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Here’s why Obama should get credit for reducing income inequality

Has President Obama shrunk inequality? (Pete Souza/The White House)

My post last week on how President Obama has reduced income inequality sparked a bit of a wonk feud.

MSNBC’s Timothy Noah took me to task, arguing that I was too quick to say that Obama has reduced inequality.  He says that inequality has increased under Obama, with the top 1 percent gobbling up 22.46 percent of income in 2012, versus 18.12 percent in 2009, citing the Saez-Piketty World Top Incomes database. New York Magazine’s Annie Lowrey and Vanderbilt professor Larry Bartels also say inequality has increased under Obama, but they agree with me that there is less inequality than there would be without his policies. And Time’s Michael Grunwald suggests that I actually understated how much Obama has done, because I did not capture the full breadth of measures in the stimulus.

This is quite a wonk feud, but like the best wonk feuds, we all actually agree.  Yes, the rich have grown farther apart from the rest of us during the Obama years. And yes, Obama’s tax policies and the Affordable Care Act are narrowing inequality to less than it would otherwise be. But the discussion is instructive in that it raises interesting questions about how we experience inequality; how we measure it; and whether we ought to give credit to policymakers -- namely, Obama -- for doing anything about it, or conversely whether we ought to criticize them for failing to do enough about it.

I'd like to make five points:

1. For starters, we’re far too vague when we refer generically to “income inequality,” and we need to better differentiate among the ways we measure it.

Much of the attention in the inequality debate has focused on market inequality, which is the income we receive before any government policy is taken into account. This type of inequality measures what the economy is doing on its own: what companies are paying workers in salary and benefits, the gains or losses of investors, etc.

Then there’s post-policy inequality, once you consider the effect of taxes and transfers such as Social Security payments and food stamps. This type of inequality measures what people actually experience: the income they have to spend at the end of the day on goods and services for themselves and their families.

Once you decide what type of inequality you want to measure, you need to decide how to measure it. It’s not quite as simple as it seems. There’s inequality between the poor and rich, between the poor and the middle class, between the middle class and the rich, and so on. Economists have developed mathematical representations of inequality known as the Gini coefficient and Pareto-Lorenzo coefficient, but these are unintuitive.

A more intuitive way to think about inequality is to look at the share of income that flows to the rich vs. the poor and middle class. If the share is increasing over time, inequality is increasing. This is relevant because it gives you a sense of how the fruits of economic activity are being distributed.

I made these four charts to provide an overview about the path of market and post-policy inequality in the United States over time.

Figure 1 graphs the income share of the top 1 percent of earners since 1917 – before taking into government policy – based on the World Top Incomes Database. The chart shows that, without question, market inequality has been increasing since the early 1970s, and it continued to rise through the Obama era.

Unfortunately, no equivalent source of data is available that looks at post-policy inequality. The closest we can come is the Congressional Budget Office’s analysis of incomes from 1979 to 2010, which has data on both the market and post-policy average income earned by the top 1 percent, the middle 20 percent, and the bottom 20 percent. By comparing how much more the rich make compared to the middle class and the poor, we can look at the path of inequality over time -- both before and after policy is taken into account.

In Figure 2, I’ve graphed average market income and average post-policy income for the top 1 percent. In Figure 3, I’ve graphed average market income and average post-policy income for the bottom 20 percent and for the middle 20 percent. You see that, throughout time, policy has reduced the income of the rich and increased it for the poor. This is redistribution at work.

Middle income earners are interesting, though. In the 1980s, policy reduced their income. In the 1990s, though, the effect diminished, likely reflecting increased health-care payments. Finally, in the 2000s, post-policy income was actually higher, reflecting tax cuts.

In Figure 4, I’ve graphed, on both a market and post-policy basis, how much more income the top 1 percent makes compared to the bottom 20 percent and the middle 20 percent – a measure of inequality. For instance, the average market income of the top 1 percent in 2010 was 92 times larger than than that of the bottom 20 percent, but the post-policy income was 43 times larger.

2. One of the big subjective questions in the wonk debate is what matters more: market inequality or post-policy inequality. Both are important, but the latter is more important.

For most of us, the number that first comes to mind when we talk about our "income" is our salary, or wage per hour. Yet few of us think about our financial well being as simply what we receive in our paycheck.

If you’re poor, you’ll also think about how Medicaid, food stamps and the earned-income tax credit supplement your payroll. If you’re middle class, you won’t spend your whole salary because you need to pay taxes. On the other hand, if you own a home, you might also take into account that your tax bill will be lower because of the mortgage interest deduction. If you're a senior, you certainly will factor Medicare and Social Security into your mental budget. And finally, there’s obviously a reason the rich are so strategic about reducing their tax burdens by exploring every deduction and loophole they and their high-priced accountants can find.

Post-policy inequality reflects the income – the living standards – we actually experience. It’s a much more precise measure of inequality in a society. Perhaps the best evidence for why we should look at post-policy inequality comes from abroad. For those who worry about inequality, countries in Europe, especially in Northern Europe like Norway and Finland, are models. Yet as this chart from the Luxembourg Income Study’s Janet Gornick shows, many of these countries have a level of market inequality similar to the United States.

Policy is what makes their societies more equal than ours.

