Inequality Trends: The Facts and Why They Matter

Alan Reynolds wants to disprove the widely accepted view that American income inequality widened after 1988. In his attempt to make this case he offers some evidence that is relevant, much more that is irrelevant, and still more that cannot be evaluated without careful and open-minded analysis of the data. Unlike many of the analysts he criticizes, including economists in the Congressional Budget Office and Professors Thomas Piketty and Emmanuel Saez, he has never actually done any of the hard analysis that would allow us to assess the importance of claimed shortcomings in the data. I leave it for other readers to decide whether Reynolds has the temperament to treat good researchers’ analysis and results with an open mind, especially when their findings conflict with his fond hope that income inequality stopped rising almost two decades ago.

In my earlier comment on his claims, I noted that the 25-year trend toward higher inequality changed sometime in the early 1990s. Between 1979 and the early 1990s the percentage income difference between poor and middle class families increased, as did the percentage income gap between middle class and very affluent families. After the early 1990s there is considerable evidence that the percentage gap between low- and middle-income families stabilized or actually began to shrink. If we use the most comprehensive definitions of income, ones that take account the effects of cash and near-cash government transfers as well as income and payroll taxes, you can make a convincing case that inequality in the bottom half of the income distribution actually declined. The strong economic expansion after 1994 produced sizeable income gains for low-income working families. A big expansion of the Earned Income Credit helped boost the after-tax incomes of many breadwinners who earn low wages. Richard Burkhauser is one among several good analysts who have demonstrated how income gains in the 1990s expansion were more broadly distributed than gains in the 1980s expansion.

Economists at the Congressional Budget Office, Professors Piketty and Saez, and economists Ian Dew-Becker and Robert J. Gordon, are among the researchers who have demonstrated that income gains at the very top of the income distribution followed a different path from the one observed in the middle and at the bottom of the distribution after 1988. Income and wage disparities at the very top of the income distribution did not shrink, as was the case in lower parts of the distribution. Income disparities at the top got bigger. For reasons mentioned in my earlier comment, income trends at the very top of the distribution are hard to measure in standard household income surveys conducted by the Census Bureau. I don’t think Reynolds has made a persuasive case against this view. Nonetheless, the Census Bureau’s main household survey also shows unmistakable evidence of growing inequality at the top of the distribution. In 1988 – Reynolds’ preferred base year – a wage and salary worker who earned the median hourly wage received $13.20 an hour (measured in constant 2005 dollars). By 2005 the median worker’s wage increased to $14.29 an hour, an increase of 8.3%. Over the same span of years, a worker earning the 95th-percentile wage experienced a 20.3% gain in pay.[1] This pattern of bigger earnings gains at the very top is mirrored in hourly pay trends for both male and female workers. It is also reflected in the annual earnings reports collected once a year by the Census Bureau in its Current Population Survey (CPS). The closer we get to the very top of the earnings distribution, the bigger the earnings and income gains enjoyed by workers and their families.

My own calculations, based on the CPS files and using the most comprehensive definition of income available to us, suggest that median household-size-adjusted disposable income increased 13% between 1988 and 2004. (The gains are calculated using constant dollars.) At the 75th percentile, real income increased 16%; at the 90th percentile, it increased 21%; and at the 95th percentile, it increased 27%. Inequality in the bottom 95% of the income distribution did not increase as much as these figures suggest, because income recipients at the bottom of the distribution enjoyed proportionately faster income gains than income recipients in the middle. Inequality in the bottom half of the income distribution fell, while inequality in the top half of the distribution increased. The bottom line, however, is that the Census Bureau’s CPS files show considerable evidence that wage and income gains were bigger at the top than in the middle.

Furthermore, the same pattern of faster income gains at the top of the earnings distribution is confirmed in both the IRS income tax data and the Social Security payroll tax data. In my earlier comment, I demonstrated how real earnings gains in the Social Security wage data showed progressively bigger percentage gains in wage and salary earnings as we move up the annual earnings distribution. A couple of additional statistics reinforce this point. In 1990 the Social Security Administration found there were about 15,600 wage earners who had annual earnings above $1 million. By 1998 the number with more than $1 million had increased to 46,700 wage earners. In 2005 it was 82,100.

