Consider the Evidence

Income inequality in the U.S. has increased sharply in the past generation. Those who worry about this development do so partly on grounds of fairness and partly because inequality may have adverse effects on politics, health, and crime. Sometimes overlooked is a more immediate cost: slow income growth for a large chunk of the population.

The following chart shows average inflation-adjusted incomes in 1979 and 2005 for various groups of households: the bottom 20%, the lower-middle 20%, the middle 20%, the upper-middle 20%, the next 10%, the next 9%, and the top 1%. The incomes include government transfers and subtract taxes. The data, from the Congressional Budget Office (here), are the best available for this purpose.

The average income among all households rose at a rate of 1.5% per year over these two and a half decades. But as the chart makes plain, much of that increase went to households at the top of the distribution, especially those at the very top. Households in the bottom three quintiles experienced very slow income growth — 0.2% per year for the poorest quintile, 0.6% for the next, and 0.7% for the middle.

What would 2005 incomes have looked like if income growth had been proportionate rather than heavily skewed in favor of the top — in other words, if all incomes had increased at a pace of 1.5% per year? The dashed line in the next chart shows the answer. To make it easier to see the effect, I include only the bottom 80% of households here. All of them would have been a good bit better off.

It’s often said that progressives focus too much on the distribution of income and don’t pay enough attention to absolute income levels. In fact, its impact on absolute incomes is one of the chief reasons to be concerned about rising inequality.

This news is discouraging, but hardly unexpected. According to a Marketplace report, a survey by the Transamerica Center for Retirement Studies (pdf here) finds that the share of workers borrowing from their 401(k) retirement funds increased from 11% in 2006 to 18% in 2007. Nearly half of those taking out such loans in 2007 cited the need to pay off debt, compared to a quarter in 2006.

Stagnant wages and salaries, most spouses already employed, rising health care and college tuition costs, higher mortgage debt loads, and falling home values mean lots of American households — including many middle-income ones — are pinched financially. The late 1990s economic boom lessened the strain for a while. Then home equity loans helped. More recently, credit card usage has jumped. Borrowing against retirement savings is the logical next step.

See more discussion here, here, and here.

Which political party is better at improving living standards?

A commonplace view is that Democrats favor policies that boost the well-being of the poor while Republicans’ policy preferences are more conducive to economic growth and rising incomes. Debates about high vs. low taxes, generous vs. stingy social programs, and heavy vs. light regulation of business often are framed in terms of a tradeoff between compassion and growth. Should government do more to assist the poor? Or should it intervene less, thereby helping the economy to grow more rapidly?

For the most part this debate is a battle of rhetoric and assumptions. Many on the right assume that lower taxes, less regulation, and less generous social policies must be good for economic growth. Some on the left accept this assumption but argue that growth will fail to trickle down to the poor. Others dispute the assumption.

Evidence can help. There is a great deal of it that is potentially relevant. Here is one piece. Using tax records and surveys, the Congressional Budget Office has compiled good data on household incomes from 1979 through 2005 (here). The presidency was held by a Republican from 1981 to 1992, by a Democrat from 1993 to 2000, and by a Republican since 2000. The following chart shows average rates of income growth (adjusted for inflation and with taxes subtracted) for each of the five quintiles (fifths) of households during these three periods.

Income growth for each of these groups, from the poorest to the middle to the richest, has been faster during Democratic administrations than Republican ones.

Does this prove that Democrats are more effective than Republicans at promoting income growth? No. A government’s ability to affect income growth is limited, Democrats controlled one or both houses of Congress during Republican presidencies and vice-versa, and each of these periods has idiosyncratic features (see here, here, and here, for instance). Still, the data offer reason for skepticism about the notion that policies favored by the right are better at raising living standards.

Nor is this peculiar to the American context. Here is a counterpart chart showing income growth in the United Kingdom over the same period. The Conservative party held the government from 1979 to 1997; the Labour party has held it since. The data are from the Institute for Fiscal Studies (here).

Incomes of the richest fifth increased slightly more rapidly during the years of Conservative government, but most British households have fared as well or better under (New) Labour.

