The Impact of Income Inequality on Colorado’s GPI

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by Chris Stiffler

What is a Genuine Progress Indicator?

A Genuine Progress Indicator is a more comprehensive approach to assessing economic progress than conventional measures like gross domestic product (GDP).  Traditional indicators like GDP only measure economic transactions; they do not include the social and environmental costs and how they influence the well-being of Colorado families.  A GPI helps measure how current economic activities and public policies are impacting long-term prosperity, both positively and negatively, in the Centennial State.  A GPI helps measure the balance between strict economic gain and ensuring social quality of life. 

A Genuine Progress Indicator adjusts for income inequality, value of household and volunteer work, pollution, traffic congestion, lost leisure time, crime, and underemployment among other indicators.   Environmental and social indicators give a better picture of the actual well-being of a typical Coloradan family.  In building a Colorado GPI, we start with Personal Consumption and then add or subtract additional indicators.  Thus volunteer hours add to GPI while pollution subtracts from GPI.  By differentiating between economic transactions that detract both from environmental and social well-being and the activity that enhances that well-being, GPI indices are designed to measure sustainable economic welfare rather than economic activity alone. (Talberth, 2007).  Colorado needs better indicators of social, environmental, and economic well-being in order to judge the sustainability and welfare impacts of current economic activity and public policies. 

One such indicator involves the distribution of income across Colorado.  Who receives what portion of income directly influences the total amount of well-being.  This report focuses on the impact of income inequality on Colorado’s Genuine Progress Indicator.  It explains why income inequality is important, why it gives a better picture of well-being than other traditional measures, how inequality is measured, how Colorado compares to other states, and how has it changed in Colorado over the past 40 years. 

What is income inequality and why is it important to Colorado’s well-being?

Income inequality describes the income differences of Colorado households.  It is often referred to as the “gap between rich and the poor.”  It measures how much income a particular portion of Colorado households have compared to another portion. 

Income inequality is important for measuring well-being for several reasons.  If inequality becomes too extreme, it can harm social cohesion, which leads to large gaps between those at the top and those feeling left behind.  Empirical evidence shows that rising income inequality hinders growth in economic welfare (Hsing, 2005).  Income inequality can harm economic welfare by increasing crime, reducing worker productivity, and dampening investment.  Inequality can also create a loss of potential economic output for society from the unequal opportunities for investment. (Todara and Smith, 2009).  This occurs, for instance, when lower-income families cannot set up businesses because of lack of credit or send their children to school.  This can ultimately lead to lower future economic potential for the entire state. 

In addition, growth in consumption yields different benefits to individuals of different income levels.  Because of the law of diminishing returns, wealthier groups gain less from a given increase in income compared to lower-income groups.  (For example: a sandwich given to someone who has already eaten lunch would produce less pleasure for society than the same sandwich given to someone who hasn’t eaten all day).  Because lower-income groups will profit more from the same increase in income than the already wealthy, it makes a difference who receives the additional income when it grows.  
Income inequality is a necessary part of a capitalist society because it acts as a signal of the rewards possible for those who work hard and take risks.  Unchecked inequality, however, can be a detriment.  Some economists worry about increasing inequality and its drag on economic growth. (Stiglitz, 2013).  Others argue that income inequality in a given year is not such a bad thing as long as there is upward mobility in society.  If families in lower-income groups can advance to high-income groups then inequality isn’t necessarily terrible.  This is a valid point; assessing inequality should be considered in the context of upward societal mobility.   

How does the addition of an income inequality indicator give the GPI are more accurate depiction of Colorado well-being? 

By factoring income inequality into the GPI, it helps describe truer measures of economic prosperity than income per capita does alone.  Income per person is a misleading indicator because it assumes each Coloradan has an identical share of total income.  However, as income distribution becomes more unequal, income-per-person becomes a less informative measure.  (Just think if there was only two people in Colorado and one person had all of the income, a measure of average income would disguise the true measure of well-being of each person.)

How is income inequality measured?

