New Studies Show the Middle Class Is Held Back by Government-Distorted Healthcare, not Income Inequality

Daniel J. Mitchell
Posted: Jan 06, 2012 12:01 AM
 did a debate on income inequality for PBS, but haven’t written much about the issue because I think it is a misguided diversion.

One frustrating aspect of this debate is that folks on the left genuinely seem to think the economy is a fixed pie and that rich people get money by impoverishing others.

This is utter nonsense. Just look at this chart comparing North Korea and South Korea, or this chart comparing Chile, Argentina, and Venezuela. With the right policies, countries can get much richer over time, yielding enormous benefits for the average household.

More rational leftists understand this data, so they change the argument by asserting that the rich are getting richer faster than the poor are getting richer and that politicians should “solve” this alleged problem with class-warfare tax policy and more redistribution.

They even cite numbers from the biased bureaucrats at the Congressional Budget Office to supposedly prove their point.

There are all sorts of methodological problems with this kind of research, including the fact that people move up and down the income ladder over time, so it is very sketchy to compare, say, the top 20 percent in 1990 with the top 20 percent in 2010.

But even if you incorrectly assume that all households are locked into their current income levels, the data used by the left is deeply flawed.

My colleague, Peter van Doren, reviewed two studies for one of Cato’s in-house journals. Here some of what he culled from the scholarly publications.*

Increasing inequality in the distribution of earnings has become one of those stylized facts that everyone “knows.” The nightly news reminds viewers that ordinary workers have not fared well in the labor market over the last 25 years, while corporate executives have. Many professional economists and a recent CBO report have supported this view as well. While it is true that the cash explicitly paid to employees has become more unequal over the last generation, the…more benign explanation for the change in cash compensation over a generation is the dramatic increase in health insurance costs. …inequality in total compensation has not increased because the fixed costs of health insurance are a much larger percentage of the total compensation of lower-earnings workers. Burkhauser and Simon explore this explanation. They add the value of employer-provided health insurance as well as Medicaid and Medicare to the pre-tax, post-cash-transfer household income data and find that the bottom three income deciles actually exhibit higher growth than the top seven deciles from 1995 to 2008. …Warshawsky makes a similar discovery. Using unpublished BLS total compensation data, including employer health insurance expenditures, from 1999 to 2006, he finds that the growth in compensation by earnings decile (from the 30th to the 99th) averages 35 percent, with 41 percent growth at the 30th percentile (workers earning $10–$14 an hour) and only 35.8 percent growth at the 99th percentile (workers earning $59–$80 an hour).

Translating all this into simple English, it turns out that the rich are getting richer slower than the rest of us are getting richer.

By the way, even though I’m glad total compensation is growing more rapidly for the non-rich, these studies should not be interpreted as good news. As noted in the excerpt above, much of the additional money is diverted into a rather inefficient healthcare system.

This is the problem, not inequality. As I’ve explained before, American healthcare suffers from a third-party payer crisis caused by too much government intervention.

And because this distorted system leads to ever-higher costs, the increase in total compensation for lower-income and middle-income people does not translate into an increase in their living standards. Ordinary people feel like they’re on a treadmill.

In other words, while assertions of rising income inequality are dubious, there is a real issue of stagnation.

But as is often the case, the left’s answer is completely wrong. Class warfare and redistributionism are terribly misguided, as illustrated by this Walter Williams column and this Margaret Thatcher video.

If we want to help people live better lives, restoring a free market to health care would be a good first step, as explained in this video.


*“Can the Rapid growth in the Cost of employer-Provided Health Benefits explain the Observed increase in earnings inequality?” by Mark J. Warshawsky. september 2011. ssRn #1932381. And “Measuring the impact of Health insurance on Levels and Trends in inequality,” by Richard V. Burkhauser and Kosali i. simon. March 2010. nBeR #15811.