Adjusting for transfers and taxes reduces income inequality between highest and lowest quintiles by 50%

From Mark Perry.

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As a follow-up to my post on Saturday about the new CBO study on the “Distribution of Household Income and Federal Taxes, 2011,” the table above shows how income inequality between the highest and lowest income quintiles changes when we account for: a) transfer payments and b) federal taxes.

Here’s a summary:

1. When we compare “Average Market Income” (labor income, business income and capital gain income), the average household in the highest income quintile received 15.1 times more income in 2011 ($234,700) than the lowest income quintile ($15,500).

2. After adjusting for government transfers, the average household in the highest quintile received only 10 times more before-tax income ($245,700) in 2011 than the average household in the lowest one-fifth ($24,600).

3. After adjusting for both government transfers and federal taxes paid, the average household in the top quintile received less than 8 times more after-tax income ($188,200) than the average household in the bottom 20% ($24,100).

Bottom Line: Almost half of the income inequality between the highest and lowest household quintiles disappears when we adjust for government transfer payments and federal taxes. Before taxes and transfers, the average income of a household in the top 20% is 15.1 times greater than the income of a household in the lowest quintile, but that ratio drops to only 7.8 times after adjusting for transfers and taxes. Much of the discussion on income inequality focuses on income differences before taxes and before transfers, and this analysis above shows how dramatically those adjustments can impact a comparison between high and low income US households."