What a New Report Gets Wrong About Economic Inequality

The latest from American Compass uses less than ideal data and overstates the increase in inequality, among other problems.

By Scott Winship.

"Last week, American Compass launched its latest project in a series designed to put meat on the bones of “national conservatism.” The new effort seeks to elucidate the “nature and meaning of inequality in America”—to “provide a straightforward overview of what the data actually shows and why it matters.” 

At a time when national conservatism seems obsessed with cultural grievance to the exclusion of economic and social policy, we should all root for more serious policy analysis on the center-right. But as with earlier projects, American Compass’s latest looks like it begins with a set of priors about political economy—center-left priors—and then figures out how to make its argument with whatever evidence can be marshaled. Their inequality work looks similarly aimed at advancing center-left views through flawed analysis, ostensibly to advance national “conservatism.”

A brief review of AC’s past projects lays out the pattern. There was the early claim that the century-long project of modern inflation measurement had overstated improvement in living standards. Echoing Democratic Sen. Elizabeth Warren’s similarly confused Two-Income Trap from 17 years earlier, Oren Cass claimed that our lousy economy and dumb policy had created a situation where families need two workers to afford the same lifestyle that a single breadwinner could provide in the past. As I showed at the time, that was all wrong. Cass had simply misunderstood and assumed away the very measurement and conceptual challenges that economists have become successively better at addressing over time—namely how to account for consumers’ ability to switch up the goods and services they buy as prices change and how to address the replacement of older, lower-quality products with newer better ones.

Not only did American Compass purport to be smarter than microeconomists measuring inflation, in its next big economics project, “Coin-Flip Capitalism,” it discovered that hedge funds, private equity, and venture capital investments are losing bets—a conclusion that up to then had evaded ultra-wealthy investors putting their own money on the line. 

But the AC analyses neglected the stronger long-run performance of private equity and venture capital beyond the 10-year window AC examined. Ignored, too, were the other reasons beyond expected average returns that investors turn to hedge funds (to hedge!), private equity, and venture capital. But concern for rich investors wasn’t the point. As Doug McCullough of the Lone Star Policy Institute succinctly put it, “American Compass seeks a virtual seat at the deal table to ensure private business decisions align with their concept of the general welfare.”

Like progressive groups such as the Roosevelt Institute (circa 2015), American Compass thinks the financial sector adds little value to the economy or the lives of everyday people and is a sort of vampire industry sucking up young talent who could do some good “in the real economy.” These critics reject arguments that finance promotes growth and higher living standards for all.

AC has also repeatedly called for industrial policy as a way to increase economic growth through reviving manufacturing employment. Those efforts have been similarly misguided, similarly reminiscent of progressive advocacy (see Robert Reich in 1982), and similarly abusive of evidence. Dispatch contributor Scott Lincicome has done God’s work pushing back against this agenda, recently defeating Cass in an Oxford-style debate on the topic. 

Finally, there was the recent report blaming Wall Street for a supposed decline in investment that has hurt American living standards. In this, AC sounds like a mouthpiece for 2016-vintage Hillary Clinton. But in a brutal thread on Twitter (and a follow-up), economist Donald Schneider showed that real net investment—the measure that matters for assessing economic growth—has not declined and that real net investment per worker is near an all-time high. Schneider noted that research indicates that slower economic growth has not been caused by changes in investment. He also called out Cass for egregiously using an inflation measure known to overstate increases in the cost of living in order to show wages are lower than half a century ago. In reality, wages are up more than 50 percent.

Which brings us to the new inequality project. The issues here will be familiar to anyone who has read progressive inequality claims over the past 15 years or so and the response from critics of those claims. It is true that inequality has increased, but analyses regularly overstate the extent of this increase and present flimsy claims about its consequences. AC’s are no different.

The American Compass report concludes that “income inequality is at its highest point in nearly 75 years.” Technically, its own estimates (which are from the Census Bureau) show that inequality (measured by the “Gini coefficient”) peaked in 2017. But it’s true that inequality is basically at a post-World War II high. Still, the report overstates the increase and obscures its timing. 

For one, Census Bureau methodological changes shifted the post-1992 estimates upward completely apart from true changes in inequality. The 1992-to-1993 jump shown by AC was one third of the entire 1947-to-2019 increase in inequality. Factor in smaller methodological changes that shift the post-2012 (see Appendix D) and post-2016 estimates upward, and up to half the increase in inequality shown by AC goes away.           

