The Myth of American Inequality

Culture - May 27, 2024

For forty years, I have been a member of the Mont Pelerin Society, an international society of conservative and classical liberal scholars and men of affairs who meet once a year or so to discuss the principles and challenges of a free society. Coming from a small and remote country, I have benefitted much from attending the meetings and listening to some of the world’s most profound thinkers. The latest meeting was at the end of October 2023 in Bretton Woods in New Hampshire, at the same hotel (depicted above) as the conference in July 1944 where the international economic order to be established after the Second World War was being designed under the leadership of John Maynard Keynes. I found one lecture in particular instructive, by former U.S. Senator Phil Gramm, who had been an economics professor before he entered politics. He spoke about the ‘myth of American inequality’. Immediately after the conference, I obtained a book he has written about this topic, with Robert Ekelund, professor emeritus of economics and author of many scholarly books and papers, and  John Early, a mathematical economist and former assistant commissioner at the Bureau of Labor Statistics. It is a readable work which refutes many current cliches, also prevalent in Europe. Senator Bernie Sanders exclaims, for example: ‘The obscene and increasing level of wealth and income inequality in this country is immoral, un-American and unsustainable.’ Even The Economist writes: ‘It is a truth universally acknowledged that inequality in the rich world is high and rising.’ The main message of the book by Gramm and his associates is that American inequality is largely a myth. The gap between rich and poor is much smaller than official statistics would suggest.

40 Per Cent of Income Not Counted!

There are two main reasons why the gap between rich and poor in America is much smaller than often believed. In calculating the income of the poor, the U.S. Census does not include most transfer payments to this group, and in calculating the income of the rich, it does not include tax payments from this group. There was a reason why the Census initially, in 1947, did not calculate transfer payments. They were then a small part of income, and somewhat difficult to estimate. Usually, households in the United States are divided into five groups, or quintiles, where the lowest-income quintile would be ‘the poor’, and the highest-income quintile would be ‘the rich’. According to the Census, the average income of the richest (top) quintile in 2017 was 16.7 times higher than the average income of the poorest (bottom) quintile. The Census also finds that the percentage of Americans living in poverty has been largely unchanged since the 1960s.

This is all wrong. The Census does not count two-thirds of transfer payments, most of which (68 per cent) end up with the poorest two quintiles. In 2017—the latest year with complete data—transfer payments amounted to no less than $2.8 trillion. Likewise, the Census does not deduct taxes from income, most of which (82 per cent) are paid by the richest two quintiles. In 2017, tax payments amounted to $4.4 trillion. This really means that the Census does not count 40 per cent of all income, either gained in transfer payments or lost in taxes. When this is however done, and all income included, the gap between rich and poor in the United States greatly narrows. The average income of the richest quintile becomes 4.0 times that of the poorest quintile, not 16.7 times, as officially stated. This is a crucial, indeed an enormous, difference.

Inequality Falling, Poverty Disappearing

In fact, when all transfer and tax payments are included, income inequality since 1947 has not risen, as is often claimed. It has fallen by 3.0 per cent. Also, if all those transfer and tax payments are included, the number of Americans living in poverty is not 12.3 per cent, as the Census claims for 2017, but 2.5 per cent. Gramm and his associates write (p. 4): ‘There are certainly people who are physically or mentally unable to care for themselves and have fallen through the cracks of the system that delivers transfer payments, but, for all practical purposes, poverty due to a lack of public or private support has been virtually eliminated in America.’

Gramm and his associates base all their findings on official statistics. But they also point out that price indices and other such statistics, even if interpreted correctly and put in proper context, do not always tell the full story. For example, when Americans started in the mid-1960s to fly rather than ride on trains or buses, in response to a fall in the relative price of air travel, the benefits were not fully captured in consumers’ indices. The same applies to the mobile phone today. It was only included in the basket of goods in consumers’ indices long after its price had fallen dramatically. If it had been included earlier, it would have shown a significant increase in purchasing power. The authors also point out the increased efficiency and efficacy of minimally invasive medical treatment and pharmaceuticals and the greater comfort, safety and size of people’s homes. (Speaking for myself, there is a great difference in how much better (or less bad) it feels to go to the dentist today than it was sixty years ago.)

Rich and Poor: Misleading labels

Gramm and his associates explain in simple, plain prose facts which are often hidden behind the averages coming from bureaus of statistics. These averages are usually snapshots from a calendar year. But during his or her lifespan an individual is migrating from one income group to another, perhaps being a low-income student for a while, then starting with a beginner’s salary at a job, gradually advancing to a higher position, one day possibly selling his or her large home or small business or collection of stocks, and finally retiring. Again, if we look at the bottom quintile, the main reason people end up there is that only a few of them work full time, for various reasons. Half of the adults in this group are retired. Of those of working age (between 18 and 65, and neither students nor retired) only 36 per cent work. Of those who do work, they put in on average only 17.3 hours a week, less than half as many hours as an average worker in the other quintiles.

Perhaps labels other than ‘poor’ and ‘rich’ would be more helpful: what makes a difference is the ability and willingness to earn an income by working. Gramm and his associates take an illuminating look at the rich, the top quintile. The main reason for the high income of households in this group is that they usually have two members in highly-paid jobs working full time. When we turn from these 20 per cent of households to the really rich, the 400 richest households in America, it is interesting that the average time a household spends in that group is only 2.01 years, largely because 60 per cent of the income in this group comes from capital gains. This is therefore atypical. As the authors point out (p. 117), most of those presently wealthy in America earned their wealth by creating economic value, thereby improving the lives of others. By contrast, the rich of the past usually obtained their wealth through the abuse of power. It was no coincidence that they were sometimes called ‘robber barons’.

In 2017, the bottom quintile of American households paid on average 7.5 per cent of their income in taxes, whereas the top quintile paid on average 35.2 per cent. It is an interesting thought experiment, described in Ayn Rand’s novel Atlas Shrugged, what would happen if the people in the top quintile would suddenly choose to leave. Would the other four quintiles quickly make up for their departure? Of course this is not a mere thought experiment. This is what happened in Cuba after the 1959 revolution when the middle class fled, taking with them all their skills and abilities; and in Algeria in 1962 when the French-speaking minority was told that it could either leave with a bag or in a bag; and in Zimbabwe after 1980 as hard-working white farmers were chased away by government-supported mobs. Breadbaskets became basket cases.

A Problem, Not a Solution

When the official figures for income distribution in the United States are corrected, they reveal that there is much less income inequality than previously believed. But this may be worrying rather than comforting. It is perhaps a problem rather than a solution. There are two ways of dealing with poverty: to facilitate moving out of it, and to facilitate remaining in it. Gramm and his associates show that in 2017, transfer payments increased the average bottom-quintile household’s income after transfers and taxes to $49,613—only $4,908 of which was earned income. This clearly produces an incentive not to seek work and to rely instead on government benefits. In 1964, President Lyndon B. Johnson declared a ‘War on Poverty’. The result has been a myriad of redistribution programmes, with baleful impact both on rich and poor, encouraging shirking, discouraging hard work and entrepreneurship. Gramm and his associates conclude (p. 68):  ‘The War on Poverty significantly increased dependency and failed in its primary effort to bring lower-income people into the mainstream of America’s economy.’