Jane Waldfogel, “What the U.S. can learn from Britain’s war on poverty” (ht Miles Corak)

Timothy Taylor, “McWages around the world” (ht Mark Thoma)

Janet Gornick and Markus Jantti, “Child poverty in high- and middle-income countries”

Peter Edelman, So Rich, So Poor: Why It’s So Hard to End Poverty in America

Rebecca Blank, Changing Inequality

Timothy Noah, The Great Divergence

Paolo Lucchino and Salvatore Morelli, “Inequality, debt, and growth”

Scott Winship, “The 1% conundrum: How much income inequality is there, really?”

Scott Winship, “What really happened to income inequality in the 20th century?”

1. What should we seek?
2. Rising incomes and living standards
3. Economic security
4. Opportunity
5. Equality
6. Health
7. Happiness
8. Education
9. Economic and social policy
10. Family
11. Economic growth and employment
12. What do Americans want?
13. Can we generate more tax revenue?
14. Is progress possible?

This is disappointing, but seemingly not surprising. After all, income inequality increased sharply during these years. The share of income going to the top 1% of households jumped from 8% in 1979 to 17% in 2007. With a larger and larger portion of economic growth going to those at the top, a divorce between growth of the economy and growth of middle-class incomes is exactly what we would expect to see.

But according to some (here, here, here, here), this picture may significantly overstate the degree of decoupling.

One objection is that the price deflator typically used to adjust GDP per capita for inflation differs from the deflator used for median family income. I’ve addressed that here by using the same deflator for both.

A second concern has to do with GDP per capita as an indicator of economic advance. Since the 1970s a larger portion of GDP has gone to replace old capital equipment and therefore can’t go to household income. Also, the number of persons has increased less rapidly than the number of households, so a per capita (per person) measure of GDP could mislead.

A third worry is that the income measure used to calculate median family income is too thin. If a growing portion of GDP has gone to employer benefits, that would help middle-class households, but it wouldn’t show up in these income data.

To address these second and third concerns, we can turn to a more encompassing measure of household income. The data are from the Congressional Budget Office (CBO). The measure includes all sources of cash income. It adds in-kind income (employer-paid health insurance premiums, food stamps, Medicare and Medicaid benefits), employee contributions to 401(k) retirement plans, and employer-paid payroll taxes. Tax payments are subtracted.

We can use average household income in these data as a substitute for GDP per capita. The CBO data set doesn’t tell us the median income, but it provides something quite similar: the average income of households in the middle quintile of the distribution (from the 40th percentile to the 60th). The following chart adds these two series. The story is virtually identical.

Decoupling is real and sizable.

This isn’t good. In a growing economy, the benefits of growth should accrue not just to those in the upper half (or in the upper 5% or 1% or 0.1%), but to everyone. The income gains needn’t be spread perfectly equally, but those in the bottom half ought to get more than a crumble.

Yet is the story conveyed by this graph misleading? The income data are from the Current Population Survey. Each year a representative sample of American adults is asked what their income was in the previous year. But each year the sample consists of a new group; the survey doesn’t track the same people as they move through the life course. If we interpret the above chart as showing what happens to typical American households over the life course, we’ll conclude that they see very little increase in income as they age. That’s not correct. In any given year, some of the people with below-median income are young. Their wages and income are low because they are in the early stage of the work career and/or because they’re single. Over time many of them will in fact experience a significant income rise. They’ll get pay increases; or they’ll partner with someone who also has earnings; or both. The chart above misses this income growth over the life course (absolute intragenerational income mobility).

The following chart offers one way to see this. The lower line shows median income among families with a “head” age 25 to 34. (As in the first chart, I use families instead of households in order to be able to go back farther in time; data for households aren’t available prior to 1967.) The top line shows median income among the same cohort of families twenty years later, when their heads are age 45 to 54.

To clarify, consider the year 1979. The lower line tells us that in 1979 the median income of families with a 25-to-34-year-old head was about $54,000 (in 2010 dollars). The data point for 1979 in the top line tells us the median income of that same group of families twenty years later, in 1999. They’re now 45 to 54 years old, which is the peak earning stage for most people. The median income in this group is now about $85,000.

In each year the gap between the two lines is roughly $30,000. This tells us that the incomes of middle-class Americans tend to increase substantially as they move from the early years of the work career to the peak years.

