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What Causes Income Inequality?

Progressive policies do.

by Francis Menton     •     City Journal

money income inequalityNew York City mayor Bill de Blasio has left no doubt that he wants to be the nation’s preeminent spokesman for progressivism. Since unveiling his 13-point Progressive Agenda to Combat Income Inequality in May, de Blasio has campaigned on the message that income inequality is “the defining challenge of our time.” His key policy prescriptions are well known: more “affordable” housing, generous welfare programs, higher minimum wages, and income-tax hikes on high earners. However, if such policies actually reduced the gap between rich and poor, jurisdictions that have already adopted them would experience less income inequality. They don’t.

Last year, Bloomberg Rankings published a national study on income inequality, using U.S. Census Bureau income data to rank each of the 435 congressional districts by economists’ standard measure of inequality, the Gini coefficient. The study found high levels of income inequality in areas of the country known for their political progressivism. Topping the inequality list was New York’s tenth congressional district, which covers the West Side of Manhattan and Wall Street—including City Hall. Of the top 25 spots, 23 went to Democratic districts—and not just any Democratic districts. The five congressional districts covering some part of Manhattan earned the first, sixth, ninth, 13th, and 20th positions. Congressional districts in solidly liberal Chicago, Cambridge, Los Angeles, Santa Monica, and Berkeley placed in the Top 25. House minority leader Nancy Pelosi’s San Francisco district ranked 14th on the list, while Democratic National Committee chairwoman Debbie Wasserman Schultz’s Miami Beach district placed 23rd. All of those congressional districts have long been associated with progressive politics; most have long since adopted at least some of de Blasio’s policy prescriptions, including extensive public and affordable-housing programs, generous welfare programs, relatively high and progressive state and local income taxes, and higher minimum wages.

Could it be that progressive policies intended to reduce income inequality actually cause it to increase? Quite likely, yes. The reason has to do with the effect of these policies on the low end of the income distribution. The government doesn’t count the distribution of in-kind benefits as income—and means-tested handouts create incentives for recipients to keep their measured incomes low. Further, where higher minimum wages—another progressive agenda item—cause higher unemployment, we see even more zero-income earners. Having lots of low-earners or zero-earners doesn’t help reduce inequality. Meanwhile, at the high end of the income distribution, taking money from high earners through higher marginal tax rates is not counted in official statistics as a cut in income—which means that income inequality again doesn’t shrink.

New York City has far and away the most extensive public and “affordable” housing programs in the United States, and exceeds national averages in usage of welfare programs from Medicaid to welfare to food assistance. Gotham’s highest-in-the-nation tax burden includes a top state income-tax rate of 8.82 percent on income exceeding $1.046 million, plus a top city income-tax rate of 3.876 percent, for a total of 12.696 percent on top earners. (California barely edges out New York City—which is something like a state within a state—for highest income-tax rate in the country, with a top rate of 13 percent.) New York City’s minimum wage rose to $8 per hour in 2014 (thus exceeding the federal minimum of $7.25), and then to $8.75 this year, with a further scheduled increase to $9 for 2016; and de Blasio wants to raise the minimum to $15 (a state wage board voted last month to hike the minimum wage to $15 for workers in the fast food industry). Even with all this, the poverty rate in New York City is 20.3 percent, compared with 14.5 percent in the United States as a whole, according to the latest U.S. Census data.

Why does New York City have such a disproportionate poverty rate? A vast system of public and subsidized housing may be one reason. The Metropolitan Council on Housing lists some 178,000 units in New York City Housing Authority (NYCHA) low-income projects, approximately 100,000 “portable” Section 8 voucher recipients, another 90,000 “project-based” Section 8 voucher recipients, and yet another 100,000 or so units in so-called “Mitchell-Lama” buildings. That comes to almost 480,000 subsidized units—or more than 15 percent of the 3.1 million housing units in the city, far above national norms. And that’s before the tens of thousands of new units now under construction as part of de Blasio’s “inclusionary” affordable housing programs. The numbers also don’t take into account the 1 million or so units covered by New York City’s rent-stabilization program.