Methodological changes aside, there are many well-known issues with the Census Bureau data, which come from the Current Population Survey. There’s the definition of income, which excludes employer-provided non-wage benefits and non-cash government benefits. Nor does it account for falling tax rates or the increasing value of refundable tax credits; it is a pre-tax measure insofar as it does not deduct individual income or payroll taxes, but it is post-tax in so far as it does not include the earnings workers never see because of employer payroll taxes and the corporate income tax. And there’s the problem of underreporting of income, mostly at the bottom and at the top. 

(There’s also a bigger problem at the top, where the Census Bureau ensures privacy by capping publicly available income amounts. Because of this issue, it is not possible to fully capture inequality using the Census Bureau data, which is why all serious data analysts looking at the top rely on other sources, such as tax data. When American Compass says that from 1969 to 2019 “the top quintile increased its share of national income by 9 percentage points,” it is not only wrong that the Census Bureau data measures “national” income. It is wrong that the top’s share of “money income”—a problematic measure, to be sure—rose by only 9 percent.)

The best Gini coefficient estimates readily available are from the Congressional Budget Office, which looks at household income rather than family income but attempts to address all of these problems. CBO finds that from 1979 to 2017 (the earliest and latest years available) the Gini coefficient rose by an amount not much different from the American Compass estimates.

But CBO shows inequality lower in 2017 than in 2000, 2005, 2006, 2007, or 2012. The CBO data also indicate that three-quarters of the increase in inequality from 1979 to 2017 was over by 1988. And while the CBO data don’t extend further back in time, research by Richard Burkhauser and his colleagues—also using a post-tax and -transfer household income measure—found that inequality was no higher in 1979 than in 1967 (the earliest year in their study). 

Combine these estimates with the pre-1967 estimates from the Census Bureau and it looks like the only substantial increase in inequality since 1947 occurred during the 1980s. The Gini was 0.41 in 1989 and 0.43 in 2017, and based on the Census Bureau data, it was probably no higher in 2019. (The Gini coefficient is zero when everyone has the same income and approaches one when a single family has all of the income.)

Similarly, CBO says the share of post-tax and -transfer income received by the bottom 60 percent of Americans was 33 percent in 1989 and 33 percent in 2017. Among households with children, the decline in the share of income received by those in the bottom 60 percent was only from 41 percent to 39 percent. As I discuss in my recent congressional testimony on inequality, Gerald Auten and David Splinter report that the top 1 percent’s share of after-tax national income was 8.3 percent in 1989 and 8.7 percent in 2017.

Inequality in disposable income seems not to have risen noticeably in 30 years. It is possible that a similar analysis using family income would come to a different conclusion. But naïve analyses using published Census Bureau data cannot resolve the question.

Why does rising inequality matter? According to American Compass, “The problem with rising inequality is not that some people are doing well, but that others are falling behind.” Which is a weird assertion, because AC’s estimates fairly consistently show everyone moving up. For instance, the report’s first chart shows median income rising $11,000 in inflation-adjusted terms from 1989 to 2019. (CBO’s better data indicate that median after-tax and -transfer household income rose nearly $26,000 from 1989 to 2017.)

A later chart shows annual household income growth by quintile and by decade. It shows that every quintile saw income gains in every decade except for 2000-2009, when even the top saw income losses. Yet another chart shows median wealth rising from 1989 to 2019, though as in the other charts the gain is understated due to the inflation measure. It is not the case that the poor are getting poorer while the rich are getting richer, contrary to the “falling behind” rhetoric. 

Nevertheless, because the share of income received at the top has risen, American Compass pursues the timeworn argument that inequality has robbed the middle class of large amounts of money—$17,000 as of 2019 alone, according to American Compass. I’ll give them this: $17,000 is $867 less than the amount the Economic Policy Institute claimed the middle class was owed in 2007 due to rising inequality between 1979 and 2007.

This was a bad argument when EPI made it, and it’s still a bad argument. It ignores the redistribution we already do through progressive taxes, it assumes that we could have had the same economic growth without letting inequality rise, and it assumes that the outsized gains that went to the top 1 percent would have gone to the bottom 80 percent rather than elsewhere within the top 20 percent. 

The American Compass report also warns that, “The longer such trends continue, the greater the threat to our social fabric, our political solidarity, and the legitimacy of our free-market system.” Putting aside the fact that “such trends” mostly stopped 30 years ago, AC is following the lead of progressive hero Thomas Piketty here in asserting such dire consequences without offering any evidence for them. Piketty’s long and empirically dense tome describing inequality patterns failed to marshal any convincing evidence that income concentration has had or will have important costs. In response to such assertions, I reviewed the evidence on the supposed harms of inequality back in 2013, for National Affairs. Spoiler alert: They’ve been greatly exaggerated. The research since then has been no less ambiguous or inconclusive. 

