The Myth of Income Inequality

published July 2014
The American dream is not dead yet
magazine cover

One of the best-selling books of 2014 is Capital in the Twenty-First Century by French economist Thomas Piketty, a 696-page doorstop tome on economic history. Why is a data-heavy treatise from the “dismal science” so appealing? Because it is about income inequality and immobility, which in a December 2013 speech President Barack Obama called “the defining challenge of our time,” concluding that it poses “a fundamental threat to the American dream.” But does it? Maybe not.

The rich are getting richer, as Brookings Institution economist Gary Burtless found by analyzing tax data from the Congressional Budget Office for after-tax income trends from 1979 through 2010 (including government assistance). The top-fifth income earners in the U.S. increased their share of the national income from 43 percent in 1979 to 48 percent in 2010, and the top 1 percent increased their share of the pie from 8 percent in 1979 to 13 percent in 2010. But note what has not happened: the rest have not gotten poorer. They’ve gotten richer: the income of the other quintiles increased by 49, 37, 36 and 45 percent, respectively.

The pie metaphor is deceptive because a pie is of a fixed size such that if your slice is larger, then someone else’s is smaller. But economies grow, and the pie gets larger such that you and I can both get a larger slice compared with the slices we got from last year’s pie, even if your slice increase is relatively larger than mine. A report released by the Federal Reserve in early 2014, for example, noted that the overall wealth of Americans hit the highest level ever, with the net worth of U.S. households rising 14 percent in 2013, which is an increase of almost $10 trillion to an almost unimaginable $80.7 trillion, the most ever recorded by the Fed. Of course, on a planet with finite resources such an expansion cannot continue indefinitely, but historically capital and wealth production shifts as industries change from, say, farming and agriculture to coal and steel to information and services.

What about income mobility, which President Obama also identified as a problem? Writing in the National Tax Journal, economists Gerald Auten and Geoffrey Gee analyzed individual income tax returns between 1987–1996 and 1996– 2005 and found that for individuals age 25 and up, “over half of taxpayers moved to a different income quintile and that roughly half of taxpayers who began in the bottom income quintile moved up to a higher income group by the end of each period” and that “those with the very highest incomes in the base year were more likely [than those in other quintiles] to drop to a lower income group.” In fact, they found that “60 percent of those in the top 1 percent in the beginning year of each period had dropped to a lower centile by the 10th year. Fewer than one fourth of the individuals in the top 1/100th percent in 1996 remained in that group in 2005.” In a follow-up study that included income data through 2010, the economists found that “approximately half of taxpayers in the first and fifth quintile remained in the same quintile 20 years later. About one-fourth of those in the bottom moved up one quintile, while 4.6 percent moved to the top quintile.”

One reason for the controversy is that people overestimate differences between the rich and poor. In a 2013 study published in Psychological Science entitled “Better Off Than We Know,” St. Louis University psychologist John R. Chambers and his colleagues found that most people estimate that the richest 20 percent make 31 times more than the poorest 20 percent (it is 15.5 times), and they believe that the average annual income of the richest 20 percent of Americans is $2 million, whereas in fact it is $169,000, a perceptual difference of nearly 12 times. “Almost all of our study participants,” the authors concluded, “grossly underestimated Americans’ average household incomes and overestimated the level of income inequality.”

So both income inequality and social mobility, though not as ideal as we would like them to be in the land of equal opportunity, are not as large and immobile as most of us perceive them.

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74 Comments to “The Myth of Income Inequality”

  1. Liz Says:

    Yes the pie gets bigger but it doesn’t take into account that prices naturally rise as well. What $5 purchased during my grandfather’s versus my mother’s versus my 20s is a drastic change. So yes… I’m makin more. But my purchasing power has declined. Hence why income inequality is still in existence.

    A better question is why are we explaining economics 101 to citizens? Why is this not discussed in schools along with basic budgeting and loan information? Shouldn’t basic money and life skills be an important class?

  2. Bill Morgan Says:

    Nathan Krawitz,

    What you said in 10 paragraphs could have been said in two well constructed paragraphs. Suggest you have an Editor review your material before you post and shorten it down to about 25% of what you said and say the same thing. Perhaps you should take an Editing Class at a local college.