But there’s little reason to think this will happen. Consider what would have to happen for market inequality to shrink: The incomes of the bottom and the middle would have to grow faster than the incomes of the rich. A more reasonable hope, though still optimistic, is that Americans throughout the income distribution experience wage growth at a fairly equal pace.

3. It doesn’t make sense to give a president credit, or to criticize him, for movements in market inequality during his tenure. 

The biggest factors shaping market inequality – technology, skills, globalization -- are far beyond the grasp of any one president to control. And to the degree presidents do influence them, policies that might affect market inequality – training, better educational attainment, trade standards -- will operate with a huge lag.

The 2007-2009 period shows why looking at market inequality over a period of a few years is a not a good way to evaluate a president’s record.

Perhaps the fastest and most concrete way to reduce market inequality is to increase the minimum wage, which should have a big effect on the income of the poor. President Bush and Congress agreed to hike the minimum wage in 2007, when the average pre-market income of a member of the bottom 20 percent of earners was $16,500, according to CBO. By the time the minimum wage increase was complete two years later, it was $15,100.

So despite the increase in the minimum wage, market incomes for the poor fell over this period.

At the same time, the average income of the rich declined by much more over the same period. The average income for the top 1 percent fell from $1.9 million to $1.2 million. As a result, the rich went from making 117 times what the poor made to 81 times.

Strictly speaking, you could argue Bush reduced income inequality in his final two years.

This is, of course, absurd. There was a recession and financial crisis that caused huge investment losses for the rich, wiping out a big part of their income. The downturn also increased unemployment and eliminated wage pressure at the bottom, far outweighing gains caused by the increase in the minimum wage.

As you can see in the following chart (gray highlights a few recessions), declines in market inequality are often a side effect of economic contractions. In the 13 recessions since the onset of the Great Depression, all but two ended with market inequality lower than it was before the recession started. Nobody would say a president should seek to cause a recession in order to shrink inequality.

4. This is why I argue Obama reduced inequality. Obama has put in place tax code changes and subsides for the poor that are narrowing post-policy inequality significantly.

This is true if you look at post-policy inequality between the rich and the poor, and post-policy inequality between the rich and the middle, although it's much less dramatic in the latter case.

The key policies Obama introduced include: higher tax rates on the wealthy, new levies on upper-income Americans in the Affordable Care Act and expanded refundable tax credits for the poor.  They also include a more generous program of health insurance for low- and moderate-income Americans, achieved through subsidies and expanded Medicaid.

The new taxes took effect last year, and the Affordable Care Act’s expanded insurance provisions began this year. Unfortunately, CBO does not have data beyond 2010. So I turned to the non-partisan Tax Policy Center to do an analysis comparing market and post-tax inequality today, versus a world in which Obama’s tax policies never took effect.

(The center’s analysis is different than the CBO’s, so you can't do apples-to-apples comparisons between the two. For instance, the center includes Social Security and food stamps in pre-tax income, and it doesn’t take into account non-cash benefits like Medicare and Medicaid. But it’s the closest approximation we currently have).

As I wrote last week, the center’s analysis showed that after taxes, the top 1 percent on average makes 84 times what the bottom 20 percent takes home. Without Obama policies, it would have taken home 91 times what the bottom takes home. The top, meanwhile, takes home 22 times what the middle takes home, versus 23 times without Obama policy.

You can extend the analysis to include the ACA’s subsidies and Medicaid expansion. This year, the CBO estimates that the subsidies and Medicaid expansion will cost $37 billion, growing to $139 billion by the time the ACA is fully implemented in 2016. Make no mistake: This is a transfer of income to the poor and middle class worth $1.8 trillion trillion over a decade.

Here's a back-of-the-envelope, illustrative calculation. With over 100 million households among the bottom 60 percent of earners, the ACA is likely to add around $1,200 in income (in the form of health insurance) for the average family in this group. It would be worth more at the lower end. If you add $1,400 to the income of the bottom 20 percent -- an 11 percent increase in income -- the ratio of the top 1 percent to the bottom 20 percent would fall further, from 84 today to 76.

5. Obama has done a lot to shrink the gap between the poor and rich, but very little to shrink the gap between the middle class and rich. And the future is working against him.

I haven't said, and I don't mean to suggest, that Obama has done enough to reduce income inequality. In fact, I'm not even arguing that it's good that Obama has taken any steps at all to reduce inequality. Instead, I'm trying to convey, as best as possible, what the impact has been, and make an argument for why it is significant.

By reducing the post-policy income of the rich, and increasing the post-policy income of the poor, Obama has made progress on his goal of reducing the income gap. To the degree that he also wanted to narrow the gap between the middle class and rich, he hasn't been particularly successful. Given the stagnation of middle class incomes -- with the theory being that income is flowing to the top rather the middle -- this must be a disappointment for him.

For those who wish see inequality narrow further, the future doesn't look bright as this chart shows. Between 2013 and 2017, the Tax Policy Center's model estimates that market income for the bottom 20 percent will grow 19 percent, without adjusting for inflation, while market income for the top 1 percent will grow 48 percent. Post-policy inequality will increase, from a multiple of 84 today to 95 in 2017.

It's true that the ACA and tax code will continue to reduce post-policy inequality as Obama wraps up his presidency. But market forces will be continuing to widen inequality.