The argument that American Compass puts the most effort into making is that rising income inequality leads to greater wealth inequality. It would be remarkable if this were not true. Before tackling the problems with the report’s wealth analyses, this is as good a place as any to note the absence of normative arguments in the report about why, if income or wealth inequality is rising, we should believe that constitutes an unfair outcome. 

The report claims that middle class households can save only $1,300 a year. This average mixes together households with greater need for saving (workers and parents, for instance) with households that have less need for saving (retirees). Oh, and the estimate ignores retirement savings, which (including Social Security contributions) total an additional $4,600 a year, on average. AC says that households “earning $100-150K save 20 times more” than households earning $50,000 to $70,000. However, when retirement savings are included, the richer group’s savings is only 5.5 times the poorer group’s. And all these savings estimates ignore wealth building through the realization of capital gains when homes are sold and the build-up of home equity as people pay down their mortgages. This is saving no less than the excess of income over spending.

American Compass has nothing to say about how much higher savings would have been absent the rise in income inequality. It shows a chart indicating that from 1989 to 2019 wealth rose by 45 percent among households in the top fifth of income, versus the 14 percent median increase. However, remember that disposable income inequality did not rise much (if at all) over these years. As it turns out, wealth also grew more than AC suggests. I estimated my own calculations using a better inflation adjustment and the same source as AC. I find that median wealth rose by 30 percent over this period, or $22,000 (while it rose 62 percent for the top fifth). So much for the report’s claim that “only the wealthy are accumulating wealth.”

AC also wants to blame the rising income inequality that did not happen for stagnant median wealth from financial assets. Which, it turns out, also did not happen. Though the AC report claims that “looking at just financial assets … the typical household has added almost no wealth in the past 30 years,” their own numbers show the value of median financial assets rising by 25 percent. And these estimates look at only people with any financial assets, a group that included 99 percent of households in 2019 but only 89 percent in 1989.

Wealth measurement is tricky. Analyses like American Compass’ include student loans on the debt side of the ledger but do not include a corresponding asset on the other side. People don’t take out student loan debt for kicks, they do so to finance investment in their human capital. Just like it is worthwhile for someone to take out a car loan to obtain a car (debt balancing out an asset), it is typically worthwhile for someone to take on student loan debt. In addition, analyses like AC’s don’t include the promise of senior entitlement as assets, even though people would save a lot more for retirement (which would show up as wealth) in their absence. 

What absolutely makes no sense, though, is carving out housing wealth from net worth. American Compass claims, “Estimates of net worth overstate the financial health of the typical family, though, because they include the value of the family’s home. Rising home prices are encouraging, but so long as each household requires a house, selling one and using the money for something else isn’t really an option. Other homes will have gone up in price, too.” 

One could just as easily write, “Rising stock prices are encouraging, but so long as each household requires a house, selling stock and using the money for something else isn’t really an option. Homes will have gone up in price, too.” The only difference between the homeowner and the stockowner in these scenarios is that the stockowner pays rent while home prices are rising while the homeowner pays down her mortgage, along with interest, while building up home equity. Both are increasing their net worth as they go, and both need a place to live at the end of the day.

I couldn’t figure out how American Compass came up with the final chart in the report, purporting to show that “factoring in debt, the middle class has lost ground.” I’m not sure they sourced it correctly, and I gave up trying to replicate it with what I think is the right source. Regardless, what is relevant is not what happened to net worth after including only the kinds of assets and debt that American Compass prefers, but what happened to net worth. As we’ve seen, it rose significantly (despite the estimates understating retirement and human capital wealth), even if unequally. Factoring in debt, the middle class gained ground. All the rest is gunning for the most dramatic fear-inducing chart.

If the past is any guide, American Compass will have some response to this critique that will attempt to muddy the picture. I suspect I’ll get an earful about why it is important to look at inequality before taxes and transfers, which is true in some contexts. But American Compass’s arguments are generally about after-tax and -transfer income. (“Higher income translates to greater disposable income and thus a greater opportunity for saving, which accumulates over time.”) 

Regardless, I’m ready for any substantive counterarguments American Compass wants to marshal. After all, I’ve heard them all before from progressives.

Scott Winship is a resident scholar and the director of poverty studies at the American Enterprise Institute."