Gary Byrne and Ken Glozer write in the latest Barron’s about the way in which the problem of income inequality has been exaggerated.
The income gap between wealth and poverty has emerged again as a political issue. Many talk about it as an established fact, and the measurement of income inequality is rarely challenged. But problems with measurement point to the likelihood that income inequality in the U.S. has been exaggerated.
Every society has an income gap. The question has always been about its size and momentum. The most commonly used statistical measure of income inequality, the Gini Coefficient, exaggerates income inequality in the U.S. because it ignores the growing underground economy, which has evolved in the U.S. to avoid taxation and regulation.
Professor Edgar Feige of the University of Wisconsin estimates this invisible cash economy to be worth at least $2 trillion in unmeasured gross domestic product, with about $500 billion in tax revenues currently being lost from these cash-based, tax-avoidance activities.
As Gene Epstein pointed out in a recent Economic Beat column, there is a factual gap in the measurement of the cash economy. Many Americans are moving from cash to credit. Just watch how many people pay for their morning coffee with a credit card. But the amount of cash in the U.S. economy has grown to $1.4 trillion as of August 2015.
This is 2.6 times the amount of cash in the economy in 2000, growing faster than either GDP or the population. There is now about $11,000 in cash for each household. By factoring in average velocity for money with zero maturity, it appears the equivalent income approaches $16,000 per household.
Hernando de Soto and other researchers suggest that most of the cash transactions in the shadow economy take place between low-income members of the population. Friedrich Schneider estimated in 2010 that about $20 trillion—31% of the world’s economy—is transacted in shadow activities.
This occurs for several major reasons. Tax avoidance is probably the largest. Then comes verification, because cash on the table is indisputably real. Cash transactions also avoid inconvenient laws and regulations prohibiting or limiting certain businesses.