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Why we should worry less about income inequality and focus on consumption

Per-capita real consumption for both the bottom and top income quintiles has been trending up. AEI economist argue that this is more important than income inequality.
Per-capita real consumption for both the bottom and top income quintiles has been trending up. AEI economist argue that this is more important than income inequality.

I had another great conversation with Aparna Mathur of the American Enterprise Institute last week (we last talked about a worrying "labor mismatch" in the U.S.). AEI is generally regarded as a conservative think tank, but regardless of your politics, it's been putting out some interesting research lately, and Mathur is an excellent explainer when it comes to labor and tax issues.

With Kevin Hassett, also of AEI, she's authored a new paper, titled "A New Measure of Consumption Inequality." Here's a sample:

Economists have widely acknowledged that consumption is a better measure of economic welfare than income. In general, individuals are better able to smooth consumption rather than income over their lifetimes, making consumption a more informative indicator in the study of inequality. Unlike income, consumption remains relatively steady throughout life since individuals borrow during years with low income and save in high-income years. Using consumption as the relevant measure of inequality, most studies conclude that, contrary to popular belief,inequality has remained fairly steady over the past thirty years. Our study retains the focus on consumption inequality and arrives at a similar conclusion. 

What Hassett and Mathur are taking aim at here is the idea that there's a widening income gap in the U.S., a notion that they assert has gained traction in the media, but that isn't supported by data.

Specifically, data drawn from the Consumer Expenditure Survey put together by the BLS, along with data collected for the Residential Energy Consumption Survey by the Department of Energy. Note that both these datasets, as economists call them, are trying to measure consumption.

"This isn't a new idea," Mathur said. "It's been around in economics for a while. But if you look at consumption inequality, the gap between top and bottom is a lot lower than if you look at income inequality. If you just looked at income, you'd see people at the low end you'd say that they're doing badly."

But, as the AEI economists argue, they're aren't, if you reframe the discussion and concentrate on the narrowing consumption gap, shown in the chart above. The red and blue lines aren't that far apart and at times, those with lower incomes consume at a more brisk rate than those with higher incomes.

"We looked at these new datasets, which capture how many microwaves, dishwashers, printers, and appliances — things like that — that people have, as well as factors such as home heating, air conditioning, the size of houses and so on. In terms of items people with lower incomes possess, it's become affordable for houses to have two or three color T.V.s, some computers, air conditioning, and heating."

According to Mathur, this "changes the picture of what poverty really looks like. A typical [lower income] household has less of these things, and they might be of different quality, but they have access."

And this is where matters get controversial. Because we're accustomed to the idea that incomes need to be equalized for inequality to be reduced. And we generally want to do that by raising taxes on the wealthy. "Redistributing" wealth, in the language of the right, and of economists on both sides. (The word has taken on charged connotations, due to its association with socialism, but really it just means moving the money around in a society, for reasons that can be debated.)

Mathur thinks we don't need to narrow an illusory income gap. Because in terms of the their ability to consume, folks at the lower levels of the economic ladder are doing fine. "If your objective is to lower inequality, then we're doing a good job," she said, "You don't need any more redistribution."

Of course, you could always cut taxes for the middle class, assuming that this will be more effective that cutting taxes for the wealthy. Mathur agreed. "If you do cut tax rates, you'd see people in the middle consume more. You'd see even even better consumption effects in the middle, if you're already seeing them so much at the low end."

The point isn't to think about who will shoulder the burden of taxes. It's to figure out how to create tax policies that have the best effects. And for Mathur, that means consumption taxes, because that's where the action is in the economy. "People prefer them in general. The current income tax system creates disincentive to save. You could get higher savings and investment from a consumption tax."

If such a tax were put in place — beyond existing sales taxes, maybe moving toward some kind of national value-added tax, with economic activity taxed at each stage of a product or service's production — "you might see consumption going down," Mathur said. "People would be able to retain a lot of their incomes. And it's a good idea in the long run to move away from taxing income to taxing consumption."

Her view on this is backed up by plenty of economists. Most recently, I heard it stressed by UCLA economists at a presentation of the Anderson Forecast. As a society we aren't saving nearly enough. So we need to transition from consumption to increased savings.

There's some common ground here between left and right, although you need to dig a bit. Both sides could concentrate on consumption and see improvement in society. Incomes may very well be a distraction. 

So what do you think? Take it to the comments!

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