Housing subsidies don’t count as income for government accounting purposes, nor are below-market rents taken into consideration. The exclusion of these subsidies and discounts makes a huge difference in the income-inequality calculation. The difference can be most dramatically illustrated by considering the effect on the measurement of income for residents of NYCHA projects in what are now gentrifying and expensive neighborhoods in Manhattan and Brooklyn. Many of the apartments in these projects would have market rental value in the range of $4,000 to $6,000 per month, but are rented to project residents for an average closer to $500 per month. Paying market-rate rent with after-tax dollars would cost tenants an extra $42,000 to $66,000 per year, but the gift of the same apartment to a subsidized tenant counts as zero income. So a family may be receiving a housing subsidy worth $42,000 or more, but it remains “poor” for want of spendable income.

The subsidized housing programs also entail powerful incentives for beneficiaries to keep their incomes low. NYCHA tenants must earn below certain income limits to qualify for housing and pay 30 percent of their household income toward rent, up to the maximum rent levels for the apartment size. In other words, if their income rises, so does their rent. In addition, most NYCHA and Section 8 tenants receive one or more government benefits, such as welfare or food stamps, also subject to income caps. To no one’s surprise, these families structure their lives to keep their measured incomes low. NYCHA reports the poverty rate in its projects tops 51 percent.

Other means-tested, in-kind redistribution programs compound the disincentives to earn a living. Of course, progressive jurisdictions are strong supporters of these programs and have participation rates far above the national average. Medicaid is by far the largest such program—and another case where benefits don’t show up in income-inequality measurements. After the recent expansions under Obamacare, Medicaid enrollment topped 71.1 million as of April 2015, or about 23 percent of the U.S. population. About 3.2 million New York City residents—or 38 percent of the population—were enrolled in Medicaid as of 2013, the latest data available. New York City goes to great lengths to maximize enrollment in all of these programs—including food stamps, WIC, energy-assistance programs, and free and reduced-priced school lunches—with little regard for the people trapped in poverty or near-poverty.

A much-higher minimum wage is a relatively recent addition to the progressive policy agenda, with Seattle, San Francisco, and Los Angeles County among the heavily Democratic areas of the country voting to phase in a $15-an-hour wage over the next few years. The progressive theory is that all or nearly all employees with wages below the mandatory level will see their pay increased, without adverse employment effects. But to the extent that much-higher minimum wages cause some people to become unemployable, zero-earners will be added to the income mix and measured income inequality will increase. This is likely to happen in New York if it embraces the $15 minimum wage. Today’s $8.75 New York City minimum wage, if earned for full-time work for an entire year, yields an annual income around 35 percent of the city’s median household income of slightly more than $50,000. A $15 minimum wage would push it to 60 percent of the median household income. What could possibly be wrong with that?

For the answer, look at Puerto Rico. The U.S. island territory is subject to the current federal minimum wage of $7.25 an hour, but its median household income is only about $20,000 per year. That means that the full-time minimum-wage work comes to over 70 percent of median household income. The negative effects have been massive. Puerto Rico’s labor-force participation rate is only 42 percent—compared with 62 percent for the United States, which is the lowest it’s been since the late 1970s. Even with that dramatically low labor-force participation, the unemployment rate on Puerto Rico exceeds 12 percent. And what effect do so many idle workers have on income inequality? Though Puerto Rico isn’t exactly known for a large concentration of high-income earners, its Gini coefficient of 0.537 would put it in the top 10 congressional districts for income inequality.

The evidence indicates that de Blasio’s policy prescriptions would actually make income inequality worse. The point of the mayor’s progressivism may not be to improve the lot of the less fortunate or to ease poverty, but rather to broaden the base of voters permanently dependent on government programs.

Francis Menton is of counsel in the Litigation Department at a major New York-based international law firm. He blogs at www.manhattancontrarian.com.