How Is Income Inequality Measured?

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Income inequality has received significant attention over the past several years. However, the way income is defined may impact the amount of income inequality seen in studies, according to an article in The Regional Economist.

Assistant Vice President and Economist Michael Owyang and Senior Research Associate Hannah Shell discussed how income inequality has changed over two broad periods: the 1970s and the period leading up to the Great Recession. (Their analysis is summarized in the blog post “How Has Income Inequality Changed over the Years?”)

But first, they discussed some of the differences in the datasets used to measure income inequality. As they pointed out: “Studies using different data sources reach various conclusions on income inequality, depending on the definition used for income.” They focused on three specific sets, discussed below.

The SOI defines income as market income, or the cash reported on tax forms. This includes before-tax income from wages and salaries, profits from businesses, capital income (such as dividends, interest and rents), realized capital gains and income from past services. (It should be noted that it excludes noncash benefits such as health insurance, which are a growing portion of middle-class income.)

The authors pointed out that this dataset more accurately measures the top of the income distribution. However, it less accurately measures the bottom because low-income households are not always required to file income taxes.

The CPS is a monthly survey of 75,000 households and releases income and poverty information once a year. It defines income as money income, which includes market income and other cash income and excludes noncash benefits. Owyang and Shell noted that the CPS provides quality low- and middle-income data but not high-income data, as incomes above a certain threshold are not reported to protect individual privacy.

The CBO’s dataset pulls from the previous two sources to draw on their strengths: the SOI for high income and the CPS for low income. The CBO reports market income, before tax income (market income plus government transfers) and after tax income (before-tax income less federal taxes).

The authors noted that more equality is seen in after-tax income, then in before-tax income, then in market income. Also, most agree that the U.S. is similar to other developed nations in terms of pretax and transfer income inequality. Owyang and Shell wrote: “In other words, U.S. income inequality is not intrinsically different from what is seen in other countries, and any differences are mainly driven by the lack of income-redistributing fiscal policies in the U.S.”

• Regional Economist: Measuring Trends in Income Inequality
• On the Economy: How Has Income Inequality Changed over the Years?
• On the Economy: Are Rising Stock Prices Related to Income Inequality?