The Gini index, a statistical measure of dispersion, measures the difference between actual income distribution and equal distribution by quintiles (1/5 of population).   It includes detailed aggregate income shares data of Colorado into a single statistic and is used to measure household income inequality for Colorado.  The values range from 0 to 1, with 0 representing perfect equality and 1 representing perfect inequality (where one household receives all of the income).  Thus the higher the Gini index, the greater the income inequality, or in other words, a greater portion of income earned by the top bracket.  Values in the range 0.20 to 0.30 signify low levels of inequality.  The U.S. experienced its lowest measure of income inequality in the late 1960’s with a coefficient around 0.38.  In 2011, the national Gini coefficient was 0.47.  
The Gini Coefficient is defined mathematically as an index that compares current income distribution with an ideal distribution of income, giving equal weight to all income levels by calculating the square root of the sum of the squared difference of each quintile from a 20 percent share.  (Talberth, 2007). 

How does it affect our Genuine Progress Indicator?

The Colorado GPI incorporates income inequality by discounting personal consumption expenditures by the amount of inequality in each year using Gini and income distribution indices.  We divide per-capita consumption levels by the inequality index for each year multiplied by 100 to get a weighted personal consumption level.   See table 2 for calculations.  Column C equals column A divided by column B multiplied by 100. As inequality grows, weighted person consumption shrinks—reducing well-being. 

The inequality adjustment reduces personal consumption levels in Colorado for all years later than 1960.  As figure 1 illustrates, there has been a divergence of personal consumption and weighted personal consumption.   Weighted personal consumption better captures well-being because it incorporates inequality. 

How has inequality changed over time?

Figure 2 shows that the income distribution index in Colorado is now at its most unequal level since 1960.  For example, the U.S. Census Bureau reported in 2011 the lowest-income 20% of population enjoyed only 3.4% of Colorado income while the top 20% received 49.1%.¹   The 1960’s saw the lowest level of income inequality, since then the trend has been upward toward most inequality.  Income inequality grew the fastest during the 1980’s.  The early 90’s had a period of declining income inequality due mainly to rising real wages, periods of low unemployment, and rising minimum wages. 

Recessions seem to exacerbate income inequality.  During the past three business cycles before the Great Recession in 2008, the highest-income groups saw their wealth rise substantially while the middle and low-income groups saw very modest growth.  The Great Recession harmed households at all income levels including the wealthiest, but the richest households have bounced back while the low-income groups continue to stagnate. 

How does Colorado compare to the U.S. and other states?

Colorado has an above average level of inequality compared to other states.  From the late 1970’s to early 2000’s, Colorado ranked 8th highest level of income inequality among the states. (CBPP, 2013).    The average income of the top 20% wealthiest Coloradoans is more than 8.2 times more than the poorest fifth of Colorado households. 

What has caused rising inequality?

Growth in wage inequality has been the biggest factor to widening income inequality.  Over the last three decades, wages of the bottom and middle-income groups have grown only modestly while wages at the top of the wage scale have grown much faster.  Periods of long unemployment disproportionately harm the wages of the lower income groups.  Foreign competition puts downward pressure on low wage jobs as well as the shift from manufacturing jobs to service jobs in America.  More women have also entered the workforce, which because women tend to have lower incomes, has also contributed to lower wages on the lower income groups. 

Changes in government policies have also lead to increasing inequality.  Changes in tax structures particularly have accelerated the trend toward growing inequality.  Colorado is one of 8 states that have a flat rate state income tax, which is very regressive.  This results in lower income Coloradans paying a higher portion of their income in taxes than the upper income groups.  The lowest income Coloradans pay approximately 9% of the income in state and local taxes while the top income Coloradans pay only 6% of their income in state taxes. (ITEP, 2013).  The expansion of investment income (dividends, interest, capital gains), which primarily accrue to the top incomes, have also increased the gap between rich and poor. 

Do other studies contradict the evidence about rising income inequality?