In 1990 the Social Security Administration found 739 earners with an annual wage above $5 million. By 2005 this number had risen to 6,746, more than nine times the number earning this amount 15 years earlier. In 2005 2,133 workers earned at least $10 million per year.[2] This is about three times as many people as the number who reported earning $5 million back in 1990.

Mr. Reynolds can spin the statistics any way he wants, but these numbers clearly show a dramatic increase in the labor incomes of America’s top earners. By most people’s reckoning, the numbers also show a noticeable increase in income inequality. The income gap between the very rich and the middle class got bigger.

Some commentators ask the question “So what?” By this they mean “Why should we care if the rich are getting richer much faster than everyone else?” It’s a good question, but it is not the question posed by Mr. Reynolds in his Cato policy analysis piece (“Has U.S. Income Inequality Really Increased?”).

Nonetheless, “So what?” is a question worth considering. One answer is that distributional statistics help us to understand how the benefits from prosperity are distributed across a population. Since Mr. Reynolds prefers to use 1988 as his base year for analysis, let’s think about how the benefits of U.S. prosperity have been divided since that year. According to the most recent reports from the Bureau of Economic Analysis, per capita GDP measured in constant chain-weighted prices increased about 31% between 1988 and 2004. This gain translates into an annual rate of increase in U.S. average income of 1.7%. That rate of improvement, which is higher than the one experienced by many other rich countries, is often seen as a vindication of modern American capitalism. In other countries, where they may speak French or German, growth rates have been slower, perhaps because these countries have an inexplicable fondness for over-generous unemployment benefits and rigid worker protection laws (or so it is said).

The vindication of American economic institutions does not look so convincing if it turns out that only a few U.S. citizens enjoyed income gains as high as 1.7% a year. In a paragraph above, I mentioned that household-size-adjusted disposable income for the median American increased 13% between 1988 and 2004. At the 75th percentile, real income increased 16%, and at the 95th percentile, it increased 27%. These numbers translate into annual growth rates of 0.7% for the median American, 0.9% a year at the 75th percentile, and 1.5% a year at the 95th percentile. If we could accurately calculate the rate of income improvement at the 99th percentile or the 99.99th percentile, our calculations would almost certainly show rates of gain that are much faster than 1.5%.

There are many reasons that measured income growth in the middle of the distribution was slower than the growth of GDP per capita. For example, some income and consumption gains enjoyed by Americans are not measured by the Census Bureau’s CPS survey. (Health care consumption, for example, is largely unmeasured by the survey.) One reason the median American has seen comparatively slow income growth, however, is that a disproportionately large percentage of measurable income gains have been enjoyed by people who are well up in the distribution.

If you happen to occupy a position at the top of the distribution, you might very well ask the question “So what?” But you should not defend American institutions by saying they have contributed to income growth in the United States that is faster than the growth in other, less favored countries. At the very least, you should first check to see whether the relative performance of median income growth corresponds with that of average income growth. If half or more of American families see their incomes grow 0.5% a year or less, it can be little comfort for them to know that average income growth in the United States exceeds growth in, say, Germany or France. For a middle-income American, the more relevant question is “How have middle-class Americans fared in comparison with middle-class Germans or Frenchmen?” On that score it is less clear whether the American economy has outperformed the economies of Western Europe.

I do not claim that median income has grown faster in Europe than the United States. I don’t know enough about the facts to hazard a guess. People who disparage income distribution statistics should recognize, however, that the statistics have practical consequences for evaluating economic performance. From the perspective of an ordinary citizen, rapid growth in average income is not a strong argument for American institutions unless the growth is reflected in a discernable improvement in the person’s material well-being. When incomes grow more unequal, the benefits of economic growth will become less obvious to poor and middle class citizens.

 

Notes

[1] Readers can confirm these estimates by checking the hourly earnings tabulations of the Economic Policy Institute, posted at http://www.epi.org/datazone/06/wagecuts_all.pdf. The EPI examines hourly wage reports of respondents to the Census Bureau’s monthly Current Population Survey.

