The Mythology and Mathematics of Income Disparity

The Mythology and Mathematics of Income Disparity

There are those who tell us that all of the benefits of tax cuts and the wealth created by our booming economy goes to the very rich; that the “one percent” has taken it all, leaving the middle class and poor behind. We are told that disparity of income and wealth, the distance between rich and poor, is at record levels, and this is a threat to our democracy. We are also often told that income disparity results from the greed and avarice inherent in a capitalist society.

This mythology is difficult to reconcile with history or arithmetic. In real dollars, the four wealthiest men early in the twentieth century, Rockefeller, Vanderbilt, Carnegie, and Ford were as rich as any today. Meanwhile, only the very rich had indoor plumbing and carriages, labor had no union bargaining power, consumers had no protection against monopolies, farmers had no electricity or tractors and the government proffered no welfare benefits or other income transfers. In earlier times kings and queens and their retinue controlled all wealth.  In ancient Rome, there were only landed patricians, plebes, and slaves. The patricians, one hundred families, less than two percent of the population ruled the Roman Empire and controlled virtually all the wealth for over two centuries. In the Roman Republic, fifteen percent of the population was enslaved.

Since economic disparity is not new, and not even close to long-term historic highs, perhaps we should examine how we measure it. The GINI Index is most frequently quoted to demonstrate the great and growing unfairness of modern capitalist society. The foundations of GINI were revelations about inequality and variability in wealth and income a century ago, but the data used to calculate and compare is still a work in process.

In 1906, Italian economist Vilfredo Pareto observed that 20 percent of the people owned 80 percent of his nation’s (Italy’s) wealth. At that time he did not realize that this relationship would be found to apply with uncanny accuracy to many situations.  In the late 1940s, Dr. Joseph M. Juran observed in quality control efforts that 20 percent of manufacturing defects cause 80 percent of the quality costs and problems in most products.

Subsequently, Pareto’s observation has been observed across the spectrum of human activity and become “Pareto’s principle” or “Pareto’s law.”  It has become axiomatic that 20% of any population creates 80% of the impact on any result from that population.  The numbers are never exact, but Pareto would predict that 20% of quarterbacks on NFL rosters would complete 80% of passes in any season, 20% of soldiers earn 80% of medals in any war, 20% of drivers have 80% of accidents and 20% of workers in any large population will produce 80% of the productivity improvement and earn 80% of the income. Pareto’s law essentially says that disparity is pervasive and is the natural order of all things human.

The GINI coefficient was first developed by the Italian statistician and sociologist Corrado Gini and published in 1912. Gini and Pareto were contemporaries and likely were acquainted with each other’s work.

A GINI index of zero, meaning perfect equality, would describe a population where income is evenly divided among all citizens. This would be as hard to find as a place where all quarterbacks completed the same number of passes or all students got the same score on their SATs. A GINI coefficient of one, an equally unlikely outcome, would indicate a population where one person in a country received all the income and thus controlled all the wealth of the nation.

GINI for various countries is a complex calculation, but it can be approximated as a function of the share of a population that enjoys one half of the total income of that population. South Africa, with a GINI coefficient of .634 has the most disparity of all 177 countries scored by the World Bank. This means that in South Africa half of the nations income is shared by the “better off” 19% of the population. The average income in this group is more than four times the average income of less well-off 81% of the population who share the other half.

According to World Bank scoring, the most egalitarian nations, those with the least income disparity are Iceland and Slovenia with GINI scores of .26.  In these countries, half of the nation’s income is shared by the “better off” 37% of the population. The average income of this group is only about seventy percent more than the average of the less well off 63% of the population who share the other half of national income.

What can we learn from this exercise in the arithmetic of GINI?  First, we learn that GINI tells us nothing about history, especially prior to the twentieth century.  Not only was the index not invented, but most of the data to fill in the equations was also not collected. We hear that disparity in the United States has gone up since the mid-twentieth century while top tax rates have gone down by more than half. How can this be surprising, that lower graduated income taxes will increase the relative income of those who pay taxes? The “poor” may have a smaller share of income, but how can they be worse off in a period when they are receiving a constant increase of tax-supported transfer payments. Disparity peaks in the United States prior to World War I were higher than any peaks since then and have drifted downward slightly since the highest peaks of the 1990s. It takes a very myopic observer to conclude that we are at any particular place on a long-term scale of income disparity.