  3. Phea Says:

    Good grief, even the Wizard himself, Alan Greenspan, admitted before Congress that his world view,(he was serious Ayn Rand devotee), was BASICALLY FLAWED!

    How any intelligent person can still peddle Objectivism and Libertarian tripe with a straight face is truly amazing. Here’s Greenspan, crushed, beaten, wrong, and admitting it, (at the end of the video).

  4. George Salis Says:

    The Federal Reserves artificially inflates fiat currency and tinkers behind tightly shut doors and windowless rooms interests and other factors. Huxley stated that for people to live in a democracy, for democracy to even exist, citizens should be able to make informed decisions. Now how can they make informed decisions when numbers are tweaked and edited at the mercy (or mercilessness) of the Fed and the Fed’s newly appointed troll? The answer is they can’t, and that was the reason for the housing bubble and collapse. With a central banking system like the Fed, we are living in an illusion that can’t go on forever. So, I’d invite you, Shermer, to figure that into account.

  5. t payne Says:

    If you think Greenspan, while Fed president, acted as a libertarian, you are as out of touch with reality as most of us who never learned economics in one lesson. The flaw that Greenspan noted is the problem with Keyneysianism and it’s magical thinking and flawed foundation. Just like Pinkety’s foundation.
    Capitalism is not the problem, rather it is the lack of capitalism that through our money itself, through monetary manipulation and government favoritism, has tilted the market toward those haves, and away from those have-nots.

  6. Steve Reilly Says:

    I don’t know why Shermer didn’t link to the Federal Reserve study he cites (or even name it) but here’s one Fed study I found from early 2014 that surely makes the case that income inequality has been increasing during the Great Recession:

    If he’d care to link to the one he means, it would make it much easier to judge the merits of his argument. It would also make it easier to not suspect that article doesn’t back up his arguments as much as he thinks.

  7. Michael Says:

    I often disagree with Dr. Shermer but this is one time I would let him some slack.
    More Americans are poorer than ever BUT the median income IS HIGHER so let’s admit that which is true…the largest share of Americans have stayed bouyant in this disaster that began so obviously in 2004, with only the actual product creating section being ‘flushed’

  8. Kevin Geyer Says:

    Judging by the amount of venom in these comments, it looks like Mr. Shermer’s article was received with the opened-mindedness of an Ayn Rand novel presented to the Marxist society.

    The biggest fault I can find with this article is that the quoted statistics are all based on income tax data and it is well documented that almost half of American adults pay no federal income tax. Both Mr. Shermer and the commenters on this page might be more convincing if they used a more representative data source.

  9. Steve Reilly Says:

    They aren’t all based on income tax data. He mentions this one but it’s not based on income tax data:

  10. Bill Morgan Says:

    Watch Bill Still’s new video Jekyll Island: The truth behind the Federal Reserve.

    It shows how the Central Bankers have gamed the money system so the top 0.1% of the population feeds off of the bottom 99.9% of the Income Earners. The Central Bankers are parasites who suck blood from the tax payers who create the real wealth.

  11. Shane Riley Says:

    I find some of the comments critical of this article amusing. They seem like knee-jerk political reactions which spout out their own preconceived notions about inequality. This is a very complex issue and cannot be summed up in a column (which I think is the root problem here). Also, you can always argue: “you should have used the top 10%, 5%, 1%, 0.004%, etc. and that would have made the numbers come out the way I want, then you would see the inequality!”

    That is not the point. To me, the main point that Shermer is trying to make is more qualitative: Just because Paul gains wealth does not necessarily mean that Bob loses wealth. In a dynamic economy, the amount of wealth is not fixed. Because the “pie” grows, it is possible, and often does happen, that both rich and poor can simultaneously gain. Because the rich gain relatively more than the poor, we may call that some type of “inequality,” but it probably has both good and bad economic effects and, in and of itself, is not inherently bad.

    Unfortunately, the human mind tends to operate in a zero-sum world (probably due to evolution), but modern economics is much more complex than that, so the dynamism of the economy must be studied and learned. Thus, sweeping statements which automatically assume that all “inequality” is automatically bad should be viewed skeptically. That’s it people, so stop freaking out.

    To some of those referencing the “Power Elite,” and asking “who does Shermer really work for?” Seriously? Why are you on a skeptic blog? Sounds like conspiracy theory claptrap to me.

