How Should We Handle Income Inequality?

Article excerpt

Every year the U.S. Bureau of the Census releases a report on "Money Income in the United States." The latest version came out on Sept. 24, and it provides details about the incomes of Americans in the year 2001.

The median household income in the United States that year was $42,228, down 2.2 percent (around $900) from the prior year. The poverty rate increased from 11.3 percent in 2000 to 11.7 percent in 2001. All in all, some 32.9 million people were living in poverty in 2001, up 1.3 million from the year 2000. That's what happens in a recession.

The Census report has a wealth of information about income inequality in the United States. For example, according to the official measure of income, the top 5 percent of households got 22.4 percent of household income in 2001, and the top 20 percent of households got more than half of all household income. On the other hand, the poorest 20 percent of households that year got just 3.5 percent of the aggregate household income that year.

That's a pretty unequal distribution of income. In that regard, one popular method of measuring income inequality is to compare selected positions in the income distribution. For example, the household at the 95th percentile of household income in 2001 received $150,499 that year. That was 8.4 times the income of the household at the 20th percentile ($17,970 that year). Similarly, the ratio of the 80th percentile to the 20th percentile was 4.65.

The report also enables us to get a pretty good idea about how our free market system distributes economic income among households and about how much the government redistributes through taxes and transfer programs. To do so, however, we need to compare estimates based on some of the Census Bureau's alternative definitions of income.

At the outset, one of the Census Bureau's alternative definitions of income shows us what household income looks like before government taxes and transfers. Under this measure, the bottom quintile of households received just 0.9 percent of pretax, pre- transfer household income, the second quintile received 6. …