How Data On Income Distribution Are Misunderstood And Misapplied

Investor’s Business Daily | by Thomas Sowell | Jan. 8, 2010

Most intellectuals outside the field of economics show remarkably little interest in learning even the basic fundamentals of economics. Yet they do not hesitate to make sweeping pronouncements about the economy in general, businesses in particular, and the many issues revolving around what is called “income distribution.”

Famed novelist John Steinbeck, for example, commented on the many American fortunes which have been donated to philanthropic causes by saying:

One has only to remember some of the wolfish financiers who spent two thirds of their lives clawing a fortune out of the guts of society and the latter third pushing it back.

Despite the verbal virtuosity involved in creating a vivid vision of profits as having been clawed out of the guts of society, neither Steinbeck nor most other intellectuals have bothered to demonstrate how society has been made poorer by the activities of Carnegie, Ford or Rockefeller, for example — all three of whom (and many others) made fortunes by reducing the prices of their products below the prices of competing products.

Lower prices made these products affordable to more people, simultaneously increasing those people’s standard of living and creating fortunes for sellers who greatly expanded the numbers of their customers. In short, this was a process in which wealth was created, not a process by which some could get rich only by making others poorer.

Nevertheless, negative images of market processes have been evoked with such phrases as “robber barons” and “economic royalists” — without answering such obvious questions as “Just who did the robber barons rob when they lowered their prices?” or “How is earning money, often starting from modest circumstances (or even poverty-stricken circumstances in the case of J.C. Penney and F.W. Woolworth) the same as simply inheriting wealth and power like royalty?”

The issue here is not the adequacy or inadequacy of intellectuals’ answers to such questions because, in most cases, such questions are not even asked, much less answered. The vision, in effect, serves as a substitute for both facts and questions.

This is not to suggest that nobody in business ever did anything wrong. Saints have been no more common in corporate suites than in government offices or on ivy-covered campuses. However, the question here is not one of individual culpability for particular misdeeds.

The question raised by critics of business and its defenders alike has been about the merits or demerits of alternative institutional processes for serving the economic interests of society at large.

Implicit in many criticisms of market processes by intellectuals is the assumption that these are zero-sum processes, in which what is gained by some is lost by others. Seldom is this assumption spelled out but, without it, much of what is spelled out would have no basis.

Perhaps the biggest economic issue, or the one addressed most often, is that of what is called “income distribution,” though the phrase itself is misleading, and the conclusions about income reached by most of the intelligentsia are still more misleading.

Variations in income can be viewed empirically, on the one hand, or in terms of moral judgments, on the other. Most of the contemporary intelligentsia do both. But, in order to assess the validity of the conclusions they reach, it is advisable to assess the empirical issues and the moral issues separately, rather than attempt to go back and forth between the two, with any expectation of rational coherence.

Given the vast amounts of statistical data on income available from the Census Bureau, the Internal Revenue Service and innumerable research institutes and projects, one might imagine that the bare facts about variations in income would be fairly well known by informed people, even though they might have differing opinions as to the desirability of those particular variations.

In reality, however, the most fundamental facts are in dispute, and variations in what are claimed to be facts seem to be at least as great as variations in incomes. Both the magnitude of income variations and the trends in these variations over time are seen in radically different terms by those with different visions as regards the current reality, even aside from what different people may regard as desirable for the future.

Perhaps the most fertile source of misunderstandings about incomes has been the widespread practice of confusing statistical categories with flesh-and-blood human beings.

Many statements have been made in the media and in academia, claiming that the rich are gaining not only larger incomes but a growing share of all incomes, widening the income gap between people at the top and those at the bottom. Almost invariably these statements are based on confusing what has been happening over time in statistical categories with what has been happening over time with actual flesh-and-blood people.

A New York Times editorial, for example, declared that “the gap between rich and poor has widened in America.” Similar conclusions appeared in a 2007 Newsweek article that referred to this era as “a time when the gap is growing between the rich and the poor — and the super-rich and the merely rich,” a theme common in such other well-known media outlets as the Washington Post and innumerable television programs.

“The rich have seen far greater income gains than have the poor,” according to Washington Post columnist Eugene Robinson. A writer in the Los Angeles Times likewise declared, “the gap between rich and poor is growing.”

According to Professor Andrew Hacker in his book “Money”: “While all segments of the population enjoyed an increase in income, the top fifth did 24 times better than the bottom fifth. And measured by their shares of the aggregate, not just the bottom fifth but the three above it all ended up losing ground.”

Although such discussions have been phrased in terms of people, the actual empirical evidence cited has been about what has been happening over time to statistical categories — and that turns out to be the direct opposite of what has happened over time to flesh-and-blood human beings, most of whom move from one category to another over time.

In terms of statistical categories, it is indeed true that both the amount of income and the proportion of all income received by those in the top 20% bracket have risen over the years, widening the gap between the top and bottom quintiles.

But Internal Revenue Service data following specific individuals over time show that, in terms of people, the incomes of those particular taxpayers who were in the bottom 20% in income in 1996 rose 91% by 2005, while the incomes of those particular taxpayers who were in the top 20% in 1996 rose by only 10% by 2005 — and those in the top 5% and top 1% actually declined.

While it might seem as if both these radically different sets of statistics cannot be true at the same time, what makes them mutually compatible is that flesh-and-blood human beings move from one statistical category to another over time.

When those taxpayers who were initially in the lowest income bracket had their incomes nearly double in a decade, that moved many of them up and out of the bottom quintile — and when those in the top 1% had their incomes cut by about one-fourth, that may well have dropped them out of the top 1%.

Internal Revenue Service data can follow particular individuals over time from their tax returns, which have individual Social Security numbers as identification, while data from the Census Bureau and most other sources follow what happens to statistical categories over time, even though it is not the same individuals in the same categories over the years.

. . . more