August 30, 2005 | WebMemo on Welfare and Welfare Spending
On August 30, 2005, the Census Bureau reported that the poverty rate was essentially unchanged in 2004 and that the level of income inequality was unchanged, as well. Still, expect the familiar refrain that the "rich are getting richer" to be echoed once again. It is important to understand what the Census numbers on poverty and income inequality really say and to draw the correct conclusion from them. While the report overstates both income inequality and poverty, the numbers do show that Americans would benefit from expanded economic opportunities. Pro-growth policies, such as a less distortionary tax code, are the way to achieve this end.
The poverty rate increased to 12.7 percent in 2004, up slightly from the 12.5 percent reported in 2003. While a rise in the poverty rate is not a good sign, there are a variety of positive indicators in the latest report:
In short, the rise in poverty occurred almost exclusively among working age adults. This points the way to improvement: more pro-growth policies that produce more jobs, lowering the unemployment rate and poverty in America. Between late 2001 and early 2004, the unemployment rate fluctuated between 5.7 percent and 6.3 percent nationwide. Only in the past year-after the full force of the President's pro-growth 2003 tax cuts had been felt-has there been a persistent decrease in the unemployment rate, which now stands at 5.0 percent.
Policymakers should resist calls for increased government social spending. Welfare reform clearly demonstrated that greater economic opportunity comes from increased work and economic independence, not from generous governmental programs. If the current positive employment numbers persist for the remainder of the year, then the 2005 poverty rate will likely come in below the 2004 rate.
The poverty numbers, as the Census Bureau currently presents them, have a variety of flaws that limit their usefulness. The poverty rate is determined by the money income definition, which excludes the variety of in-kind, non-cash benefits, such as Medicare, Medicaid, food stamps, and other forms of assistance. The Census figures also do not include taxes or tax payments like the Earned Income Tax Credit (EITC). If taxes were subtracted from income and non-cash benefits were added in, the poverty rate would be more than two percentage points lower than reported, based on historical experience.
An example may help to illustrate how this works. A single parent who earns $11,000 per year and has two children would be considered poor by Census standards. However, that family would receive more than $4,000 under the EITC, raising its income sufficiently to clear the Census definition of poverty.
Income inequality is an especially egregious example of bad data informing public policy. Again, the Census Bureau considers only money income in its inequality calculations and does not take into consideration the effects of taxation. Because the United States has a progressive tax structure, low-income individuals pay few taxes, while high-income individuals pay most of the individual income taxes in America.
Thus, Census reported that the top quintile earned 50.1 percent of money income in 2004, slightly above its 49.8 percent take in 2003. The share of income going to the bottom two quintiles was unchanged at 3.4 percent and 8.7 percent, respectively. However, if taxes were included in these calculations, the results would show much less income inequality in the United States.
Another major problem with the Census numbers is that the Census Bureau bases its quintile statistics on households instead of individuals. Many households in the bottom quintile are single-parent households or single-person units. In contrast, households in the upper quintile are generally larger. Earlier work shows that the top quintile of households may account for almost a quarter of the population, compared to only fifteen percent in the bottom quintile.
Thus, households in the upper quintile contain more earners than households in the lower quintile. Census data show that the level of income inequality is partly explained by the difference in hours of work between the different quintiles. The top two quintiles, for example, account for well over half of all work in the United States. It is not surprising that the level of income in the top two quintiles reflects the preponderance of hours worked.
While the annual income and poverty report provides good information, it is limited in its usefulness. In particular, the report overstates both income inequality and poverty in America. Policymakers would therefore be wise to take the report's findings with a grain of salt.
Policymakers should, however, continue to enact pro-growth policies that expand the economic opportunities of Americans rather than more social program spending.
 U.S. Census Bureau, "Income, Poverty, and Health Insurance Coverage in the United States: 2004" Current Population Report #P60-229, August 2005, at /static/reportimages/AED357397B8DD1FD731B3EF92FD0E965.pdf.
 For a complete discussion of what income the Census Bureau does and does not include, see Robert Rector and Rea S. Hederman, Jr., "Income Inequality: How Census Data Misrepresent Income Distribution," Heritage Foundation Center for Data Analysis Report No. CDA99-07, September 29, 1999.
 Rea S. Hederman, Jr., and Robert Rector, "Two Americas: One Rich, One Poor? Understanding Income Inequality in the United States," Heritage Foundation Backgrounder No. 1791, August 24, 2004.