from Barron’s The Exaggerated Income Gap by Gary Byrne and Ken Glozer

excerpt:

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.

The U.S. has approximately 120 million households. If about 80% of the income in the shadow economy accrues to the poorest third of U.S. households (about 40 million), income in the lower economic level is being understated in official figures by as much as $30,000 to $40,000 a year per household.

This does not suggest that these households are moving from dire poverty to middle class, but it certainly argues that the size and momentum of income disparity are likely to be exaggerated.

HKO

I have posted several items on the distortions in measuring inequality, mostly from Alan Reynold’s work, Income and Wealth. These include:

the time period measured
measurements of households vs individuals
adjustments for hours worked
measurements of compensation benefits
whether taxes or transfer payments are included
measurements of categories vs actual people- real people rise and fall- mostly rise- between categories.

this article adds the cash economy to the list and it can also have a significant effect on the measurement. A better measurement would be to measure consumption which is less distorted.

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