“Today’s problems have less to do with the size of the economic pie than the way it is divided.” This, according to a New York Times article, is what Hillary Clinton’s economic advisers believe. I’m certain John Edwards’ economic team would agree with the statement, and I suspect Barack Obama’s would too.

Is this a sensible view? That’s a large question, but here is one way to think about it. The solid lines in the following chart show trends since World War II in inflation-adjusted incomes of families at the 60th, 40th, and 20th percentiles of the income distribution. The data are from the Census Bureau (here).

From 1947 to 1973, incomes at each of these three levels grew at an annual rate of about 2.7%. That was approximately the same as — actually slightly faster than — the rate of growth of the economy as a whole; GDP per capita during that period grew at a rate of 2.5% per year.

Since 1973 incomes in the middle and lower portion of the distribution have increased much less rapidly: 0.8% per year at the 60th percentile, 0.5% per year at the 40th, and just 0.3% per year at the 20th. Is this because the economy as a whole has failed to grow? No. The annual growth rate of per capita GDP since 1973 has been 1.9%. Instead, it’s because most of that economic growth has gone to those at the top of the distribution.

The dashed lines in the chart show what incomes at the 60th, 40th, and 20th percentiles would have looked like had they grown at the same 1.9%-per-year pace as the economy since 1973. The difference is striking. Incomes for a very large swath of the American population would be much higher — $15,000 to $30,000 higher — if economic growth since the mid-1970s had been distributed more equally.

Some will respond that the heavily skewed distribution of post-1973 economic growth contributed to that growth. In other words, the pie would now be smaller if those below the top had gotten more of it during the past generation. If you believe that, see this post.

The share of American households delinquent or in default on their mortgage payments has been increasing for several months. The Wall St. Journal reported yesterday that the same is true for auto loans. The New York Times reported last Friday that food bank use is on the rise.

The proximate cause of these developments is the housing crisis. But there is a longer-term element. We may be embarking on a period in which sour economic turns — an increase in unemployment, a rise in interest rates, a significant jump in gas or food prices — create substantial financial difficulty for a larger share of households than has previously been the case. Why? Because more households have little financial “wiggle room.”

The conventional story attributes this to Americans’ increasing recourse to debt. Household debt has indeed risen sharply in the past two and a half decades; debt as a share of disposable personal income jumped from 70% in the early 1980s to 130% in 2005, according to calculations by Lawrence Mishel, Jared Bernstein, and Sylvia Allegretto of the Economic Policy Institute. Part of this is credit card debt, but the bulk is mortgage debt — a product of rapidly-rising home prices, low interest rates, low-down-payment mortgages, and home equity loans.

The following chart shows the average ratio of debt payments to income for families in the bottom three quintiles of the income distribution. The data are from an analysis of the Survey of Consumer Finances by Federal Reserve economists Brian Bucks, Arthur Kennickell, and Kevin Moore. (The calculations are available beginning in 1989.) For each of these groups, which together comprise 60% of the population, average debt payments have increased. Yet they haven’t exactly skyrocketed.

Debt is by no means the whole story. Equally important are two other developments. First, except for a brief period in the late 1990s, inflation-adjusted earnings for people in the lower half of the distribution have been stagnant since the late 1970s. The next chart shows this.

Second, many two-adult households have offset wage stagnation by sending the second adult into the the labor force. But as Elizabeth Warren and Amelia Warren Tyagi point out in The Two-Income Trap, for a lot of households that option is no longer available. The next chart suggests why. Nearly three-quarters of prime-working-age (25 to 54) women are now employed, up from half in the early 1970s. Thus, many of the households that can have two employed adults already do.

The result? Households now appear to be more sensitive to serious short-run financial strains — job loss, a medical problem that results in significant cost (due to lack of health insurance or inadequate coverage), a hike in rent, a rise in mortgage payments (as a low-interest-rate adjustable mortgage rolls over). A generation ago a household could adjust to this type of event by having the second adult take a temporary job to provide extra income. During the economic boom of the late 1990s they might have been able to switch jobs in order to get a pay increase. In the past ten years they could run up credit card debt or take out a home equity loan.

For many households with moderate or low incomes, these strategies are now foreclosed.