Simply defined, income inequality is the gap between the incomes or earnings of individuals at different levels of the income distribution. A typical way to measure income inequality is to first define how we measure income for a particular household, and then divide households into equal sized groups to compare households at the top of the distribution with households at the bottom or middle of the distribution. Several reports and papers in recent times have argued that there has been an increase in income inequality over the last two to three decades, while others counter that inequality is in fact narrowing by some measures. What is often lost in this back and forth is the focus on the poor, because a change in the income distribution across all households says little about how people are faring in absolute terms at the bottom of the distribution.
The first point made by this testimony is that the issue of income inequality is often complicated by the fact that different studies often provide vastly differing results on the magnitude of the problem since income is not consistently measured across these studies. Second, the testimony questions whether income is in fact the best way to measure increases in inequality. Most economists would agree that consumption is a better measure than income of household welfare since individuals are better able to smooth consumption over their lifetimes than incomes. This happens because while incomes may be low in the extremes of the age distribution and high in the prime working years, individuals can smooth consumption by borrowing in the low-income years and saving in the high-income years. In addition, many redistributive policies support consumption for low-income households and provide transfer payments to them. As a result, consumption is both a better predictor of lifetime or permanent incomes and reflects the impact of government transfer programs on household welfare.
While one can argue endlessly about the exact magnitude of the problem, the real issue is not whether the top of the income distribution has incomes that are ten times higher than the bottom, but whether low and middle income people in America are enjoying a decent standard of living. The unfortunate reality is that millions of people in America are living in poverty and facing the very harsh consequences of the worst recession in recent history. As per the latest report from the Census Bureau, 15 to 16 percent of the population can be defined as living in poverty in 2012. That translates to more than 47 million people. We are now in the fifth year of an economic recovery that does not seem like a recovery to most people in the labor market. There are 10.4 million unemployed workers, of which 3.9 million have been jobless for longer than 27 weeks. In addition, there are another 10 million who are either in involuntary part-time jobs, or discouraged workers. Further, youth and teenage unemployment rates are above 16 percent. Therefore, the focus on income inequality is somewhat misplaced. Fundamentally, this is a problem of poverty.
When high rates of poverty exist in an economy with low economic mobility, the problem is exacerbated. The purpose of this testimony is to summarize some ideas that might help policymakers address the current economic crisis facing families and provide them opportunities to be productive participants in the labor market and rebuild their lives. This testimony however argues that while trying to equalize outcomes for families by attempting to equalize incomes may be an impossible goal, equalizing opportunities for individuals by providing access to good schools and good jobs may be more attainable and realistic.
In the this testimony, I describe the studies and data on income inequality trends. I focus on consumption inequality and discuss economic mobility issues. The testimony also includes some policy suggestions and a conclusion section.