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Tag Archives: Lorenz Curves

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“What then is the American, this new man?…He is an American, who, leaving behind him all his ancient prejudices and manners receives new ones from the new mode of life he has embraced, the new government he obeys, and the new rank he holds…Here individuals of all races are melted into a new race of man, whose labors and posterity will one day cause great changes in the world.”  (J. Hector St. John De Crèvecoeur, U.S. visitor, 1782)

Today, asked “What then is the American?” we would probably answer, “Middle class.”

In an August Pew Research survey of 2508 adults, almost one-half said they were middle class. It seemed not to matter that dividing the number of US households into fifths and then looking at the middle fifth, income ranged from $38,040-$61,720 (2010). Moving beyond any valid income definition, people with more income and less said they were middle class.

Why?

This takes me back to a blog I wrote in 2010:

In a recent NPR interview, a painting contractor, an employee of Healthy Montana Kids, a man who runs a hi-tech robotic firm, and a hospice worker, all earning between $25,000 and $100,000 annually, said they were middle class.

Sort of like “Goldilocks and the Three Bears,” most Americans prefer identifying themselves as the middle class: “They don’t want to seem {too} poor, they don’t want to seem {too} rich-they want to seem like everyone else.” Why? Probably because middle class means more than income. Also, it connects to our values, our aspirations, our education, our jobs.

In a wonderful column, David Brooks identifies “middle class” as the key to our American identity. But then, he asks, as the rest of the world becomes more like us through a gigantic global middle class, how will we perpetuate our leadership and distinct identity? The answer, he says, are our middle class values. Our middle class values fuel our achievement, our innovation, and our sense of community that everyday activities like Little League embody. While Brooks cites Ben Franklin as a model, I like to remember that John Winthrop, governor of Massachusetts Bay Colony said we can be, “A city on a hill.”

Whereas we all agree that people like to identify themselves as middle class, the disagreement starts when we ask what is happening to the middle class. I hope you will take a look at these 2 links. While one focuses on whether middle class income has stagnated and the other looks at the changing size of the middle class, both show that your conclusions depend on how you interpret the statistics. Also, the August Pew Research on the middle class is here, my census statistics come from here, and the Crèvecoeur quote is from here.

Who is middle class?

 

 

 

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Their conclusion was clear. A recent Federal Reserve study tells us that the rich are getting richer. A closer look, though, reveals it is a lot more complicated.

We need to be aware of two issues.

  1. How should we define income and wealth? Calculating income, certain variables are obvious such as wages. However, should we include workplace benefits? “Psychic income” from the environment is even a possibility. You might think “psychic income” is ridiculous but think for a moment about Manhattan and Missoula. If the cost of living is much higher in Manhattan than Missoula, should we add the “psychic income” of the pleasures of Manhattan to offset its added expense? Similarly, assessing wealth involves decisions about what to include. On page 32 of the Federal Reserve study, you can see the variables they selected. 
  2. Are the same people becoming more affluent or have others replaced them? A recent report from the Treasury tells us that the “rich” consistently change. As average net worth grows, different people move into the top “slots.”

Our point? Basing tax policy on income distribution statistics returns us to the mathematician, Benoit Mandelbrot. The closer we look, the more we see.

The Economic Lesson

Using Lorenz Curves, we can divide family incomes into quintiles and see the proportion of total national income possessed by each group. The answer, though, is only a starting point when we try to grasp income distribution.

An Economic Question: Knowing that income distribution is a complex subject, still, we can decide whether our bias is toward equality or efficiency. As a voter, would you prefer the equality that results from more redistribution through higher taxes or less redistribution that encourages competitive behavior and growth.

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There is a connection between baseball and President Obama’s budget proposals.

Let’s start with USA Today’s baseball salary database. For 2011, at $32 million, NY Yankees’ 3rd baseman Alex Rodriguez earns the most; #2 is LA Angels’ outfielder Vernon Wells at $26,187,500 and #25 is Boston Red Sox pitcher John Lackey at $15,950,000. Much lower but still astronomical, the median salary for the NY Yankees is $2,100,000 and for the Boston Red Sox, $5,500,000.

Historically, the numbers reflect a huge increase. In 1990, at the top were Milwaukee Brewers’ outfielder Robin Yount, and Minnesota Twins outfielder Kirby Puckett who were earning, respectively, $3,200,000 and $2,816,667.

Comparing top baseball salaries, can we say that the rich are getting richer?

This takes us to a University of Michigan blog from Professor Mark Perry. Disagreeing with UC Berkeley Professor Robert Reich that the rich are getting richer, Dr. Perry points out that today’s rich are different people from those with massive net worth 20 years ago. (You could look here for Dr. Reich’s position.)