Should this reduce our concern about the over-time pattern shown in the first chart above? No, it shouldn’t. Look again at the second chart. Between the mid-1940s and the mid-1970s, the median income of families in early adulthood (the lower line) rose steadily. Median income for these young families was around $25,000 in the mid-1940s. By the mid-1970s it had doubled to $50,000. Americans during this period experienced income gains over the life course, but they also tended to have higher incomes than their predecessors, both in their early work years and in their peak years. That’s because the economy was growing at a healthy clip and the economic growth was trickling down to Americans in the middle. (Though I don’t show it here, the same was true below the median.) After the mid-1970s, this steady gain disappeared. From the mid-1970s to 2007 the median income of families with a 25-to-34-year-old head was essentially flat. Each cohort continued to achieve income gains during the life course. (Actually, we don’t yet know about those who started out in the 1990s and 2000s, as they’re just now beginning to reach age 45 to 54. The question marks in the second chart show what their incomes will be if the historical trajectory holds true.) But the improvement across cohorts that had characterized the period from World War II through the 1970s — each cohort starting higher and ending higher than earlier ones — disappeared.

So yes, for many Americans income rises during the life course. And yes, this is hidden by charts such as the first one here. But that shouldn’t lessen concern about the decoupling between economic growth and household income growth that has occurred over the past generation. We should want healthy income growth not just within cohorts (over the life course) but also across them.

Here’s what the pattern looks like according to Miles Corak, the source of Krueger’s data (enlarged version here). The vertical axis in the chart is immobility; lower means more mobility. The horizontal axis is income inequality a few decades earlier.

Nations with lower income inequality tend to have more intergenerational mobility, and the association is quite strong. There are concerns about the data. But suppose the data are accurate, and suitable for testing this link. What does the association depicted in this chart tell us about the magnitude of inequality’s impact? How much would reducing income inequality in the United States help?

For most, the aim isn’t high intergenerational mobility per se; it’s low inequality of opportunity. Mobility serves as an indicator (not perfect, but not bad) of equality of opportunity.

Money ought to be good for children’s opportunity. Kids growing up in households with higher incomes are more likely to have good health care, low stress, learning-centered preschools, good elementary and secondary schools, extracurricular activities that promote cognitive skills and earnings-enhancing noncognitive traits, and access to a strong university. It would be surprising, therefore, if inequality of parents’ incomes did not contribute to inequality of opportunity among their children.

But how large is the effect? After all, money isn’t the only thing that matters; a good bit of our abilities and motivations when we reach adulthood stem from nonmonetary influences such as genetics, in-utero developments, our parents’ habits and behaviors, and peers. Also, there are diminishing returns to money; beyond a certain point, more parental income probably helps only a little, if at all.

Yet the graph suggests a large impact. Apart from data concerns, is there any reason to question this? I think so. First, let’s set aside the low- and middle-income countries (Argentina, Brazil, Chile, China, Pakistan, Peru, Singapore). Mobility processes in these countries may or may not be comparable to those in the rich nations. Next, notice that inhabiting the lower-left corner of the chart are the four Nordic nations: Denmark, Finland, Norway, and Sweden. These countries have been providing affordable high-quality early education to a substantial portion of children age 1 to 5 for roughly a generation. James Heckman and Gøsta Esping-Andersen, among others, have argued that early education is perhaps the single most valuable thing a society can do to equalize opportunity. These countries also feature late tracking in elementary and secondary schools and heavy subsidies to ensure college is affordable for all. These public services, rather than low income inequality, might be the chief reason the Nordic countries have such high intergenerational mobility.

What would that imply for the cross-country association between income inequality and intergenerational mobility? As the following chart shows, if we leave out the Nordic nations the association is still there, but the countries are widely dispersed around the line, suggesting weaker grounds for confidence that the association is a strong one. (For the statistically inclined, the r-squared is .47 with the Nordics included and .16 without them.)

Is it possible, then, for a country to have high income inequality but also low inequality of opportunity? John Quiggin is skeptical. He suggests the UK experience has debunked this “third way” notion. I’m not so sure. Imagine a rich nation with America’s income inequality and Nordic public services: affordable high-quality early education, K-12 schooling with late tracking and equal funding, and widespread access to good-quality universities. And perhaps also comprehensive prenatal care. Would its opportunity (mobility) structure look more like America’s or more like Sweden’s?

But, some will respond, you can’t get those services if income inequality is high. The rich will block the heavy taxation needed to fund them. Maybe. But income inequality has been rising in Sweden. In fact, in the late 1990s and mid 2000s the top 1%’s share of income (including capital gains) in Sweden was about the same as in the 1970s United States (see figure 7 in this paper by Atkinson, Piketty, and Saez). So far this hasn’t undermined Swedish taxation, though it’s probably too soon to draw any firm conclusions.

