The Cato Institute

The Truth About Inequality

Poverty in the U.S. has declined sharply while income inequality has risen only modestly…

Public understanding of poverty and income inequality in the U.S. has been distorted by misleading statistics.

Many U.S. politicians are promoting policies to reduce income inequality and poverty by increasing taxes and transferring more income to lower-income households. These proposals rest in part on claims that income inequality in the United States is greater than that in other Western democracies and is growing, and that poverty persists at high levels.

The usual statistics invoked to support those claims, however, are misleading.

The official poverty measure stood at 13.5% of the population for 2015 and has fluctuated between 11.1% and 15.2% of the population with no trend of improvement since the War on Poverty was instituted. This apparent lack of improvement arises from definitional gaps in the measure. 

Poverty metrics exclude about $1 trillion in annual transfer payments to lower-income households and do not account for the effects of taxes. When those transfers and tax effects are included, income inequality in the United States is lower than that in many Western democracies and has grown at rates similar to income inequality in other nations. 

Only about 2% of today’s population lives in poverty, well below the 11% to 15% that has been reported during the past five decades. In other words, income inequality in the United States is approximately three times smaller and poverty five times less frequent than generally claimed.

This result is confirmed by other independent data that show improved nutrition, health, housing, consumption, and physical wealth.

After accounting for all transfers to lower-income households and taxes paid by all households, the  ratio of spendable income between the highest and lowest quintiles drops to only 5.6 — about three times smaller than the generally publicized number.

The Gini coefficient, a commonly used measurement of income inequality, uses incomplete data and does not factor in some major income transfers in the U.S. when making comparisons internationally. Gini coefficients adjusted for missing elements in spendable income show only a modest difference between the U.S. and other large, well developed economies, such as Denmark, Sweden, and Germany. Most importantly, per capita income in the U.S. is between 16% and 40% higher than that of any of the other countries. On average, a household at any point in the income distribution for the U.S. will have higher income than a household at the corresponding point for the other countries.

Productive conversations on the efficacy and efficiency of existing and proposed policies and their economic effects require data that reflect an accurate picture of the state of income inequality and poverty in America.

Learn more…

Award Winning Films

Two films associated with the Cato Institute were recent award recipients at the Anthem Film Festival. School Inc. – Andrew Coulson’s three-part documentary on innovation in education, and Freedom on Trial – the @libertarianismdotorg courtroom drama on income inequality, were both honored at the festival. Both films are available for online viewing.

• Watch School Inc.
• Watch Freedom on Trial

The Top Five Myths about Economic Inequality

Economic inequality has risen to the top of the political agenda, championed by political candidates and best-selling authors alike. Yet, many of the most common beliefs about the issue are based on misperceptions and falsehoods.

Have you fallen for any of the top five myths about economic inequality in America?

1. Inequality has never been worse in the US. The commonly used formulas for inequality are flawed. Most claims that income inequality is at a record high in the United States are based on a measure of “market income,” which does not take into account taxes or transfer payments (or changes in household size or composition). The failure to consider those factors considerably overstates effective levels of inequality.
   
2. The rich have not rightfully earned their wealth. According to data, inheritance plays a very small role in wealth accumulation. While it is true that luck, privilege, and government policies certainly have their influences, for the most part, the rich become wealthy through their work and value creation to society.
   
3. The rich get richer, while the poor get poorer. While economic mobility might not be as robust as in the past, research has shown that it is rare for someone to spend extended periods of time in any income bracket, rich or poor. Only about 2.2 percent of people spend five or more years in the top one percent of income distribution from age 25 to 60. Research also indicates that one out of every five children born to parents in the bottom income quintile will reach one of the top quintiles in adulthood.
   
4. More inequality means more poverty. The idea that one person’s gains in wealth can adversely affect others does not reflect the reality of an economy that is constantly creating value.
   
5. Inequality distorts the political process undemocratically. Activism of wealthy individuals is balanced across the political spectrum, and offset by groups that represent low income individuals and other non-socioeconomic specific groups.

Five Myths about Economic Inequality in America, a new analysis by Cato senior fellow Michael Tanner, breaks down the wrongheaded beliefs on income inequality that have been bandied about by academics, pundits and politicians on both sides of the aisle, concluding that America’s poor would be better served by politicians implementing policies that actually reduce poverty, not attacking inequality itself.

“While inequality per se may not be a problem, poverty is. But there is little evidence to suggest that economic inequality increases poverty,“ writes Tanner. ”Policies designed to reduce inequality by imposing new burdens on the wealthy may perversely harm the poor by slowing economic growth and reducing job opportunities.”

What policies do help alleviate poverty? Education reform, reducing occupational licensing and other regulatory barriers to entrepreneurship, reforming the criminal justice system, and eliminating the perverse incentives of the welfare state. Let’s stop worrying about inequality, and start actually helping people escape poverty.

Read the new study….