[2] The Social Security Administration’s tabulations of the W-2 earnings data for 2005 are reported here. The Social Security Administration uses current dollars to measure the income thresholds in its tables. Therefore, the numbers reported in the text do not make an adjustment for inflation. Even making an inflation adjustment has little effect the basic finding that income gains at the very top of the earnings distribution were much faster than the gains in the middle and bottom of the distribution.

Also from This Issue

Lead Essay

  • Income Distribution Heresies by Alan Reynolds

    A headline in today’s Wall Street Journal reads “Fed Chief Warns of Widening Inequality.” Bernanke worries that inequality erodes tolerance of the “dynamism” that lays the golden eggs of “economic progress.” But is inequality widening at all? Cato Institute senior fellow Alan Reynolds has his doubts. Following up his own controversial Wall Street Journal op-ed, a Cato Institute policy forum, and a new Cato policy paper, Reynolds in this month’s lead essay digs yet deeper into the mysteries of the official numbers and comes up with … not much: “If there were any [good] data showing a significant and sustained increase in the inequality of disposable income, consumption, wages, or wealth since 1988,” Reynolds concludes, “I suspect someone would have shared it with us by now.”

Response Essays

  • Ben Bernanke is Right by Gary Burtless

    Gary Burtless agrees that analysts of the American income distribution should “take seriously some of Reynolds’s criticisms of the data on income disparities.” “Reynolds points to some serious problems,” Burtless concedes, “and in many cases fair-minded experts will agree with him.” Nevertheless, Burtless dissents sharply from Reynolds’s larger claim that inequality apparently stopped increasing in the late 1980s. “Income inequality was higher at the end of the 1980s than it was in the beginning of that decade,” he states, “and it was higher in 2005 than it was in 1989.” According to Burtless, Reynolds can reach his unorthodox conclusion only by manipulating the evidence. “The problem is,” Burtless charges, “he is harshly critical of data series that do not support his views, while he is usually silent about equal or more serious problems with data sets that show little change in inequality.”

  • Yes, Virginia, Income Inequality is Still Rising” by Mark A. Thoma

    In his response to Alan Reynolds, Mark Thoma invites us to “step back” and survey the wider picture of data and expert opinion on income inequality. The verdict? Fed Chairman Ben Bernanke, and the consensus generally, has got this one right. “The preponderance of evidence and of professional opinion,” writes Thoma, “clearly indicates that inequality has been rising since [at least] 1988.” Like Burtless, Thoma finds little in Reynolds’ analysis to agree with, describing his main points as “either too inconsequential to change the inequality picture,” suffering from “an incomplete presentation of the evidence, or rebutted by other work.” Thoma then goes a step further, pointing to new evidence suggesting that income inequality might be even greater than currently estimated.

  • Measuring Economic Well-Being: What, How and Why by Richard Burkhauser

    Invoking Kurosawa and Derrida, Richard Burkhauser dives into the contested complexities of the Current Population Survey data on household income. His conclusion: “Over the 1990s business cycle the entire distribution moved to the right with little or no change in income inequality. Since 1989 household income inequality has risen very little and much less than in the previous decade. This is very good news that matters.” Burkhauser admits that the CPS data are not well suited to tracking trends for the top 1 percent of earners. “But does this really matter?” he asks. “Our economy is not a zero sum game. My gain does not mean your loss or vice-versa. I know of no evidence that increases in the incomes of the top 1 percent of our population are the root cause of the challenges faced by those at the other end of the distribution.”

  • Inequality in What? by Dirk Krueger and Fabrizio Perri

    Dirk Krueger and Fabrizio Perri suggest that we shift our attention away from inequality in current incomes. “[I]f one is ultimately interested in the distribution of well-being across U.S. households,” they write, “the object of study ought to be the joint distribution of lifetime consumption and leisure across them.” Unfortunately, good data on lifetime consumption are not available. However, citing Milton Friedman and Franco Modigliani, Krueger and Perri contend that “if households can borrow and lend on financial markets, then there is a strong link between the lifetime resources of a household (sometimes also called its permanent income) and its current consumption.” And the trends in current consumption data show that “the increase in income inequality in the U.S. has been much more pronounced than the corresponding increase in consumption inequality.”

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