In 2004, John Edwards built his presidential campaign around the theme of “two Americas”: a small portion doing well while the rest struggled or fell behind. The language might be different in 2012, but many commentators continue to argue that the rich are getting richer while everybody else is falling farther behind. But as in 2004, many of these arguments overstate the conclusions that can be drawn from the underlying data. The details in this area matter a lot — especially today, because many policymakers believe income inequality is becoming a bigger issue, impeding economic mobility. They perceive just one solution: higher taxes and more wealth redistribution.
To be sure, income growth over the past few years has been modest to nonexistent as a result of the financial crisis, the subsequent recession and the tepid recovery. At a recent event sponsored by Economics21 and the Manhattan Institute, former White House economic adviser Jared Bernstein reviewed the status of the academic literature on income inequality and economic mobility. “There is not a lot of social science controlled experiment evidence linking inequality and opportunity,” he concluded, suggesting that the current connection between inequality and economic mobility “is correlational at best.”
The general lack of research connecting inequality with diminished economic mobility weakens the case for President Obama’s populist push for wealth redistribution. It’s also important to keep in mind that any analysis of income inequality in isolation offers an incomplete picture.
Two complicating factors deserve more attention. First, comparing the income distributions for a single year is much less meaningful than commonly supposed, because it’s not clear which of the underlying tax returns remain in the top 1 percent from year to year. Every decade or so, the Treasury Department releases a data series with which we can track taxpayers. The available data show only two out of five households in the top 1 percent are still there ten years later. This is why it’s often misleading to discuss the top 1 percent as if it’s necessarily the same households amassing more and more wealth each year.
Second, tax policy can magnify how income inequality is measured while not always changing the underlying wealth dynamics. The income statistics analysts use to assess inequality depend critically on the way taxpayers choose to organize their finances, and particularly their businesses.
Looking back at the last 30 years (from the peak of the most recent business cycle), the category of income that witnessed the largest increase for the top 1 percent was business income. Part of this growth was likely a function of changes in tax policy that made “flow-through” business income over this period more tax-advantaged compared with C corporations. Had the tax system continued to favor keeping retained earnings inside of corporations, the reported income of the top 1 percent would be lower today — not because of any change in the economic reality (i.e. looking broadly at the wealth of shareholders), but simply because less business income would have been reported or realized at the individual level.
Simply put, the research community has not yet demonstrated how the growth in perceived income inequality has harmed economic mobility and opportunity. Moreover, even the underlying income inequality trends require further study. With a deeper understanding of these issues, the 2012 version of the income inequality debate could be a net positive for the country. After all, economic mobility is a bipartisan issue.
Christopher Papagianis, a former special assistant for domestic policy to President George W. Bush, is managing director of the think tank Economics21, a partner organization with the Manhattan Institute.
