What is totally lost in debates about changes in income inequality and living standards over the past 40 years is … well … most everything that is relevant. How often have you heard that since 1980 the typical (median) person is no better off? How often have you heard that the rich are getting richer and the poor are getting poorer? Among the many problems with such assertions is that they leave out most of what government does and its impact on living standards. This would seem an odd omission for folks particularly for those who have a greater appreciation of government than I do.
Take a simple example. The city schools in Rochester propose to spend $705 million for the next academic year to educate 32,000 students, or a per-pupil expenditure of about $22,000 per year. We can argue about that number if you wish – cut it in half for all I care, the point remains. If you are a parent sending a student to one of the city schools, you go for free. If we think government schools are so terrific, then how come we do not count, as compensation each year, the $22,000 gift you are getting? Seriously. If my university gives me a tuition benefit to take additional graduate classes, that counts as income to me and I must pay taxes on it. At least if we are going to ask the question of how well off people are, should we not include this? A family that has one working parent at minimum wage working full time with two kids in the city schools would therefore be earning the equivalent of almost $60,000 per year ($44k in education benefits, $15k roughly in wages). Or cut the $22k number in half. Then the family is receiving about $40k per year in compensation. What? You don't think we should count this? Why not? Are the schools worthless? Is this not part of your living standards? What if you had to go out and purchase schooling on the open market? And remember that spending per student in real terms has well-exceeded the rate of growth in the economy, so the value of this compensation to all of the people getting "free" education has been increasing.
And let's be consistent. The government at all levels spends about $6.5 trillion. Let's be generous and say that $2 trillion of that represents the provision of pure public goods. This means that every man, woman and child in the country receives about $6,500 of pure public goods each and every year as compensation. Why is this not computed in measures of well-being (I know that some transfers are, I mean here the provision of actual public goods – and also note that this is distinct from GDP accounting which typically includes $1 of government spending as $1 of GDP, I mean reported income measures)? Surely some amount of spending on national defense is a good to me and you. Surely some amount of spending on global warming research is a good to me and you. Surely some amount of spending on roads and libraries and sewers and water systems is some amount of benefit to me and you. And surely spending has increased at rates much faster than wages have increased.
To see the point more clearly, imagine that some innovator managed to make a machine that produces food, clothing and shelter for free and it magically appears in everyone's home for free. Suppose people respond to this by taking all of their time as leisure and that the government provides whatever necessary medical services you might need over your lifetime and everything else you might need for free. After all, we'd be living in a time of universal abundance. But we'd have no income. Would you argue that "living standards are stagnating?" Would you say that the inventor of the machine "reaped all the gains, leaving the poor behind?" I think not. And if you don't think we ought to add the expenditures of governments into everyone's measure of well-being, why not? Wouldn't that imply that you think government services are … worthless?
And think of what such a correction would do to inequality measures. If I add a fixed amount to two different numbers, their relative distance shrinks. For example if Jack earns $10,000 and Jill earns $1,000 and then we add $1,000 in benefits to each of these measures, Jack's well-being as measured by compensation falls from being 10x more than Jill's to 5.5 times more than Jill's. That would surely be a good thing, right? *Note that the entire post is assuming a net position. For example if we look at income measures, someone who pays $20k in taxes and gets $20k in public school benefits is a wash – their income reasonably approximates their well-being according to what I wrote above. But this is not the case for all of us, and the more general point is that if the government is truly providing valuable public goods, then they are providing value over and above the tax revenues received – we need to include that value.