From Thomas Sowell in his book Economic Facts and Fallacies: Second Edition*:
One widely quoted study, for example, used income tax data to show dramatically growing income inequality among â€œtax units,â€ leaving the impression that there was a similarly sharp increase in income inequality among human beings. Some tax units coincide with individuals, some coincide with married couples, and some coincide with neither, because some of these tax units are businesses. Comparisons among such heterogeneous categories are comparisons of apples and oranges. In some media translations of these studies, these tax units are often referred to loosely as â€œfamilies.â€36 But a couple living together and filing separate income tax returns are not two families, and to record their incomes as family incomes means artificially creating two statistical â€œfamiliesâ€ averaging half the income of the real family.
Tax laws changed significantly during the period when this dramatic increase in statistical inequality occurred, so that some income that had previously been taxed as business income was now being taxed as personal income, particularly at the highest income levels, where business income is an especially large share of total income. In other words, money that would previously not have been counted as personal income among the higher-income tax units was now counted, creating the statistical impression that there was a dramatic change in real income among real people, when in fact there was a change in definitions used when compiling statistics. This study mentioned such crucial caveats in a footnote but that footnote was seldom, if ever, quoted in the many alarming media accounts.
Just as income statistics greatly under-estimate the economic resources available to people in the lower income brackets, steeply progressive income taxes substantially over-estimate the actual economic resources at the disposal of people in the upper income brackets. Most income statistics count income before taxes and leave out both cash transfers and in-kind transfers from the government. Since most of the taxes are paid by people earning above-average incomes and most of the income of people in the lowest income bracket comes from government transfers, income statistics exaggerate the differences in actual standards of living. Disparities between A and B will always be greater if you exaggerate what A has and understate what B has.
Makes sense but unfortunately, it doesn’t get a lot of attention from main stream media and our politicians won’t gain votes talking about the issue from this perspective.