Suppose income inequality continues to rise in Sweden but its public services hold up. Will Sweden’s intergenerational mobility a few decades from now look like ours does today? I’d predict no. I suspect opportunity-enhancing programs can overcome a good bit of the harm done by income inequality.

That’s not to say we shouldn’t also try to reduce income inequality. I think we should. The point is that if we want to reduce inequality of opportunity, reducing income inequality isn’t the only way, and perhaps not even the best way, to do it.

1. Should we legalize marijuana?
2. Are humans causing dangerous climate change?
3. Should same-sex marriage be legal?
4. Is rising income inequality a serious problem?
5. Are Americans overtaxed?
6. Should we promote gender equality?
7. Why are some of us red and others blue?
8. Is party polarization bad?
9. What drives government policy?
10. Is big business ruining America?
11. What should we eat?
12. Are American universities failing?
13. Free trade or fair trade?
14. What should we do about immigration?
15. When should we intervene abroad?

A few other worthwhile recent reads on these topics:

Jared Bernstein’s blog

CBO, Trends in the distribution of household income

Center on Budget and Policy Priorities, A guide to statistics on historical trends in income inequality

OECD, Divided we stand: why inequality keeps rising

Scott Winship, Mobility impaired

Miles Corak, The decline of the American dream

Reihan Salam, Understanding America’s income mobility problem

Mike Brewer and Liam Wren-Lewis, Why did Britain’s households get richer?

James Plunkett, The potential for female employment to raise living standards in low to middle income Britain

Between 1979 and 2007, inflation-adjusted hourly wages for Americans at the median and below were essentially flat. Household incomes in the lower half increased, but not very much. Both wages and incomes for many ordinary Americans trailed far behind growth of the economy. At the same time, the earnings and incomes of those at the top exploded (see here, here, here, here).

One story sometimes told about the 1980s, 1990s, and pre-crash 2000s links these two developments to offer an optimistic verdict on the evolution of living standards for America’s lower half. The story goes something like this: A winner-take-all economy reduces income growth for low-to-middle Americans. But it nevertheless produces a substantial rise in living standards for them. It does so by increasing financial incentives for inventiveness and hard work, which yields leaps in consumption that aren’t reflected in the price data used to measure changes in the cost of living.

To put it more precisely, the story has four parts:

1. Returns to success soared in fields such as entertainment, athletics, finance, and high tech, as well as for CEOs. These markets became “winner-take-all,” and the amounts reaped by the winners mushroomed.

2. For those with a shot at being the best in their field, this increased the financial incentive to work harder or longer or to be more creative.

3. This rise in financial incentives produced a rise in excellence — new products and services and enhanced quality.

4. These improvements haven’t been satisfactorily captured in the price index by which we assess changes in the cost of living. Watching Michael Jordan or LeBron James play basketball is a qualitatively superior experience relative to what came before in a way that isn’t reflected in the price of a ticket or of a cable TV subscription. Similarly, the Macintosh, iPod, iTunes, iPhone, and iPad are so different from and superior to anything that preceded them that what they add to living standards isn’t likely to be adequately measured.

I think there’s a good bit of truth to parts 1, 2, and 4 of this story. But I’m skeptical about part 3.

This brings me to Steve Jobs. Apple and its delightful, user-friendly, (eventually) affordable gadgets play a key role in this story. The question is: Would Jobs and his teams of engineers, designers, and others at Apple have worked as hard as they did to create these new products and bring them to market in the absence of massive winner-take-all financial incentives?

In the things-have-improved-more-than-the-income-data-make-it-seem story, the answer is no. The financial incentive is the critical spur to inventiveness and hard work.

But I don’t find anything in Isaacson’s account of Jobs that supports this view. Jobs himself seems to have been driven mainly by a passion for the products, for winning the competitive battle, and perhaps for status among peers. The satisfaction of achieving excellence and of beating one’s opponents appears to have been far more important than monetary compensation. Excellence and victory were their own reward, rather than a means to the end of financial riches. In this respect Jobs was little different from scores of inventors and entrepreneurs over the ages, or for that matter from Bill Russell, Larry Bird, and Michael Jordan.

The rise of winner-take-all compensation occurred simultaneously with surges in innovation and productivity in certain fields, but that doesn’t mean it was the cause of those surges.

