13. Meaningless Earning Gaps

THE NEWS TODAY INUNDATES us with misleading statements and statistics. What does the oft-stated claim “The poor are getting poorer and the rich are getting richer” imply? Does the statement imply that the poor are becoming poorer than they were previously, while the rich are becoming richer than they were previously? If so, data will refute that notion. The state of humanity is improving as a whole, and the standard of living of each quintile²⁰ of wealth is also improving.²¹ But this overall view doesn’t provide a clear picture, either.

The U.S. Census Bureau reports that those in the highest quintile earn about 50 percent of the total income generated, while those in the lowest earn 3.5 percent. You would expect this statistic to mean that 20 percent of the people earn 50 percent of the income. Wrong! Census figures are tracked by household. There are many more working people in the top quintile than in the lowest—namely, 70 million versus 40 million. On average, the people in the highest quintile have more education, and they work one-third more hours than those in the poorest quintile, many of whom are just part-time workers.²² This is not surprising, since most people realize that obtaining an education and working more hours are advantageous to gaining wealth.

When we hear reports about the poor, who make up the lowest quintile of income, we seem to envision a fixed group of people. Yet how many of us individuals of middle-age or older are no longer in that quintile, but were at one time in our early lives part of it? Very likely, most of us. Census income figures are inherently misleading because they are based only on snapshots of a population. Income figures do not track population mobility—that is, the movement of people from one income group to another over a period of time.

We do know that those who make up the lowest income group are far younger on average than those in the upper income groups. Consider a thought experiment in which each person begins adult life in the lowest quintile of income and moves to each of the next higher quintiles as the person ages.²³ If such were the case, the income inequality between groups would be absolutely meaningless. The greater the income mobility, the less meaningful the income gaps would be. So how mobile are we relative to actual income groups?

A University of Michigan study using data from the Panel Study of Income Dynamics found that, in the U.S., only 5 percent of those in the lowest quintile in 1975 were still in that quintile by 1991. By that latter year, most (59.3 percent) had mobilized to occupy the two top quintiles (30.3 percent and 29.0 percent), while the balance (35.6 percent) mobilized to the second and third quintiles (14.6 percent and 21 percent). There was also downward mobility with over one-third of those in the top quintile in 1975 occupying a lower quintile in 1991. During a shorter period of time (1979–1988), the U.S. Treasury reported that only 14.2 percent remained in the lowest quintile, while 39.7 percent had moved to the upper two quintiles (25.3 percent and 14.4 percent). Therefore, it’s misleading to look at income shares for each quintile and say, “The rich got richer and the poor got poorer.” Why? Because the people who were poor at the beginning of the time period are not (entirely) the same people who were poor at the end of the time period (and likewise for the rich).²⁴

While all quintiles show gains in real earnings, it is also true that the higher quintiles show greater dollar gains than the lowest quintile—which is good news, since virtually all of us progress along the path to greater wealth.

Notwithstanding all these facts, we have yet to address the crux of what “financial inequality” means. While the statement “The poor are getting poorer and the rich are getting richer” is false, underlying this statement lingers the notion that society would be better off if there were smaller or no financial gaps between people’s income. Addressing this underlying notion is of greater social and economic significance than are the facts that refute the statement stemming from the notion. The quintessential question here is: “Would society be better off without financial inequalities?”

Those who claim that the earnings gap is “worsening” imply by the very use of that word that something is bad and needs correction. John Kenneth Galbraith saw this widening gap between the rich and the poor as a moral crime. Those making this claim imply by their statements that if the rich were less rich, then the poor would be less poor. However, that is a fallacy. Such fallacies make good news fodder, of course, and are extremely useful for free rider groups to lobby for more welfare programs and higher tax rates for the rich.

Earning wealth is neither a zero-sum nor a negative-sum game. If Joe earns 1 X, and Tom earns 10 Xs, what can Joe do to get 2 Xs? Does Joe have to take an X from Tom or from someone else? Of course not. It depends on what Joe does to increase his productivity. Joe can gain 20 Xs without lowering Tom’s Xs—or anyone else’s. It doesn’t matter if others gain more Xs. Their gain does not prevent Joe from gaining Xs too.

Joe’s earnings worsen if his Xs decrease and improve if his Xs increase, regardless of the amount of Xs Tom earns. The words “worsen” and “improve” do not apply to earning gaps between different people. Such terms only apply to current earnings of individuals and entities relative to their earnings during an earlier period.

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²⁰The ranking of five equal segments of a population from lowest (first quintile) to highest (fifth quintile).

²¹Julian Simon, The State of Humanity (Cambridge, Mass.: Blackwell Publishers, 1995).

²²Robert Rector and Rea Hederman, Jr., “Two Americas: One Rich, One Poor? Understanding Income Inequality in the United States, Heritage Foundation,” www.Heritage.org.

²³Glen Whitman, ECON 309, Spring 2007, Lecture #13: Economic Myths and Reality. The lecture syllabus can be found at http://www.csun.edu/~dgw61315/econ309.html.

²⁴Ibid.