The Myth of American Inequality

by Phil Gramm

In short, earned-income inequality has risen because some people have been induced to work less by the availability of greater government transfer payments, while others have worked more to promote their households’ well-being.

Those who are the most vocal critics of our economic system for its growth in earned-income inequality in postwar America are also often the most committed advocates of expanding the very transfer payments to low-income Americans that have been the largest cause of the growth in earned-income inequality. They also have been the biggest promoters of the public education system that has left so many behind and the greatest critics of education reforms, such as school choice, that enable more children to raise their future earnings. But, as has been shown in this chapter, the growth of earned-income inequality has been produced by government

programs that discourage work, growing equality for women, a rise in the value of education, and the free choices made by people who love each other. On any kind of factual basis, it is hard to argue that the growth of earned-income inequality in postwar America is a result of some fatal flaw in our economic system.

experience accounts for 2.0 percent of the inequality of earned income, and, on average, across individuals’ work lives, real earnings rise by 91 percent.2 This growth of earnings within an occupation or from honing skills and moving on to higher pay and greater opportunity is obscured by just looking at the average compensation number.

In short, should you believe your eyes or the official government measure of real hourly earnings?

Compared to 1972, our homes today are much more spacious and modern. The proportion of homes with two or more rooms per person is 33.5 percent greater today. The proportion with two or more bathrooms has grown by 200.5 percent; 313.1 percent more have central air conditioning; and 68.3 percent more have dishwashers.3 Most homes in 1972 had televisions, but only about half were color. Today they are all color, and most are high-definition, flat-screen TVs connected to cable or satellites.4 Most homes in 1972 had at least one phone, but none had cell phones or internet access.

Our cars last more than twice as long,6 they are almost four times safer,7 and many have GPS navigation and premium sound systems.

Americans live 7.8 years longer,9 partly because the death rates from cancer declined by 31 percent from 1991 to 2018.10

So how did we obtain this massive cornucopia of prosperity without a pay raise since 1972?

This overstatement of inflation is

Fortunately, the Bureau of Labor Statistics has developed and for twenty years has published an index called the Chained Consumer Price Index for All Urban Consumers (C-CPI-U or Chained CPI) that largely solves this “substitution bias” problem.

Real median household income as calculated by the Census using a traditional CPI shows an increase of 33.5 percent over the fifty-year period, but using the more accurate Chained CPI shows real median household income rose by 47.7 percent,

Annual price increases for medical care were 3 percent too high because they did not account for the greater efficiency and improved outcomes of new drugs and procedures. Inflation for shelter was shown to be overstated by 0.25 percent annually because government statistical agencies ignored some of the consistent improvements in greater living space and added modern conveniences in homes.

This CPI-U overstatement of inflation in medical care has,

Official figures for real GDP show an increase of 297 percent from 1967 to 2017, but if adjustments were made to account for the value of new and improved products, GDP would have increased by 446 percent over the fifty years, or by an additional $5.3 trillion of real economic value created by the nation in 2017.27

The official productivity estimates show an increase of 164 percent over the full fifty-year period. If the inflation adjustments had corrected for the known understated value from new and improved products, productivity would have risen 325 percent—almost twice as fast. Accounting more fully for the value of new and improved products raises the value created by an hour of work in the private sector from $35.80 to $57.80.

Adhering to this directive for inflation adjustment, the Census Bureau has increased the official poverty thresholds by 701 percent from 1963 to 2017. But if a more accurate price index that avoids substitution bias, such as the Chained CPI or the PCEPI, had been used to adjust for inflation, then the thresholds would have risen only 529 percent.

Consequently, using the CPI-U, which overstates inflation, to calculate poverty thresholds has actually overstated the standard of living below which families are defined as being poor by 72 percent.

12.3 percent of the population was living in poverty, only a small decline from the 14.2 percent in poverty in 1967. If, instead, Census had adjusted the poverty thresholds using the more accurate Chained CPI, 9.1 percent of the population would have been in poverty. Incorporating the better measures of the effects of new and improved products would have lowered the poverty rate even further to 6.5 percent—a decline of more than half from 1967.

Accounting for the missing transfer payments and using more accurate inflation adjustments not only reveals a much lower level of poverty overall but also sharply narrows the differences in the poverty rate among different

The more accurate measures show that only 1.3 percent of children and less than 0.4 percent of seniors live in poverty. For children living with married relatives, the poverty rate is a mere 0.2 percent. Poverty affects 1.7 percent of Blacks, about 92 percent fewer than shown by the Census counts.

While the improved measures show that poverty among Blacks is still somewhat higher than for Whites, the difference is only 0.6 percentage points, versus the 11.5 percent difference in the Census numbers.

The improved inflation adjustment does not, of course, change the relative positions of the growth rates among the various income quintiles, but by using the more accurate inflation adjustments, all five quintiles show dramatically

stronger income growth.

Adoption of the more accurate Chained CPI for indexing tax brackets was a significant reform and improvement.

