Working Paper 2016-09: Jonathan Fisher, David Johnson, Timothy Smeeding, Jeffrey Thompson

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090716-WP-Inequality-in-3d

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Authors:

Jonathan Fisher, Research Scholar, Stanford Center on Poverty and Inequality
David Johnson, Research Professor, Survey Research Center, Institute
for Social Research, University of Michigan, Law School
Timothy Smeeding, Lee Rainwater Distinguished Professor of Public Affairs
and Economics, University of Wisconsin-Madison
Jeffrey Thompson, Principal Economist, Board of Governor of the Federal Reserve System


Abstract:

We do not live in a world where we need to choose between income, consumption, or wealth as the superior measure of well-being.
All three individually and jointly determine the well-being of households, and we have access to data that contain all three measures, including the values for the highest stratums of income and wealth. And indeed, economic inequality is multi-dimensional. Income, consumption, and net wealth, independently and jointly, inform the perception and reality of inequality. Yet most studies of inequality limit analysis to one dimension.

Most research on inequality focuses on income alone, but that may well not be the best single measure of inequality. Economists prefer consumption as a measure of permanent income, and we argue that wealth incorporates the ability to increase income and the ability to consume directly, allowing top quintile and top ventile households to smooth shocks in income or consumption at their own whim. It therefore appears to us that wealth may be the most important dimension of the three.

Even those using more than one measure present the measures separately and often from different datasets. Because the three measures are not perfectly correlated, our understanding of inequality deepens, broadens, and becomes more nuanced by studying inequality in two and three dimensions fro the same population. We are the first to study inequality in three conjoint dimensions, and to do so in this paper we use income, consumption, and net wealth from the 1989-2013 Surveys of Consumer Finance (SCF) to complement our similar work with the PSID.

We use both the SCF and PSID in our more general body of work because they each have different strengths and weaknesses. The SCF includes top income earners and wealth holders, but has a more limited set of consumption expenditures which we supplement with the CEX. The PSID allows us to add intragenerational mobility and to use all three inequality dimensions from the same dataset. Because the SCF gives us better perspective and insight on the top end of the distribution , it provides a better frame to consider aggregates and macro-micro matches and that are not possible with the PSID.

Individually, we show that inequality in one dimension has increased since 1989 for each measure. Further, our results point toward an increase in inequality in two dimensions and in three dimensions, and with this increase in inequality in two and three dimensions being faster than the increase in inequality in one dimension. The top 5 percent increased its concentration in all three dimensions. The top quintile of the distribution gained in own and cross shares, and the remaining four quintiles lost own and cross shares. The top quintile has a higher share of income, consumption, and wealth in 2013 than 1989, and there is a stronger correlation between the three measures in 2013 as well. The gains at the top came from all four lower quintiles. And finally, inequality in three dimensions increases the fastest of all.

In particular, our works suggests the crucial role of wealth as a stock that can be used to stabilize consumption in times of misfortune, or to increase realized income flows. Because wealth is so highly skewed and becoming more skewed over time, it also allows the wealthy to ensure the economic success of their children. That is, personal and business wealth provides one an ever-increasing cushion against economic misfortune and a dynastic advantage to maintaining one’s own social position over time. And so wealth may compromise equality of opportunity and diminish intergenerational mobility. High wealth also provides an increased ability to use their wealth and power to shape public policy and receive favorable legal treatment and tax treatment. In turn, this increase in inequality and concentration of power may lead to lower rates of human capital accumulation, and hence slow economic growth, a topic we plan to examine in our next phase of this research.