Missing the Point on Income Inequality in the 1920s and Today

Gary Burtless of the Brookings Institution takes issue with widely publicized findings that income inequality in the United States has reached the level that prevailed in the 1920s, when the top one percent of earners received 20 percent of total income. According to Burtless, that conclusion ignores the creation of the welfare state, consisting of Social Security, Medicare, Medicaid, and other government programs that aim to redistribute disposable income and goods and services to Americans in retirement and those at or near the poverty line. These programs did not exist in the 1920s, argues Burtless, so to ignore them is to misrepresent the degree of income inequality today. Columnist Robert J. Samuelson made the same argument in a column yesterday.

In support of that argument, Burtless turns to the Congressional Budget Office, which calculates measures of pre-tax-and-transfer “market” income, post-transfer income, and post-tax-and-transfer income. Specifically, Burtless turns to a report CBO published breaking down income in 2010. That report does show that taxes and transfers redistribute income relative to “the market,” meaning gross household income from labor, capital, rent, royalties, and miscellaneous non-government sources.

But this CBO analysis doesn’t provide crucial context—the extent to which the redistribution of income through tax policies and government spending has declined since 1979. I discussed this last week, largely in reference to an earlier CBO report that explicitly tracks the trends in pre- and post-tax-and-transfer income distributions. The data needed for that analysis doesn’t extend back to the 1920s, but Burtless is likely correct that since there was far less in the way of redistributive government policy back then, the post-tax-and-transfer distribution then was more stratified than it is now.

But this line of argument neglects that between the 1920s and today income became much less stratified, thanks to higher effective taxes on the very wealthy that helped pay for the New Deal and Great Society progressive programs enacted in the interim—policies that resulted in sustained and stable economic growth, unlike what prevailed before or after. Since the advent of supply side economics in the 1980s, of course, tax policies have become less redistributive in percentage terms exactly as market income has become more unequal, and transfer programs have shifted their focus toward the elderly of all income levels and away from the poor.

The upshot: the potential for policies to rectify income inequality and boost economic growth is very high, which by itself invalidates long-term conservative arguments that government is powerless or ineffective in the face of “the market’s” inexorable force. Burtless’ claim is correct, but some conservative critics of the latest research on income inequality are using the welfare state they previously devoted themselves to dismantling to support their argument that inequality either doesn’t really exist or is at least not as bad as in the 1920s.