Focusing on Wealth Inequality Is Counterproductive

A new Congressional Budget Office (CBO) report on wealth inequality trends over the last 30 years has generated much concern that wealth inequality is too high. Some attribute this to policy choices that the U.S. has made over the past few decades, implying that policy changes could significantly reduce the wealth gap.

While there is more we can do to encourage lower- and middle-class households to save more and build wealth, a closer, more comprehensive look at the data and trends in other countries suggests that America’s wealth gap is not as alarming as some may think.

The CBO headline numbers conclude that the bottom half of the income distribution holds only 2 percent of all wealth in the U.S.—a share largely unchanged over time, despite the wealth holdings of the top 10 percent continuing to grow significantly.

The analysis primarily relies on the Survey of Consumer Finances (SCF) to track changes in the household wealth distribution since 1989, when the survey was first administered. As noted within the report, the survey does not track wealth changes in particular households over time, but rather provides a “snapshot” of the wealth distribution in any given year. This matters because of changes in wealth that occur as individuals age, also known as life-cycle effects.

For example, consider a 22-year-old recent college graduate. He likely has student debt and lower earnings than more experienced workers because he is just starting his career. But over time he will progress, earn more, save, pay off his debts, and perhaps start a family and purchase a house. Though he might start at the bottom of the wealth distribution early on in his career, over time he will gradually move up. A snapshot in time of wealth will miss these effects.

Looking at six birth cohorts, from those born in the 1930s to those born in the early 1980s, the report finds that, as expected, wealth generally increases with age. Given that, on average, people live longer and work more years than they did many decades ago, they have many more opportunities to continue to build wealth. And since wealth compounds over time, even a few extra years can make a significant difference in wealth accumulation. Although the report doesn’t present demographic data for each income quintile, controlling for age and life-cycle effects would likely reduce some of the wealth disparities.

Of course, these factors alone do not account for all of the wealth differences across the distribution. For example, even when controlling for age, the report shows that a person aged 25 to 29 that was born in the early 1980s had lower levels of wealth than a person of the same age who was born in the 1970s. On its face, this seems to suggest that current generations are having trouble building wealth compared to past generations.

But there are additional demographic factors that make these cohorts less comparable. While the more recent cohort is more likely to go to college (increasing their earning potential), they are more likely to have debt when they are younger (reducing their net wealth). Additionally, this recent cohort is less likely to be married, so some of the differences in wealth are due to the smaller household size. Finally, although the report does not provide a racial breakdown, it does note that members of this recent cohort are less likely to identify as white than earlier cohorts. As newer immigrants—who often start near the bottom of the income distribution but like other households eventually move up—comprise an increasing share of these cohorts over time, they will artificially make these snapshots of inequality look worse than they otherwise are.

One improvement this paper makes over studies using similar data is that it more accurately captures wealth at the bottom. Previous analyses had ignored defined-benefit positions—employer pensions that return a benefit based on a specific formula—because they can be difficult to measure, even though these plans are an important source of wealth for those in the bottom half of the income distribution. This paper includes defined-benefit wealth. However, it excludes another significant source of wealth for lower- and middle-class households: Social Security benefits.

One recent paper from Federal Reserve economists found that accounting for Social Security benefits reduced the ratio of the wealth gap for earners at the 90th income percentile relative to the median earner by nearly half, for households aged 40 to 59. The wealth gap shrunk even more when comparing the median earner to those in the bottom 10th percentile. That ratio fell by 67 percent for those aged 40-49, and by 80 percent for those aged 50-59. Another paper reached similar conclusions, estimating that Social Security benefits accounted for 59 percent of the wealth for the bottom 90th percent of the income distribution, and that their inclusion reduced the top 10 percent’s share of wealth significantly.

How does the U.S. compare to other developed countries? When looking at other more “equal” countries, the same gaps in wealth appear to persist. For instance, even in Norway and Sweden, which are generally recognized as having larger social welfare policies than the U.S., wealth inequality remains quite high and comparable to U.S. levels. And much like here, adjusting for age and life-cycle effects reduces the wealth gap somewhat.

There are certainly things we can do to encourage lower- and middle-class households to save more and build wealth, but punitive tax increases on wealth shouldn’t be one of them. Simplifying and expanding our savings accounts and better tax treatment of savings more broadly would increase incentives to save. And there’s more to be done to improve tax and financial literacy across America. But the economic data suggests we should stop obsessing over the wealth gap and instead pursue policies that improve living standards for all Americans.

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