Income Inequality's Reality

What's the real story of the increase in income inequality? Are we all doing better, or just some of us? If inequality is increasing, does it matter? One thing that is for sure is that over the next 20 months, answers will certainly be intensely debated in the 2008 presidential election.

This week, Federal Reserve Chairman Ben Bernanke expressed an upbeat view of the economy, and the stock market rose accordingly. But last week, on February 6, Mr. Bernanke said, "by many measures, inequality in economic outcomes has increased over time as well, albeit at varying rates." In a similar vein, on January 31, President Bush announced, "The fact is that income inequality is real; it's been rising for more than 25 years."

The accepted view is that growing inequality is real and that it is a problem. Recent data provide ammunition: Earnings of the top fifth or tenth of the income distribution have shown a strong upward trend. Headlines regularly highlight substantial payments for both working and fired Fortune 100 executives.

But this inequality story is simplistic because it's hard to measure income and it's even harder to measure wealth. All income groups are better off than 25 years ago in terms of real spending power and material possessions. As the president said in the same speech, "Some of us can still remember when cell phones were the size of bricks and considered a luxury. Now they fit in your pocket, they take photos, they play music, and every teenager in America has one, it seems like."

Americans regularly change income groups due to age and family circumstances. If two law school students with no incomes were to graduate and take jobs at New York law firms, they would jump to the top fifth of the income bracket. If they were to marry, they would appear to be doing even better.

Family circumstances can also work the other way. A New York police officer married to a teacher, both in their 50s, fare relatively well compared to many families, but if they were to divorce and split the household into two, each household would be poorer.

No one has an unambiguous measure of income or wealth-income distribution in America. But neither perceptions of inequality nor envy is new. Both are as old as the Tenth Commandment, which tells us not to covet our neighbor's goods.

Much public attention focuses on chief executive officers, who constitute a tiny fraction of high-income earners. Yet their compensation packages generate the most publicity, particularly when a company performs poorly. One reason is that such compensation packages are public information disclosed on the Securities and Exchange Commission's forms. The compensation of hundreds of thousands of other high-income individuals — from CEOs of privately held companies to athletes who earn more off the field than on — is not publicly known.

Forbes publishes widely read lists of the wealthiest individuals in the world. In the 21st century, it is striking how few of the hundreds of billionaires around the world received their wealth by inheritance. Most came from modest backgrounds, little different from those of many if not most Americans. Some, such as Bill Gates and Steve Jobs, were even college dropouts. Most billionaires created their wealth with their own skill and ingenuity.

The story of billionaires creating wealth is retold, on a smaller scale, at other income levels. Regardless of their wealth, most Americans earned it the old-fashioned way with hard work.

If there is inequality in America — and no one can accurately measure it — it is not the product of a dysfunctional inheritance system that preserves the oligarchy of one generation for the next. Rather, income and wealth inequality in America is almost entirely the result of an economic system that rewards skills and hard work, and rewards unusually savvy people extraordinarily well. This is not new to the 21st century; it has always been this way in America.

Getting rid of inequality is practically impossible because there will always be low-skill workers entering the labor force, whether through immigration or through students who aren't motivated to study. It is unrealistic to assume that all workers will have the desire to gain the skills to reach higher income levels, and some may fall on troubled circumstances. This is why our society has a safety net in the form of the Earned Income Tax Credit, food stamps, Medicaid, and housing vouchers to ensure that everyone has a minimum standard of living.

The American dream is not broken. Our economic system, however flawed with perceptions of inequality, attracts people of all abilities from around the world. People who aspire to be computer programmers, financiers, gardeners, and taxicab drivers all gravitate toward America. Parents who hope that their children may have a chance to do well and amass a small fortune come to America.

They come not because they worry about income inequality; they come precisely because they do not.

Ms. Furchtgott-Roth, former chief economist at the U.S. Department of Labor, is a senior fellow at the Hudson Institute.