  12. Bill Morgan Says:

    Shane Riley, “Just because Paul gains wealth does not necessarily mean that Bob loses wealth.” Wrong. The Big Banks were bailed out by the American Tax Payers over and over again over the last 100 years since the Federal Reserve was established. To the amount of hundreds of Billions of dollars. Central Bankers Win. Taxpayers Lose. A 12 year old can research this on Google and get to the truth.

    Check out “33 conspiracies that actually happened” on Google. MS once told me in an email that he does not believe in ANY Government Conspiracies. He does not believe in ANY Government False Flag operations. This is nonsense. A 12 year old can research and find out there are conspiracies and false flag operations. So which Intelligence Agency does MS really work for?

  13. Gabriel Says:

    One article you disagree with and that makes some of you a Michael Shermer expert? Claiming to know exactly what kind of person he is? Thank you to those who respectfully disagree. And please think about how much credibility one would have if you agreed with him/her on everything.

  14. Mani Deli Says:

    To totally dismiss Micheal Shermer on account his opinions here is unfortunate. I will continue to read his generally informed intelligent opinions in spite of my total disagreement with the above.

  15. Shane Riley Says:

    Bill Morgan, Just for the record, I too am AGAINST bank bailouts and the Federal Reserve in general. I do think that the system is “rigged” in this sense. I am FOR a precious metal standard of objective value (gold or otherwise), instead of Government fiat. I agree with the sentiment that central bankers win and taxpayers lose. Government bailouts are creating a moral hazard that socialize bank losses and we all pay for them.

    But this changes NOTHING about the fact that the wealth is not a zero-sum game. These are too different things.

    By the way, I’m pretty sure that Shermer believes everything I have said above, too. I have no reason whatsoever to suspect that he is being used by some larger organization or that this isn’t really his opinion. Sorry, but I’m not going there.

  16. Randy Grein Says:

    I too was disappointed with Michael’s limited grasp of economics, as well as his long history of libertarian bias. That doesn’t mean I will stop reading his articles; on other subjects he is thoughtful and through; but even in this area it’s useful to read opposing views.

    What surprised me most is that all commenters (so far) have missed the elephant in the room – Michael discounts investment income, which was a cornerstone of the book he was reviewing. Going up the economic scale earned income plays a progressively smaller part in total income and investments rule. The huge rise in total ownership at the top pretty much says it all.

    Michael is right to point out the fallacy of assuming the size of the economy is static. It’s not a zero sum game. That doesn’t mean the increase is distributed evenly, or even that one group or another will keep what they have. Mapping the US economy from 1870-2010 shows this conclusively; the rise of the middle class corresponds with a decrease in inflation-adjusted billionaires; the diminution of the middle class since 1970 follows an increase in the number of inflation-adjusted billionaires.

    Given the number of studies I have seen that agree with Mr. Picketty I would need a much more convincing argument and better data to take Michael seriously. He is not an economist and the evidence presented is necessarily sketchy; there isn’t room in a blog to do more. As a rebuttal it falls short. It does provide some interesting things to think about, but I think Michael should take his own advice about believing myths. Under all conditions and in all subjects we need to be skeptical of our own biases most of all.

  17. James Says:

    “MS’s work is as scientific as his main field is; ie. psychology. Wanna read real skeptics? Go for Tomas Szasz for example.”

    Tomas Szasz? Seriously? He is not a skeptic. He is a mental illness denier.

    Just compare Shermer’s Wikipedia page information to Szasz’s. Tonas Szasz is known for only one thing….mental illness denial.

    Skepticism is a discipline that encompasses all human thought, not just ideas you don’t like or disagree with. Everyone is skeptical of ideas that don’t fit their own world views, beliefs, or ideologies.

  18. Francisco G Nobrega Says:

    Many mentioned that our “skeptic” believes in Government and question his sources. No wonder, MS believes also fervently in anthropogenic catastrophic global warming, a fine construct from a bunch of interested parties, one of them Al Gore. Since then I lost interest in The Skeptic. About inequality, it is a serious issue and the problem is what con be done for those in want because inequality will always exist, people are different in their ability and interest in amassing fortune. I was much impressed by the solution proposed by Charles Murray, a well known libertarian in “In our hands – a plan to replace the welfare state”

  19. plebrise Says:

    Whenever I see a claim on how “economy grows” I smell a rat. If any scepticism should be applied then it’s to the idea that income, like some mysterious alchemy, is able to grow. This omits the fact that income (like any other assets) simply change hands. Nothing has grown, because every sterling has either come from a consumer, debt payer, profit made on the back of cheap workforce, bonus payout, salary, share, inheritance or family wealth. In other words – they came from other people’s wallets, debts, unpaid or much less paid work. That profit didn’t just grow all by itself. It was generated by other people.