Because of “considerable” income mobility and rising incomes, there were meaningful shifts in the actual people in the different income brackets. Many households in lower income quintiles moved up while those in top groups fell. The “…share of income of the top 1 percent is higher than in prior years…” but it is a different group of households.

So yes, the rich are richer. But, it is not the same people.

How does this relate to the President Obama’s budget proposals? It relates to tax policy. Believing that incentives fuel economic growth, those who care most about income mobility tend to support tax cuts for the affluent.

Your opinion?

The Economic Lesson

A very real issue that concerns economists is income distribution.  In the U.S., our national income comes from wages and salaries, rent, interest, dividends and profits from businesses that are not incorporated. To picture our income distribution, please think of a pie as the total national income and then individual slices as the proportion that different groups receive. That would mean that if total national income were $1,000 and a society had only five households (people living together), then if every household earned $200, distribution was equal. By contrast, if one family earned $800, then, because $200 remained for everyone else, there would be considerable inequality. Recently, the top quintile of households in the U.S. earned close to 50% of all income. This quintile approach for representing income distribution was developed by statistician Max Lorenz.

*Original content has been minimally edited.

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During the 2008 presidential campaign, when asked who is rich, John McCain jokingly said the dividing line was $5 million while Barack Obama said $150,000. Now, referring to proposed tax legislation, President Obama says that a family earning $250,000 is rich and should not get a Bush tax cut extension.

Some history: The year was 2001 and the nation was in a recession when the Congress passed the largest tax reductions in 20 years. Impacting such areas as income, estate, and capital gains taxes, selected parts of the law were scheduled to expire on December 31, 2010.

Here we are and what to do? Taxes are all about income redistribution. Economist Arthur Okun has said that we should consider Equality and Efficiency: The Big Tradeoff. If we promote equality, we will have more income redistribution through taxes, more fairness, and a common living standard. However, economic efficiency will suffer and our economic pie will grow more slowly. By contrast, economic competition leads to more efficiency, more entrepreneurial energy, more economic growth and a bigger pie. And, is it fairer to be able to keep more of what you earn?

Yes, there are countless other issues. They include the deficit, income inequality, innovation, the role of government, defining who is rich, and the unemployment rate. But still, I wonder whether it all comes down to the side you take for “the big tradeoff”.

The Economic Lesson

One way to look at U.S. income distribution is a Lorenz Curve. Created by statistician Max Lorenz, the Lorenz Curve divides the total number of U.S. families into 5 equal groups. Then, Lorenz used coordinates to show how much of the total income each fifth of families earns. For example, on a graph a dot at (20,20) would mean that 20% of all families received 20% of the income. Continuing the same idea, we could place a dot at (40,40), (60,60), (80,80) and (100,100). The result would be a straight line reflecting totally equal income throughout that society. Displaying inequality, the actual U.S. curve for 2007 is bowed to the right.

Arthur Okun said that when we try to affect income inequality by taxing the more affluent, we have a “leaky bucket” problem. Assume, for example, that the “rich” pay a $100 tax. Society will benefit from less than $100 because of administrative distribution costs and skewed spending incentives.

 

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I once read that Thorstein Veblen let his dirty dishes accumulate until his cupboard was bare, then sprayed them with a hose and started all over again. Maybe a good idea, but unusual. This early 20th century scholar (1857-1929) was somewhat eccentric.

We remember Veblen for his The Theory of the Leisure Class (1899) and his theory of conspicuous consumption. According to Veblen, affluent consumers try to convey their power and wealth through wasteful and unproductive behavior. The affluent can do less because their servants and employees do more. And then, to display their prestige and power, everyone else also wants to do less. As expressed by Veblen, “The members of each stratum accept as their ideal of decency the scheme of life in vogue in the next higher stratum, and bend their energies to live up to that ideal.”

In a 2009 essay, columnist Daniel Gross asks whether Veblen is still right. Does wasteful spending convey prestige? Yes, he concludes. But, when Veblen says the affluent become unproductive, times may have changed. “Type-A” behavior has become prestigious. Maybe now, “there’s a sort of reverse prestige associated with leisure.”

More tomorrow with specifics on what the rich buy.

The Economic Lesson

Using Lorenz curves developed by statistician Max Lorenz, we can look at income distribution in the U.S. Lorenz divided the total number of families into 5 equal groups as the X-axis of his graph. For the Y-axis, he looked at the total amount of income that all families received. Then, he used coordinates to show how society’s total income was distributed. For example, a dot at (20.20) would mean that 20% of all families received 20% of all income. If the line moved from (20.20) to (40.40) to (60.60) and finally to (100,100), income distribution would be equal. Displaying unequal income distribution, in the U.S., the most affluent quintile receives close to 50% of all income. 

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