Income distribution misreprsents inequality

There are important reasons for the income gap between the “rich” and the “poor” that have gone largely unrecognized, explain Richard McKenzie and Kathryn Shelton in a new report for the National Center for Policy Analysis.

While a number of social and economic factors explain the growth in income disparity — from family breakdown to government welfare program incentives — McKenzie and Shelton identify two additional reasons why the relative growth in the income of the rich is “practically inevitable,” by official measures:

– The way that the income distribution is split into “fifths” of households gives the misleading impression that individuals at the bottom of the income ladder are making fewer gains than they actually are.
– The rich have more opportunities to diversity their investment portfolios and soften the consequences of risk-taking.

The division of households into “fifths” or “quintiles” gives the appearance of greater inequality than actually exists. While one might assume that there are equal numbers of individuals in each quintile, there are actually far more people — and workers — in the upper income brackets.

– There are 82 percent more people in the top fifth of households than in the bottom fifth.
– In 2006, 81 percent of households in the top fifth had two or more workers, but only 13 percent of households in the bottom fifth had two or more workers.
– In almost 40 percent of households in the bottom fifth, no one was working.

Significantly, assessing income inequality by comparing fifths of households does not take into account the fact that people in different income divisions do not remain in those divisions throughout their lives. When low-income individuals move into higher income brackets, their newfound wealth is reflected in the upper income brackets that they reach, not in the lower income brackets that they leave behind. And income mobility remains a reality in the United States today:

– Of all adults in America, 67 percent had higher incomes than their parents, according to the Federal Reserve Bank of San Francisco.
– Forty percent of people in the lowest fifth of income earners in 1986 had moved to a higher income bracket by 1996. Almost half of the people in the lowest income quintile in 1996 had moved to a higher bracket by 2005.
– According to one study that tracked 25- to 60-year-olds over a 44-year period, a majority of Americans spent at least one year in the top 10 percent, and three-fourths spent at least one year in the top quintile.

McKenzie and Shelton also describe how the wealthy are able to maintain highly diversified investment portfolios. Their wealth allows them to take on risky investments that carry high rates of return without the hazards associated with the far less diverse portfolios of lower income individuals.

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