Government’s standard measurements of well-being are significantly understated because they use price measures that have overstated the actual rate of inflation that occurred during the last fifty years.

Public discussion of income inequality has often focused on the very richest—the “billionaires” or the “400 richest.” These households are the outliers, the exceptions to the overall distribution of income, but advocates for more income redistribution have sought to make these unrepresentative groups the focal point of the debate.

The fact that income from work is the dominant determinate of earned income for 99.99 percent of all households

Prosperity for all but a tiny outlier group of very-high-income households comes from normal, everyday work.

recent study of millionaires (households with a net worth of more than $1 million) discovered that only 21 percent of them had received any inheritance. Only 16 percent inherited more than $100,000, and only 3 percent inherited $1 million or more.

Certainly, they were well off, though hardly super rich. In fact, the first households earning $1 million do not appear until percentile 99.3.

These so-called millionaire earners, however, lost about 40 percent of their income to taxes, and 57 percent of them dropped below the millionaire-earner status after taxes.

The legal and medical professions also had significant membership in the top 0.1 percent. The arts, media, sports, academia, and the sciences were among those professions well represented. Earners in other very-high-income households came from a wide array of other pursuits.

Reports of celebrity pay in the general press show that many entertainers and news commentators make incomes from $10 million to over $100 million annually, squarely in the top 1 percent of the top 1 percent (0.01 percent overall), with a few even reaching $500 million and making it into the top four hundred.

Football coaches at major tax-payer-supported universities also fall into the top 0.1 percent.5 Their fans obviously think they are worth it.

For those who earn very high incomes, their stay in the exclusive income groups can be short.

A study of publicly available IRS data between 1992 and 2014 showed that 4,584 different households were in the top four hundred at some point over the twenty-three years. Nearly three-quarters qualified for only a single year. The average length o...

Aside from the usual economic ups and downs of the marketplace, one reason for this high turnover is that more than 60 percent of income among the top four hundred comes from capital

With all of the political rhetoric about the one-percenters, it is important to look more closely at the economic profile of the top 1.0 percent of households. Their incomes before taxes start at less than $600,000, which is often earned by two full-time workers.

And they are highly productive. Almost two-thirds came from poor to upper-middle-class families, including 7.0 percent from poor families that faced serious obstacles, often as immigrants. Twenty-three percent inherited significant wealth but actively managed it to grow it into the Forbes 400 class. Only 6.5 percent merely lived on the wealth they inherited.

They discovered that while the total wealth of the wealthiest individuals grew somewhat faster than the nation’s wealth, most of the growth came not from individuals who were already on the list but rather from new people who earned their way onto the list through invention, innovation, entrepreneurial risk, and personal drive.

generally fell off by half in twenty years or less. As a result, the wealthiest families from the nineteenth century are all but gone from the ranks of the wealthiest, and most of those from fifty years ago are gone as well.

Claims have even been made that rich Americans pay a smaller share of their income in taxes than do middle-income households.14 These claims are verifiably false.

To put the economic significance of this tiny group of super-rich households in perspective, if government seized all of their after-tax income, it would fund the federal government for less than six days.

In June 2021, ProPublica posted what it claimed were tax returns of the twenty-five richest filers stolen from the IRS. It used the revelation of stolen returns to claim that the wealthiest twenty-five people only paid 3.4 percent of their incomes in income taxes in recent years.17 That claim was contrary to the actual stolen tax returns themselves and is inconsistent with the publicly available IRS data showing that the top four hundred income earners paid on average 32 percent of their income in federal income and payroll taxes.

Like a modern-day Scrooge, Buffett has accumulated vast wealth over decades of thrift and wise investing. Famous for both being the world’s greatest investor and living modestly, he eats using coupons from McDonald’s, works in a cheap office, drives an old car, and lives in a modest home. No one seems to ever ask, “If Buffett is not benefiting from all his wealth in the way he lives, who is benefiting?”

Since Scrooge and Marley never consumed the wealth they created, its use was, in reality, a gift to humanity. It funded the factories and railroads, tools and jobs that first fed and clothed millions of British people and then billions around the world.

The top 1 percent of households have an average tax rate of 29.9 percent, higher than for any lower-income group. Within the top 1 percent, however, there is a lot of variation, as rates rise to 33.2 percent and fall to 23.0 percent.

The differences come from what Saez and Zucman count as income. They count only earned income. They completely ignore transfer payments that make up more than 90 percent of the income of the bottom quintile and 50 percent of the income of the second quintile. By not counting transfer payments as income to the recipient households, they grossly understate income in the bottom two-fifths of the population. So, when they then divide the actual taxes paid by an income amount that is between two and nine times smaller than the real amount, the resulting tax rates are unbelievably too high.

They “solve” this problem by excluding individuals who have earned less than $7,250. That exclusion is strictly arbitrary and actually removes more than 80 percent of the observations from the bottom quintile.