers. They ignore large demographic shifts that affect the distribution of income.

It may well be a mistake to think of “income inequality” in simplistic terms as “the gap between the highest earners and the lowest earners,” as Ben Shapiro reports. There can be low earners whose standard of living is higher than the standard of living of high earners. A simple example is retirees, whose earnings may be low, but whose standard of living is supported by a lifetime of saving and investing.

More to the point, as noted above, a low earner may receive health insurance worth thousands of dollars, and therefore have a higher standard of living than someone whose nominal income is greater.

Income gaps have reliably “widened and narrowed over time”, Ben Shapiro explains, and there is no “correlation between levels of inequality of outcome and general success of the society or individuals within it.” Income inequality at any one point in time is misleading, because it is a continuously changing variable. Income inequality between various social classes is also misleading, because mobility means that individuals are constantly moving in and out of the various classes.

It’s quite possible for income inequality to grow while those at the bottom end of the scale get richer. In fact, that’s precisely what’s been happening in America: the middle class hasn’t dissipated, it’s bifurcated, with more Americans moving into the upper middle class over the past few decades. The upper middle class grew from 12 percent of Americans in 1979 to 30 percent as of 2014. As far as median income, myths of stagnating income are greatly exaggerated

What is now called “income inequality” should be understood as an often transient condition. The fact that one person earns more and another person earns less is evil only if those individuals are irreversibly locked into those conditions. But in fact, most American wage-earners are in a position of mobility: they can work their way up, and earn more in the future.

Well-intentioned but mistaken efforts to “eliminate income inequality” lead to the unintended consequence of freezing individuals at certain income levels and reducing chances for advancement.

Income inequality exists everywhere, and “social justice” destroys personal liberty and exacerbates inequality.

Attempts to “eliminate income inequality” actually ossify inequality. Only the fluid system of a free market creates chances for individuals to move up in terms of their incomes.

Enslaving the Free Market: The Era of the “Bailout”

In August and September 2008, Lehman Brothers (officially Lehman Brothers Holdings, Inc.) filed for bankruptcy. The firm came to an end as part of an event known as the “subprime mortgage crisis.” Both executive policies and Congressional legislation gave rise to this event, or more precisely, series of events.

The policies and legislation in question encouraged or required financial institutions to give loans and mortgages to customers who were manifestly unable and unfit to repay. This money was lent primarily for the purpose of buying houses. The inevitable and foreseeable result was a wave of defaults and foreclosures: individuals and families unable to pay their monthly amounts.

As the number of defaults and foreclosures increased, the banks and other institutions who’d lent the money and who now were unable to get it back, were left with little or nothing, and went bankrupt. The number of lenders going bankrupt grew, and the size of the institutions going bankrupt grew. The pattern culminated in the bankruptcy of Lehman Brothers.

Lehman Brothers was a major company. It had more than 26,000 employees and over $600 billion in assets.

Naturally, some observers were surprised, shocked, or worried. They assumed that the bankruptcy of a major company would cause trouble for the economy. They were wrong. They had forgotten the economic principle of “creative destruction.”

It is easy to assume that, if a large corporation goes bankrupt, that this will create problems like unemployment, inventory shortages, etc.

This assumption ignores the fact that when a business fails and collapses, it creates opportunities for new businesses which are better, more effective, more efficient, bigger, more profitable, and more adapted to the marketplace. The end of an old business creates space for a new business.

Metaphors may be useful in understanding this concept: One demolishes an old building in order to construct a new, better, larger building; one cuts down some old trees in a forest in order to plant younger and healthier trees.

A bankruptcy can create short term dislocation, like temporary unemployment and a dip in the stock market. In the long run, however, it can create more jobs than it destroyed, and better-paying jobs with better chances for advancement, resulting in a net increase in prosperity. In many scenarios, workers who are laid off eventually find employment at higher wages than the job they lost. The stock market, likewise, will not only recover from a downtick, but eventually go even higher in the wake of bankruptcy.

This principle is associated with a broad variety of economists: Joseph Schumpeter, Karl Marx, Werner Sombart, etc.

Adherence to this principle would have directed that the government, in the wake of the Lehman Brothers collapse, should have refrained from any intervention, and allowed the next two companies in line to go bankrupt as well: Goldman Sachs and Morgan Stanley. Had they gone bankrupt, their workers would have found new jobs at higher wages, the stock market would have recovered from a drop and gone on to new highs, and general prosperity would have increased.

Sadly, various elected and appointed leaders in government forgot this basic principle — or never knew it to begin with.

Congress passed several pieces of legislation, primarily the Troubled Asset Relief Program (TARP) and the Emergency Economic Stabilization Act of 2008. These legislations gave billions of dollars to companies which were in danger of going bankrupt. In addition to Goldman Sachs and Morgan Stanley, other companies soon asked for help, including Citigroup, Chrysler, American Express, and many others. The money given to these businesses came from two sources: either it was confiscated from ordinary American citizens by means of taxes, or it was borrowed, and ordinary American citizens will be required to repay this money by means of taxes.

Instead of allowing these corporations to go bankrupt — and only a few of them would have done so; the others simply asked for the money and got it — the TARP legislation kept them alive, but allowed them to remain inefficient and irresponsible. Had they gone out of business, new and more productive companies would have arisen in their places.

The end result was higher taxes for ordinary people, and debts which will have to be repaid with even more higher taxes.

This colossal misjudgment was made possible by government officials who were ignorant of basic economic principles, or who ignored them, or who forgot them.

David Stockman was a U.S. Congressman and later Director of the Office of Management and Budget. Concerning TARP, he points out that many government officials understood why it was wrong:

Certainly President Eisenhower’s treasury secretary and doughty opponent of Big Government, George Humphrey, would never have conflated the future of capitalism with the stock price of two or even two dozen Wall Street firms. Nor would President Kennedy’s treasury secretary, Douglas Dillon, have done so, even had his own family’s firm been imperiled. President Ford’s treasury secretary and fiery apostle of free market capitalism, Bill Simon, would have crushed any bailout proposal in a thunder of denunciation. Even President Reagan’s man at the Treasury Department, Don Regan, a Wall Street lifer who had built the modern Merrill Lynch, resisted the 1984 bailout of Continental Illinois until the very end.

As David Stockman shows, this was not a “Democrat” issue or a “Republican” issue. It was an issue about the basic principles of economics. A free market must be allowed to find its own way to an equilibrium.

The women and men who promoted TARP were in many cases people of good will: they legitimately wanted to help. But even well-intentioned governmental interventions in a free market economy are harmful.

The economy organically works toward an equilibrium, and at that equilibrium point lies maximal prosperity for all. The blind forces of demand and supply distribute better wages and higher standards of living to everyone in the marketplace, from the smallest to the largest.

Statist intervention in markets can only prevent the economy from achieving the best results for everyone.