Measuring income inequality at the state level is challenging given the limitations on data.  Some researchers argue that income inequality is overstated because the studies focus on before tax income and ignore the value of government programs.  On the other hand, most income inequality measures don’t capture capital gains. Thus most Gini inequality studies actually under-estimate the amount of income inequality because the wealthy tend to owe a much higher portion of investments.  Given Colorado’s regressive income tax structure, limited government, and high portion of wealth based on financial investments, income inequality is not over-stated but probably understated in Colorado. 

Methodology

Gaining income inequality data at the state level faces many challenges.  Other GPI studies use IRS data which has a limitation because of the omission of people whose earnings are less than a threshold level of income.  Using IRS data, researchers generally focus on the top-income earner shares.  Non-IRS data does not have this problem but the data is not available annually.  For instance, the decennial census income data is only available every ten years.  Only recently has the Current Population Survey provided Gini numbers for years 2006 forward. 

Other GPI studies have used Nielson’s (1997) methodology for decennial years and used national data to piece together state level inequality numbers.  Instead of extrapolating decennial data, which we view as less accurate, we use  “Frank, Mark W. (2008). “A New State-Level Panel of Income Inequality Measures Over the Period 1916-2005.”  The author calculates 5 measures of inequality (Atkinson Index, Gini Coefficient, Relative Mean Deviation, Theil Index, Top 10% and Top 1%) for each state up till 2005.  Years 2006 and forward we rely on the U.S. Census Bureau’s Gini figures.  

In order to splice the CPS data with Frank’s data from 1960-2005 we had to pair-down Frank’s data to fit into the Census Bureau’s data.  (Franks Gini index for 2005 was .58 and Census Bureau’s was .45).  We reduced Frank’s series by a factor of (.45/.58) in order to preserve the inequality ratio and thus be able to use Census Bureau’s numbers for future years.  
Next we index these inequality coefficients setting 1960 as the base year (most other GPI researchers use a similar base year because 1968 was when inequality was at its smallest value on the national level).  An index allows us to show relative change from year to year. 

The formula:  The Gini Coefficient of Colorado; a statistical measure between 0 and 1 of family household income inequality.   Indexed by  (Gini current year * 100)/(Gini base year)

^1 Analysis of 2011 U.S. Census data chart “Shares of Aggregate household income by quintile” for Colorado 3-year estimates available at http://factfinder2.census.gov/faces/tableservices/jsf/pages/productview.xhtml?pid=ACS_11_3YR_B19082&prodType=table

Bibliography:

American Enterprise Institute Public Policy Blog  http://www.aei-ideas.org/2011/10/5-reasons-why-income-inequality-is-a-myth-and-occupy-wall-street-is-wrong/comment-page-2/#comments

Center on Budget and Policy Priorities (CBPP). 2012. Pulling Apart: A state‐by‐state analysis of income trends.  Available at http://www.cbpp.org/cms/?fa=view&id=3860

Hsing, Yu. 2006. “Economic growth and income inequality; the case of the U.S.” International Journal of Social Economics. 32(7): 639-647.  

Institution on Taxation and Economic Policy (ITEP) 2012. Who Pays: A Distributional Analysis of the Tax Systems in all 50 States.  Available at http://www.itepnet.org/whopays.htm#map

Stiglitz, Joseph E. (2013) “Inequality is Holding Back the Recovery.” The New York Times available at  http://opinionator.blogs.nytimes.com/2013/01/19/inequality-is-holding-back-the-recovery/

Talberth, J., Cobb, C., and Slattery, N., 2007. The Genuine Progress Indicator 2006: A tool for sustainable development. Redefining Progress: Oakland, CA

Todaro, M. and Smith S. 2009. Economic Development, Tenth Edition, Pearson, Addison‐Wesley.

Data Source: 

1960-2005 – “Frank, Mark W. (2008). “A New State-Level Panel of Income Inequality Measures Over the Period 1916-2005.”  Data available for download here:  http://www.decisionsonevidence.com/2013/01/historical-state-gini-coefficients-1916-2005/

2006-2012 – U.S. Census Bureau’s  2011 American Community Survey Gini Index of Inequality Chart of Colorado available through the American Fact Finder at: http://factfinder2.census.gov/faces/nav/jsf/pages/searchresults.xhtml?refresh=t