Income Data is a Poor Measure of Inequality

Richard Borean

Friday, August 15th, 2014

Social scientists regularly use IRS and Census Bureau income data to expound on the measure of inequality in the United States. However, because of the substantial disparities in cost of living, how dramatically income varies over a person’s life cycle, and the inconsistent or absent measurement of retirement saving, Census and IRS data are flawed tools for understanding inequality. This is according to a new report from the nonpartisan Tax Foundation.

IRS income data is collected for the purpose of raising revenue annually in the manner that Congress directs; it was not intended to be a measure of one’s overall wellbeing. It has massive confounding factors; not minor technical nitpicks, but big glaring issues so plain and so relevant that they can be expressed in terms of the lives of ordinary people. People develop professionally with age. People go to college. People think about where rents are high and where they are low. People save in retirement accounts. Relying on IRS income data ignores these factors.

The report finds that:

  • The average taxpayer’s income changes dramatically throughout his lifetime; the average tax return for an 18- to 25-year-old shows about $15,000 in adjusted gross income where an average tax return for someone between ages 55 and 64 shows above $80,000.
  • College students, particularly, comprise a very large number of low-income taxpayers.
  • Incomes go considerably farther in some places than in others. Much of the narrative about rural states being poorer is mistaken.
  • Much capital income—especially capital income in tax-free middle-class retirement accounts—goes uncounted in income data, heavily distorting the measurement and making people appear poorer than they are.
  • Thomas Piketty’s popular analysis on income inequality leaves out $19 trillion of pension assets, which are yet to be attributed to any individual. 

“Income data would be a reliable measure of social inequality if it weren’t distorted by virtually every major decision people make in their lives,” said Tax Foundation Economist Alan Cole. “Income data, out of context, leads us to conclusions so absurd that the entire project of dividing people up into quintiles may be an intellectual dead end. The dollar-denominated sum of certain classes of market transactions is not enough to identify suffering or plenty.”

As an instrument of the federal government, the IRS is best when used for its intended purpose: collecting revenue. It is considerably less effective at creating social justice, which is not something easily determined using a Form 1040 alone. Efforts to fight social inequality would be best undertaken by humane institutions with well-defined purposes and local knowledge of the problems they are designed to handle—not a large centralized bureau built to extract revenue on a mass scale.

Full report: Income Data is a Poor Measure of Inequality