The Cost of Rising Inequality

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.

12 thoughts on “The Cost of Rising Inequality

  1. The counterfactual part is a great illustration.

    The economic “landing” we are about to have is going to be very turbulent. Every Thursday I go to the post office in the small town/city I live in (Census 2000 19.8% families below poverty threshold) and for the past three months the number of people lining up at the soup kitchen behind the church around 11:30am seems to have doubled. Could be biased observation or a quark, but I think it means something especially when food price inflation is going up among other things.

  2. Your counterfactual completely ignores incentives. There’s no reason to think we’d have seen 1.5% growth rates (btw, we had 1.9% growth at an individual level) if we’d implemented the necessary redistribution to make your counterfactual reality.

    Also, doing analysis on percentiles is misleading in the extreme for doing the sorts of experiments you’re suggesting. Many of those in the bottom percentile are now in the top percentiles and many of the rich in the 70’s are poor today. Does your counterfactual redistribute from the new rich to the old rich? Why? If anyone had opportunities, its the old rich.

    A larger question though: how does it offend Justice to have unequal, but positive, growth rates between groups? If the pie is getting bigger for everyone, how can one interpret the situation as unfair?

  3. pushmedia: “There’s no reason to think we’d have seen 1.5% growth rates (btw, we had 1.9% growth at an individual level) if we’d implemented the necessary redistribution”

    There’s no reason to think otherwise.

    Growth in real GDP per Capita (by PPP) 1979-2005:

    US: 61%

    EU15 (wait for it…): 60%

    After 25 years of supply-side economics, take a look at the change in incomes for bottom 20%: none. (Okay, okay, they went up by 6.25%, from $14.4K to $15.3K. That’s for a household, not a worker. How much did your household spend on utilities last year?)

    Is it still trickling down? Should we just wait a little longer? Are we going to catch up with those tax-and-spend Europeans eventually?

    >Many of those in the bottom percentile are now in the top
    >percentiles and many of the rich in the 70’s are poor today.

    Economists learn in kindergarten that earnings change over lifetimes. Compare cross-generational studies–what are the chances your child will climb the ladder. The odds are significantly higher in Scandanavian countries than in the US.

    It’s about time to put an end to faith-based economics, and start looking at reality.

  4. Lane,
    There seems to be a misprint on the bottom part of your graph (the most important part?). It looks like the bottom percentile went from about $18K to about $22K. If income grew 1.5% for 25 years, shouldn’t that take the lowest quitile to closer to $25K? (And by 2008 to about about $27K — a 50% increase?; BTW, inequality began around 1973 — don’t know why 1979 has become the starting point for so many inequality comparisons lately.)

    Also, if you are getting your stats from the Census, I believe that the Census top codes out of its survey all income above $1 million a year for households — just as it does for families. When I adjusted for the top code with families by assuming that overall family income grew in step with per capita income between 1967 and 2005, enough extra income popped up to increase top family share of overall income from 47% to 59%.

  5. pushmedia,
    The pie isn’t getting bigger for everybody. The lower income have just sent more people to work. The minimum wage dropped from $10/hr ($1.60 nominally) in constant dollars from LBJ’s 1968 raise to almost half that until the recent small increase — even as average income doubled.

    BTW, the lower minimum is not because a higher tech economy pays lower skills less (Russia should pay fast food more than we do if so). The means to doubled productivity are salted at every level of work from copying machines that laid off millions of typists (visited the “typing pool” lately?) to jet engines that require only 5% of the maintainence of piston engines to automation and the internet (you have visted Amazon).

    Notice the generation long gap between the LARGE productivity jumps cited in the last paragraph — that is because maturing technology is what pumps up productivity, not the machinations of finance as trickle-downers would have us believe — and between 1973 and 1995 productivity grew ONLY 1.5% a year because no large jumps came in.

    The only reason American labor is suffering from what I call the “Great Wage Depression” (“inequality” seem a weak term for those of us trapped in literally depression era wages — FDR’s minimum wage: $4.65/hr w/no tax) is that American workers have never broken free from the unfettered free market myth — they have never learned by and large the need to bargain as powerfully as the testoterone over-loaded Teamster’s Union.

    There is an easy anwer for them (even if they are not all testosterone over-loaded): sector-wide labor agreements (collective-collective bargaining) — simplest version the French Canadian, wherein nonunionized firms must operate under the same terms as unionized terms; Americans grocery and airline workers would kill to get that — acts like power steering and power brakes. Labor has so much bargaining power built in under sector-wide that it must step lightly not to crush ownership — which captial it of course depends on just as much as it depends on itself — instead of the current, uniquely American, situation wherein labor is being crushed by ownership.

  6. I should have added above that with wages on the bottom actually dropping (LBJ’s minimum wage is now the 25 percentile American wage!), the only reason bottom 20 percentile households may made any progress at all is more members working — and those working, working more hours.

    Imagine is that were added to 50% more income (by 2008) — there might be scarcely any poverty except perhaps among disfunctional individuals. LBJ would have won his war on poverty — as he should have. Wake up American workforce — unionize the modern way used all over the better paying OECD world: collective-collective bargaing.

  7. Denis,

    In the hypothetical scenario, the average in the bottom quintile goes from $14,400 in 1979 to about $21,000 in 2005 (constant dollars). The beginning year is 1979 because that’s the earliest for which the CBO data are available. They’re preferable to Census (Current Population Survey) data for this type of analysis because they’re better on top incomes.


  8. Incentives still work in the EU, so I don’t see your point. Your growth numbers are suspect, btw. Looking at the penn world tables, the EU15 grew 57% between 1979 and 2004 and the US grew 64% (using chain weighted gdp). Much of that growth in the EU comes from the UK and Ireland. The Social Democratic paradises of Sweden, France, Italy, Germany and Denmark are all below the EU average over the period. OTOH, Finland saw solid growth.

    We’re not seeing US-style increases in inequality rise in Europe because we’re not seeing as much increase in the incomes of the rich there (see Prof. Kenworthy’s previous post). This makes your minimum wage/unions story pretty weak.

    In the US, individual wages have been increased for all percentiles since 1988 (source: CPS, see Autor et al 2006). This suggests the HH demographic shift you suggest would have bumped up HH incomes relative to individuals. In other words, unless we’re sending fewer household members into the work force, this trend in individual wages suggests HH incomes are positive for every income percentile (at least in the most recent decade and a half).

  9. Pushmedia1:

    You should review the literature on income mobility b/c the qualitative statement in your first post does not match estimates I’ve seen based on the NLSY

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