Second, GINI tells us little about mobility between better off and less well off groups. Doesn’t disparity of income in any year become less disturbing if many people moved up or down, from poor toward rich or rich toward poor in each year?  In the eighteenth century this rarely happened. In the twenty-first century it is commonplace.  The best kind of disparity is when the child of an unwed welfare mother becomes a star in the NFL, or when the son of a civil servant in India becomes president of Microsoft Corporation or when a 20-year-old refugee from communist Hungary becomes a founder and president of Intel Corporation or when two boys, both raised by their mothers of very modest means, one in Hope Arkansas and another in Hawaii both become president of the United States. Each year in the Forbes 400 list of the wealthiest you can find famous figures in sports, entertainment, science and business.  Many of these men and women started on the first rung of the economic ladder and provide examples of motion from the bowels of the less well off to the pinnacle of power and economic success. There are hundreds of thousands, perhaps millions more perhaps less dramatic but equally important biographies. Stories of journeys up the economic ladder, from the first rung of unpaid or underpaid apprenticeship to a position of prosperity and comfort.  Each journey is a story of income disparity.  Most of the “Baby Boomer” generation’s parents started their lives in the depth of the great depression, fought in the great war and then through their industry and ingenuity powered a great economic boom for themselves and their children. We should all be so lucky to have such great disparity between the beginning and end of our journey. We should not forget that at every moment our population is made up of people at every stage of their journey. A population without disparity is a population without opportunity. It is unknowable how much of the disparity in the population of any country is due to people building on their individual potential and how much to other factors, but when you think you want less disparity be careful what you wish for.

Third, GINI tells us almost nothing about how well off the less well off are groups in any country vs. the same groups in other countries.  This data is readily available but seldom expressed in the myth-making about the disparity. According to 2017 World Bank Data, there are six nations with more nominal GDP per capita than the United States.  Suppose we could magically reduce our average GNP per capita from $59,532, the seventh highest in the world, to $50,000 the eleventh highest. Let’s do this by taking away income only from the people in the top 25% of incomes. This magic would reduce our GINI coefficient from its current .41 to around .32. It would not change the actual incomes of our less well off at all. It would only reduce their opportunity to profit from excellence.

The final thing we do not learn from GINI is the importance of federal and state taxes and transfer payments and philanthropy in reducing real income disparity. Many of the benefits from these huge economic transfers do not get included in the GINI calculation. Different countries make the calculation differently.  For example, nearly all countries that subsidize medical care do so for every citizen in the same way, so medical costs are removed from any calculation of disparity.  Medicare and Social Security work this way.  Everyone who is eligible gets the same benefit regardless of income or wealth.  Medicaid does not work this way.  People get Medicaid benefits only when they exhibit economic need. However, Medicaid benefits do not get included in their income so Medicaid recipients have a real income that is not included in GINI calculations. The benefit reduces income disparity without changing the GINI score. The same is true for all benefits given to “the poor” but not recorded as income including most federal and state welfare programs, food stamps, housing subsidies, earned income tax credits and a myriad of other federal programs.  Reasonable people may disagree how much these programs get recorded differently from country to country, but there is no argument that the bill in the United States is greater than one trillion dollars annually and much less of the cost or benefit of transfer payments is reflected in the U.S. GINI calculation than in most other places.

Let’s make a simple calculation. If we assume one trillion dollars of benefits to the least well off 25% of our population financed by the most well off 25% and not reflected in GINI calculations, the result would be income transfers costing $6,000 annual income transfer from each of the 25% highest income individuals to each of the 25% with the least.

The other side of this coin is a graduated income tax structure.  Most other developed countries have lower top rates and collect more consumption (sales and value added) taxes that on a percentage basis are most expensive for the least well off.

We should be both proud and happy that the United States, more than most other countries, eases the tax load on the poor and directs many benefits focused on those who most need them. We should not despair that countries with for example, total government medical coverage for all, show statistical measures of less disparity because they deliver more “benefits” to the “rich”.  Think again about our simple calculation above and ask what shadow it casts on those who despair over disparity.

We should also be proud of the philanthropic tradition engrained in American culture. It goes back to the pioneers welcoming those who followed them and to the great fortunes of Rockefeller, Carnegie, Vanderbilt and Ford turned into the great foundations and to thousands of smaller foundations emerging from lesser fortunes to the outreach and mission projects funded by every church and synagogue in America. Every dollar that these foundations spend on helping the less fortunate helps to decrease disparity but is completely invisible to disparity statistics.

So what have we learned about income disparity?  We know that the high and low ends of the economic spectrum are highly visible.  We know that for all the money we spend, we have not completely solved the problem of desperation in our society.

We know that the more we spend, the harder it is to find and help the people we miss. We know we need to recognize the limits of programs to help and emphasize the need for people to help

We know that the closer we are to the people who need help, the easier it is to find and help them.

Finally, we know that many things we do that are most effective at reducing income disparity, especially including increased opportunity, philanthropy, and programs that target non-taxable benefits for the less fortunate all help solve the problem without making our GINI coefficient look any better at all.

So, what should we do?  Perhaps we should forget about the statistics and focus on the real intractable problems that keep people from climbing the ladder of success. This is not hard at all.  We know that mental health, substance abuse, early childhood education and through all of these, crime are the big ones.  We all know that these are local problems. They are all individual problems. They can only be solved one at a time by local and individual resources.  These are the “Thousand points of light” in George H.W. Bush’s vision of America.

The best leadership we can hope for from Washington is one that fosters economic growth and opportunity and holds locales responsible and accountable for local problems.  That same leadership will recognize that re-focusing and refining many of the 126 existing federal income transfer programs founded with good will in earlier or even recent generations can be far more productive than inventing more federal programs that will not solve local and individual problems.