Monday, October 31, 2011

Trick or Treat

By Lewis Sage

I couldn’t decide on a costume for tonight, so I went to a scary place, the Congressional Budget Office for inspiration.
The CBO’s report, Trends in the Distribution of Household Income Between 1979 and 2007, came out a little early for Halloween, but it is just as full of tricks – for most of us – and treats – for a select few - as earlier reports (see especially Piketty and Saez, Income Inequality in the United States, 1913-1998, Quarterly Journal of Economics, 2003).  The news, in case you’ve been off the planet for the last generation, is that between the pre-recession peaks of 1979 and 2007, the inflation-adjusted after-tax-after-transfer income of the average American household rose an average of 1.8% per year, a total of 62% since the waning days of the Carter administration.  Pretty good, if you live in the average household, but there’s no such thing as an average household.
If we sort households by income from highest to lowest, the rising economic tide turns out to have been a flood for the top 1%, but no more than a heavy dew for those in the bottom 20%.  After-tax income for the top 1% has risen at an average rate of 5% per year, a pace at which it doubles twice a generation; for the bottom 20%, the rate is 0.6%, doubling their standard of living every four generations.  In between, income growth has been, well, in between.  But the facts are clear: only those households in the top 20% have seen above-average increases, and those have been heavily concentrated in the top 1%, so that by 2007, the aggregate income of the top 1% equaled that of the bottom 40%.
There are three main reasons for this skewed growth pattern: disproportionate growth at the top of the wage distribution; a shift toward highly concentrated income sources; reduction in the progressivity of the federal tax structure.  Concentrated growth was not limited to wages, however:
In 1979, the bottom 80 percent of the population in the income spectrum received nearly 60 percent of total labor income, about 33 percent of income from capital and business, and about 8 percent from capital gains In 1979, the bottom 80 percent of the population in the income spectrum received nearly 60 percent of total labor income, about 33 percent of income from capital and business, and about 8 percent from capital gains… By 2007, the share of labor income going to the bottom 80 percent had dropped to less than 50 percent, their percentage of business income and income from capital had decreased to 20 percent, and their share of capital gains was about 5 percent.” (p. 10) Increasing demand for highly skilled labor, exploding compensation for upper management, the growth of the superstar model, all have been proposed to explain the concentration of labor income.
Inequality has also increased because the top 1% shifted sources from capital income to business income (perhaps in response to changing tax rules) and business income was at the same time the fastest growing income source. And finally, the tax and transfer structure of the federal government has contributed to the concentration of income at the top, becoming less progressive, with tax rate reductions at the upper end, and increased reliance on payroll taxes.
One percent wins; 19% break even; 80% slip backward.  Maybe I’ll go as an occupier.

Dr. Lewis C. Sage (AB Kenyon, PhD U. Maryland) likes intersections. Since 1991, he has taught Law and Economics, Mathematical Economics, and the Economics of Healthcare. A former Fulbright Fellow (Bulgaria 1995-6), he teaches an interdisciplinary Honors seminar, Enduring Questions, and is studying strategy in the NFL draft with faculty and students in Sport Management and Psychology. E-mail:

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This blog lives under the auspices of the Department of Economics whose mission has been to hold high the lantern beaming an "economic way of thinking" onto the world. Selfishness, rationality and equilibrium have been central to the teaching of an economic way of thinking rooted in the Renaissance. And, in this regard, the department has faithfully stayed the course. The intent of this blog, thinking out loud..., however, is to entertain exchanges which may challenge the centrality of economics as we teach it.