Inequality: What We Earn vs. What We Consume

Is inequality better measured by what we earn or what we spend? The difference is surprising. [Credit:]

Is inequality better measured by what we earn or what we spend? The difference is surprising. [Credit:]

Is your standard of living better measured by what you earn or by what you buy?

The question may seem an odd one, but it is critical to understanding the problem of rising inequality.

Most of what’s been written on the subject focuses on widening income disparities.  Thomas Piketty’s celebrated work, Capital in the Twenty-First Century, relies on a trove of income tax data from the US and other prosperous countries to argue that income disparities are rising throughout the developed world and reaching levels not seen since the early twentieth century.

In an earlier post, I discussed several criticisms of the study, including Piketty’s failure to take into account the effect of transfer programs on household income.  It is not valid to compare the income of an impoverished family in the 1920s with a similar family today without counting the value of cash welfare benefits, food stamps, Medicaid, housing assistance, help with paying utility bills and a range of other benefits that were unavailable to people in previous generations.  These benefits are considerable.  Citing a Congressional Budget Office study, I noted that such families receive an average of $3 in benefits for every $1 they earn.  By ignoring those benefits, Piketty’s analysis may overstate income inequality.

A recent collection of essays published by the American Enterprise Institute argues that income isn’t the best measure of inequality at all.  We should gauge inequality, the authors say, not by the wages and benefits households receive but by the goods and services they consume.

Consumption is a better measure of well-being than income.  What we buy and consume with our income directly adds to our utility and happiness, and also has a direct impact on our standard of living [p.35].

To measure consumption, Kevin A. Hassett and Aparna Mathur, whose essay appears in the AEI volume, use data from the Bureau of Labor Statistics (BLS) and the Energy Department.  The BLS Consumer Expenditure Survey measures what households spend and what they spend it on.  The problem of inequality looks very different when examined in this way.  Disparities between rich and poor appear less extreme, as the table below illustrates.

Disparity Ratios: Income Disparities vs. Consumption Disparities
1984 2010
Consumption Disparity Ratio (BLS) 3.7 4.4
Income Disparity Ratio (Census Bureau) 11.0 15.4

In 1984, for example, households in the top quintile accounted for 37 percent of total expenditures while those in the bottom quintile accounted for 10 percent.  That is a ratio of 3.7 to 1.  By 2010, that ratio had increased to 4.4  to 1 [p. 36].  That still marks an increase in inequality, but one that is much less pronounced and growing half as quickly as disparities in income, as the table shows [p. 37].

Hassett and Mathur go further, noting that the BLS consumption data don’t consider durable goods owned by households.  That information is captured in the Energy Department’s Residential Energy Consumption Survey.  Comparing data from the 2001 and 2009 surveys, the authors found substantial increases in the percentage of poor households (defined as those with incomes of less than $20,000 in 2009 dollars) that owned computers, dishwashers, air conditioners, microwaves, cellphones and similar devices.  [p. 36]

Living standards are thus improving for households at the bottom, the authors argue, though they are uncertain about the reasons for that improvement.

Whether the explanation for improvement in living standards lies in redistribution policies and the growth of the safety net, or technological improvements that allowed prices of electronics and other durable goods to drop, or real improvements in productivity and wages, the bottom line is: people are better off today than they were twenty or thirty years ago.  Households are consuming more and the typical low income household possesses more appliances and gadgets that have traditionally been considered the preserve of the rich than at any time in history. [p. 38]

This diverges sharply from the prevailing income inequality narrative in which the rich are said to have enjoyed vast improvements in their living standards, while the rest have made little progress, struggled to tread water, or lagged farther behind.  Data on household consumption of durable and nondurable goods presents a much less dreary picture, showing that living conditions have gotten better in recent decades even for the poorest families.  That this improvement has occurred despite stagnant wages suggests that income disparities may indeed overstate the economic distance between rich and poor.

No statistic measures this distance completely or without distortion.  There is value to taking consumption, as well as income, into account.  However measured, the gap persists, is growing larger, and seems impervious to government intervention in developed countries on both sides of the Atlantic.

While public assistance programs almost certainly have dampened inequality by providing material benefits to low-income households, in another sense they have done little to improve quality of life.  Smartphones, dishwashers and other gadgets cannot alleviate the psychic poverty that characterizes the poorest families.  It is a world in which videogame consoles and flat screen TVs are far more commonly found in the home than fathers and where an estimated one in six African American males have been incarcerated.

This reality defies quantification, as does the yawning social and cultural gap between the poorest families and the elites who run governments, universities, Wall Street and the entertainment industry.

That cultural chasm may help explain why those elites seem at a loss to explain and understand, much less to effectively address, the inequality problem.