    A lot can be said about Michael Shermer clearly not having any personal experiences of poverty, or of having done unpaid work such as caring for babies or relatives whilst not having anyone supporting him or having earlier earnings to rely on. If he did, he would never have minimised the actual damage that poverty causes.

    Someone who better debunks poverty myths is the writer and reporter Erika Eichelberger. Here she argues against rationalisations made by National Review Online:
    It’s worth reading her earlier articles on the subject too.

  20. plebrise Says:

    Ops, amongst money changing hands I forgot speculation on properties and the stock market. Sure, it may look like a “growth” when a property or a share has increased in value but all that’s actually happened is that they are now bidded at a higher price after a bunch of rich gamblers have hyped up its value.

    A typical attempt on their part to avoid paying tax and instead labelling their gambling as “investments” to be sold for maximum profit until these bubbles burst.

    That’s not growth. It’s gambling. And the result of these gambles are not some mythical “trickle down effect” but economic downturns for which all of us but mostly the poorest people get blamed for.

  21. William Penfield Says:

    Economic inequality is not a bad thing, except when the politicians are in charge of distributing economic benefits. Then the politically well-connected get very rich, and everyone else gets very poor, a situation that becomes worse over time as there is ever less wealth to redistribute, resulting in Cuba, North Korea, and Detroit. When the free market is allowed to be free, everyone gets wealthier, and the people who produce the wealth get very rich. This is something we should encourage. The richer the other guy gets, the wealthier we are.

  22. Nathan Pen Says:

    Shermer, thank you for having the guts to publish the truth about income inequality even thought you will have to apologize to the “victim crowd” most of which are (were) your followers.

  23. plebrise Says:

    “When the free market is allowed to be free, everyone gets wealthier”.

    That’s a rich myth which really needs questioning. Because it’s just like saying “take away laws & police enforcement and all thugs will behave”. It simply is not true.

    An unregulated market does not make it free. There has been no evidence to support that. What has been noted is that deregulated markets have enabled unscrupulous business-men* to take over and limit economic chances for everyone else.

    – This is seen when the wealthy elite only sponsor parties that protects their sponsors’ interests at the expense of the public’s needs.
    – This is seen when mass marketing and publicity is only made affordable to the richest corporations, leaving other businesses, political parties and organisations unable to gain same exposure.
    – This is seen when every world leader come from same 5 elite universities (of which at least 2 are funded by poor people’s taxes).
    – This is seen when the legal system is made affordable to the rich, but not the poor. Leaving poor people unprotected from the onslaughts on their wages, working conditions, rights to benefits, housing, health and well-being without the ability to sue or even get advice on their legal rights.
    – This is seen when parenting and caring of relatives is not valued as work, which leaves mostly women** struggling on benefits.
    – This is seen when most working-class jobs are so badly paid that people are constantly struggling to make ends meet, leaving them no time, or peace of mind, to prosper.
    – This is seen when wealthy investors force poor people out of their homes once an area becomes more desirable for richer people to move in to.

    The examples are endless, but they all prove one thing:

    [b]We cannot achieve a free market by deregulating it.[/b]

    Because a truly free market requires regulation (policing if you like) so that wealth does not concentrate in few unscrupulous hands. Because wealth needs to be redistributed (taxed if you like) to enable all of us to prosper. Be it financially or in other areas like arts, developing projects, doing research, parenting, caring for others, scientific studies, inventions, etc. That’s when we get a truly free market.

    *yes, they are usually men, white and come from privileged backgrounds.
    **yes, most parenting and caring of elderly or disabled relatives is carried out by women, who don’t get paid for it.

  24. Kernos Says:

    Shermer gives a rather egregious presentation of incomparable statistics to attempt convince us skeptics that all is well in the land of the ‘free’. Only one with Shermer’s net worth would dare such obfuscation.