Income Inequality Metrics - Proper Use of Income Inequality Metrics

Proper Use of Income Inequality Metrics

1. When using income metrics, it has to be made clear how income should be defined. Should it include capital gains, imputed house rents from home ownership, and gifts? If these income sources or alleged income sources (in the case of "imputed rent") are ignored (as they often are), how might this bias the analysis? How should non-paid work (such as parental childcare or doing ones own cooking instead of hiring a chef for every meal) be handled? Wealth or consumption may be more appropriate measures in some situations. Broader quality of life metrics might be useful.
2. The comparison of inequality measures requires that the segmentation of compared groups (societies etc.) into quintiles should be similar.
3. Distinguish properly, whether the basic unit of measurement is households or individuals. The Gini value for households is always lower than for individuals because of income pooling and intra-family transfers. And households have a varying amount of members. The metrics will be influenced either upward or downward depending on which unit of measurement is used.
4. Consider life cycle effects. In most Western societies, an individual tends to start life with little or no income, gradually increase income till about age 50, after which incomes will decline, eventually becoming negative. This affects the conclusions which can be drawn from a measured inequality. It has been estimated (by A.S. Blinder in The Decomposition of Inequality, MIT press) that 30% of measured income inequality is due to the inequality an individual experiences as they go through the various stages of life.
5. Clarify whether real or nominal income distributions should be used. What effect will inflation have on absolute measures? Do some groups (e.g., pensioners) feel the effect of inflation more than others?
6. When drawing conclusion from inequality measurements, consider how we should allocate the benefits of government spending? How does the existence of a social security safety net influence the definition of absolute measures of poverty? Do government programs support some income groups more than others?
7. Inequality metrics measure inequality. They do not measure possible causes of income inequality. Some alleged causes include: life cycle effects (age), inherited characteristics (IQ, talent), willingness to take chances (risk aversion), the leisure/industriousness choice, inherited wealth, economic circumstances, education and training, discrimination, and market imperfections.

Keeping these points in mind helps to understand the problems caused by the improper use of inequality measures. However, they do not render inequality coefficients invalid. If inequality measures are computed in a well explained and consistent way, they can provide a good tool for quantitative comparisons of inequalities.