The report was released today in conjunction with this event in London.

What should we make of this? On the one hand, it’s good that there was little reduction in progressivity. The progressivity of federal taxes helps to offset the regressivity of state and local sales taxes.

On the other hand, there was a compelling case in the early 2000s (and still today) for increasing the progressivity of federal taxes. One of the chief rationales for progressive taxation is that those with high income can afford to contribute a larger share of that income. In the 1980s and 1990s, the top 1% of Americans enjoyed whopping income gains. Between 1979 and 2000,  the average (inflation-adjusted) income of households in the top 1% jumped from $350,000 to $1 million. For households in the bottom 20%, average income barely budged; it was $15,300 in 1979 and $16,500 in 2000. Given these developments, it would have been sensible to increase the effective tax rate a bit for those at the top and perhaps reduce it a little for those at the bottom. President Bush and the Congress instead chose to reduce rates for everyone.

The chief harm inflicted by the Bush tax cuts wasn’t to progressivity. It was to government revenues. The average effective federal tax rate for all households dropped from 23% in 2000 to 20.4% in 2007. Judging from the CBO’s data on income, that two-and-a-half percentage point decline subtracted roughly $300 billion from federal tax revenues in 2007. Proponents of the tax cuts hoped the economy would grow faster, mitigating the revenue loss caused by the lower rates, but that didn’t happen.

$300 billion a year wouldn’t address all of our revenue needs, but it could do a lot of good.

How much does economic growth benefit the poor? When and why does growth fail to trickle down?

How can social policy help? Is more social spending better for the poor?

Can a country have a sizeable low-wage sector yet few poor households?

Are universal programs better than targeted ones?

What role can public services play in antipoverty efforts?

What is the best tax mix?

Does improvement in the living standards of the least well-off require a sacrifice of other desirable outcomes?

Richard Freeman and William Rodgers were among the first to draw attention to the shift. In 2005, well into the recovery following the 2001 recession, they noted the anemic job growth relative to prior recoveries and wondered if the labor market had changed fundamentally.

Here are some revealing indicators.

During the growth phase of the business cycle, from 2002 to 2007, the number of people employed increased less rapidly than in previous upturns.

The employment-to-population ratio gained no ground over the 2002-07 upturn. It was 63% when the economy emerged from recession at the beginning of 2002 and 63% just before it plunged back into recession at the end of 2007.

Rising employment is particularly important for those at the low end of the labor market. Here too the 2000s upturn was a disappointment. In working-age households in the bottom quartile of the income distribution, average employment hours failed to rise at all.

What caused this collapse of the American jobs machine? I think the most convincing explanation is a shift in management’s incentives and in its leverage relative to employees. According to Robert Gordon, this has its origins in the 1980s and 1990s but emerged in full force in the early 2000s:

Business firms began to increase their emphasis on maximizing shareholder value, in part because of a shift in executive compensation toward stock options. The overall shift in structural responses in the labor market after 1986 were caused by … the role of the stock market in boosting compensation at the top, … the declining minimum wage, the decline of unionization, the increase of imported goods, and the increased immigration of unskilled labor. Taken together these factors have boosted incomes at the top and have increased managerial power, while undermining the power of the increasingly disposable workers in the bottom 90 percent of the income distribution.

Executives’ compensation is heavily influenced by their firm’s stock price. Financial advisers believe “lean and mean” delivers better long-term corporate gains. Employees have limited capacity to resist employment cutbacks during hard times and to press for more jobs during good times.

During the 2000s upturn this made for sluggish employment growth despite conditions that were, in historical and comparative terms, quite favorable for hiring: buoyant consumer demand, low interest rates, limited labor market regulations, modest wages and payroll taxes.

Is there direct evidence that employers were reluctant to hire? The pattern in the following chart, from Scott Winship, is telling. In the 2001 recession, posted job openings as a share of the labor force (the blue line in the graph) fell to their lowest level in more than half a century. Then, as the economy picked up steam, posted openings didn’t budge. The lack of increase was a sharp departure from previous upturns.

Many hope that when the economy finally gets moving again, we’ll return to the glory days of rapid employment growth. But developments in the 2000s, prior to the crisis, paint a discouraging picture.

The importance of this slowdown in employment growth is hard to overstate. In recent decades the American labor market has suffered from twin maladies: it’s been producing fewer middle-paying jobs and wages in the bottom half of the earnings distribution have been stagnant. For much of this period its chief virtue was that it created a large number of jobs. That looks to have gone by the wayside.