Bacon's Rebellion

by James A. Bacon

While the United States economy has grown over the past three decades, there is a widespread belief, reflected most recently in the Occupy Wall Street movement, that the poor get poorer while the rich get richer. While the rich may be getting richer, the poor are not getting poorer. The widespread belief that they are is based upon the stagnation in earned income among the poor — as in, income reported to the Internal Revenue Service for the purpose of paying taxes. Such analysis is totally divorced from reality. It ignores two things: (1) unreported income from the cash economy, and (2) massive income transfers through federal anti-poverty programs.

By its nature, the cash economy is difficult to measure. But by all estimates it is huge. Write Friedrich Schneider and Dominik Enste in a 2002 International Monetary Fund report (not funded by the Koch brothers, by the way):

A factory worker has a second job driving an unlicensed taxi at night; a plumber fixes a broken water pipe for a client, gets paid in cash but doesn’t declare his earnings to the tax collector; a drug dealer brokers a sale with a prospective customer on a street corner. These are all examples of the underground or shadow economy—activities, both legal and illegal, that add up to trillions of dollars a year that take place “off the books,” out of the gaze of taxmen and government statisticians.

Citing a survey that dated back to 1999, shadow economies ranged in size from 77% of the real economy in some developing nations to roughly 10% in the United States. Most shadow-economy income goes to people who would be classified as poor, working class or in some cases middle class. By contrast, the salaries, dividends, capital gains and other sources of income for millionaires and billionaires is all reported to the IRS. It’s an open question whether the shadow economy has grown or shrunk over the past three decades, but any analysis that excludes this source of income exaggerates the scope of the income gap.

Another source of income excluded from conventional analysis is government transfer payments, which include $488 billion for non-taxable Medicare benefits in the Fiscal 2012 budget, plus $989 million for other mandatory spending programs, much, if not most, of which are means tested. (And that doesn’t even include the Earned Income Tax Credit, which costs the government $50 billion a year, nor state contributions to Medicaid.)

If consumption, not income, is measured, the poor and middle class have fared much better over the past three decades. In a new American Enterprise Institute paper, “The Material Well-Being of the Poor and the Middle Class Since 1980,” Bruce D. Meyer and James X. Sullivan adjust for government transfer payments as well as long-term biases in the Consumer Price Index. They conclude:

Our results paint a picture of widespread improvement over the last thirty years in the material well-being of American families. Improvement is seen in the middle of the distribution and among those near the bottom. After appropriately accounting for inflation, taxes, and noncash benefits, we show that median income rose by more than 50 percent over the past three decades. This increase is considerably greater than the gains implied by official statistics—official median income rose by only 14 percent between 1980 and 2009.

One can take issue with their methodology. Using an alternative measure of inflation is particularly tricky. What cannot be argued with is that acknowledging the existence of income transfers totally changes the picture. To decry a growing income gap while excluding two of the largest sources of income for poor people — shadow economy earnings and government transfers — is foolish. Throw in the failure to adjust for regional differences in cost of living, which Meyer and Sullivan overlook but I discuss here, and it is evident that most of what is written on the topic is utterly meaningless.

Does that mean that the earnings gap is not a problem? I’m not saying that. Perhaps the income gap is getting wider. But that fact has yet to be demonstrated. In fact, the evidence just presented suggests otherwise. I am not persuaded by pundits who cite the same IRS data, no matter how often they repeat it, nor am I moved by scruffy, ill-informed ideologues who camp on the public squares of major cities and blame the capitalist system.

There are problems galore with our society, such as dislocations caused by the end of the Era of Indebtedness and Mass Consumption, the impending fiscal calamity of the federal government and slowing economic growth caused by the government-directed mis-allocation of resources, not to mention dysfunctional human settlement patterns, environmental degradation, rising health care costs and inadequate schools. Those problems are real, they are well documented, and they engender much of the frustration expressed by the Tea Party and the Occupy Wall Street movements. Let’s focus on real problems, not statistical figments of our imagining.