Income inequality for dummies

And by dummies, I mean me. Analyzing income inequality has become a national pastime in recent years and threatens to remain so, since the extent of increased inequality seems so hard to put to rest. Some point out that high-income individuals are pulling in a greater share of total income than in the past. Others argue that the picture isn’t so simple, since tax reforms in the 1980s presented incentives to shift what was previously business income into personal income. And these questions only scratch the surface. What’s a simple man like me to make of it all? Here’s how I think about it. When you get a dollar of income, you can do one of two things with it: spend it or save it. So rising income inequality should lead to rising inequality of either consumption (the spending part) or wealth (the saving part). But has it?
Wojciech Kopczuk of Columbia University and Emmanuel Saez of the University of California, Berkeley, show that the share of wealth held by the top 1 percent of households has remained roughly constant since the 1940s and is actually somewhat lower today than it was in the mid-1980s. So if the rich are gaining more income, it doesn’t seem that they’re saving it.
So they must be spending it, right? Maybe not. Dirk Krueger of Stanford and Fabrizio Perri of NYU find that “from 1972 to 1998 the standard deviation of the log of after-tax labor income has increased by 20 percent while the standard deviation of log consumption has increased less than 2 percent.” Krueger and Perri argue that part of the measured increase in income inequality is a function of higher income volatility from year to year. But if households can borrow in bad years and save in good years, consumption can be smoother than income. And ultimately it’s consumption that matters.
None of this puts the question to rest. Survey data on consumption isn’t as high quality as for income, so it’s possible we’re missing something important. But it’s also possible that the income data that shapes our perceptions of inequality are missing something as well.

> By Andrew Biggs