See America’s income inequality grow during 1979-2011, a driver of Campaign 2016

Summary: To understand this election we must see the accumulated stresses which produced the insurgencies in both parties. Rising income inequality — “the hollowing out” of the middle class and rise of the 1% — is probably the biggest, yet still poorly understood (until recently conservatives denied it). This great study by one of our top economists describes the dismal picture, essential for us to understand if we are to begin the reform of America.

Income growth by quintile — and by percentile for the top quintile

Growth of income and welfare in the U.S, 1979-2011

By John Komlos. Published by the NBER, April 2016
Excerpts. Red emphasis added.

Conclusions

{These} estimates have to be considered preliminary. Nonetheless, there are a few consistent patterns in which we have confidence that they will survive successive improvements.

These include most vividly what in the colloquial is referred to as the “hollowing out” of the middle class. The lower-middle class 2nd quintile and the middle class 3rd quintile fared the worst in all specifications: their income increased at a rate of between 0.1% and 0.7% per annum (Figure 1). In contrast, the only group whose income grew remarkably was the 5th quintile and especially the top 1% whose income registered an astonishing growth rate of between 3.4% and 3.9% per annum, reaching an average value of $918,000 by the end of the period under consideration.

Somewhat surprising is the consistently positive growth of the income of the lowest quintile. The poorest group registered an income growth estimated to be between 0.5% and 1%, i.e., consistently above that of the 2nd and 3rd quintiles, and equaling that of the 4th quintile (Figure 1). This is all the more surprising insofar as their net transfers decreased over time while those of the three middle class quintiles increased by as much as $9,000 per annum (Table 4).

… However, it is astounding that the relative income of the rest of the 5th quintile besides the top 1% did not experience such humongous growth. Only the top 1% increased enormously from a factor of 21 to a factor of 51, a surge of no less than 144%.

… Another recurring pattern is that the income of the 2nd and 3rd quintiles consistently lagged behind the other quintiles. This is referred to in conventional parlance as the “hollowing out of the middle class”. … According to the low estimates, it would take about 600 years for incomes in the 2nd quintile to double and on the order of a millennium for welfare to double. These are growth rates that are reminiscent of those that prevailed prior to the Industrial Revolution.

Role of government transfers of income (benefits minus taxes)

Not surprisingly government transfers minus taxes were the largest in percentage terms in the 1st quintile (Table 3). Their market income was increased by 31% by net transfers. The share declines with higher incomes until it became negative in the 4th quintile. For them taxes were greater than the transfers they received, so that their net income was smaller than their market income by 8%. Only the 5th quintile (including the top 1%) was in a substantially negative position, i.e., only they paid more taxes than the transfers they received. …

Another question is the extent to which transfers net of taxes have increased or decreased during this 32-year period (Table 4). Here we stumble upon the unexpected result that net transfers of the 1st quintile have actually decreased over time while that of the three middle-class quintiles increased markedly. The taxes on the 5th quintile (and on the top 1%) increased substantially. The implication is that the hollowing out of the middle class occurred in spite of the increases in government transfers.

…Consequently, the net transfers made up a substantial portion of the increases in total incomes of the three middle classes.

About life on the bottom

…{T}here are many products and services today that did not exist in 1979 which makes it challenging to compare the cost of living across generations. For instance, in 1979 we did not have to pay at all for watching television while now we do. Aside from introductory offers, basic cable services cost about $64 per month or $768 per year.

If we were to subtract this single expenditure from the annual disposable income of the bottom quintile of $17,948 the growth rates would decline by 0.1%… In other words, such expenses did not exist in 1979 but they make it much more difficult for the poor to maintain the living standard that is considered normal for the times in which they live.

Another inaccuracy creeps into the estimates on account of the way households are defined insofar as the 2.3 million people in prison or the 0.5 million homeless, for example, are left entirely out of consideration without explanation why this should be the case.

The number of people in prison today is about 1.7 million more than in 1979. Suppose that they were all from the first quintile and let us add their presumably zero incomes to those of the 1st quintile. …  all of their gains barely sufficed to pay for cable service if one also considers increases in the number who are inexplicably not accounted for in these statistics. …the average income of the bottom quintile in 2011 was just $32 above the poverty income of a three-person household.

The illusion of rising income created by rising health care costs

… Although Medicare and Medicaid payments did increase from 2.5% to 8.8% of total income, the actual benefits most likely have not increased meaningfully over time. Moreover, these increases were most likely caused by the aging of the population which necessitates greater Medicare expenditures. This consideration points to one of the more serious shortcomings of all of these estimates, namely that they are not standardized for the age structure of the population which changed obviously over time and the demand for medical services is particularly age-sensitive. As a consequence of all these issues, it seems appropriate to leave these items out of consideration until these uncertainties are resolved.

About the data

…{T}he measurement of income and its growth remains somewhat controversial. Most estimates are based on pre-tax pre-transfer incomes collected by the Census, which are, of course, important in themselves insofar as they reveal market outcomes; however, they fail to reveal accurately actual purchasing power… However, post-transfer incomes calculated by the Congressional Budget Office (CBO) has its own problems, namely that much of it is financed through government debt so the burden of the transfers will be born, in the main, by generations yet unborn and consequently cannot be netted against government liabilities. This, of course, introduces a difficult-to-calibrate bias into the calculations insofar as the accumulated debt is not accounted for anywhere in these statistics. Hence, the post-transfer incomes leave the impression that the accumulation of government debt could be income and welfare enhancing.

An additional formidable challenge is posed by a litany of intractable problems associated with the estimates of the rate of inflation which introduce measurement errors upon which the whole exercise might well turn and which might affect various income groups differently.

… {T}he high estimates use the modified CBO data (deflated with the PCE price index) while the low estimates use the same data deflated with the CPI.

————————– End excerpt ————————–

About the study

Growth of income and welfare in the U.S, 1979-2011
By John Komlos
National Bureau of Economic Research, April 2016

We estimate growth rates of real incomes in the U.S. by quintiles using the Congressional Budget Office’s (CBO) post-tax, post-transfer data as basis for the period 1979-2011. We improve upon them by including only the present value of earnings that will accrue in retirement and excluding items included in the CBO income estimates such as “corporate taxes borne by labor” that do not increase either current purchasing power or utility. We estimate a high and a low growth rate using two price indexes, the CPI and the Personal Consumption Expenditure index.

The major consistent findings include what in the colloquial is referred to as the “hollowing out” of the middle class. According to these estimates, the income of the middle class 2nd and 3rd quintiles increased at a rate of between 0.1% and 0.7% per annum, i.e., barely distinguishable from zero. Even that meager rate was achieved only through substantial transfer payments.

In contrast, the income of the top 1% grew at an astronomical rate of between 3.4% and 3.9% per annum during the 32-year period, reaching an average annual value of $918,000, up from $281,000 in 1979 (in 2011 dollars). Hence, the post-tax, post-transfer income of the 1% relative to the 1st quintile increased from a factor of 21 in 1979 to a factor of 51 in 2011. However, income of no other group increased substantially relative to that of the lowest quintile. Oddly, the income of even those in the 96-99 percentiles increased only from a multiple of 8.1 to a multiple of 11.3.

We next estimate growth in welfare assuming diminishing marginal utility of income. A logarithmic utility function yields a growth in welfare for the middle class of roughly 0.01% to 0.07% per annum, which is indistinguishable from zero. With interdependent utility functions only the welfare of the 5th quintile experienced meaningful growth while those of the first four quintiles tend to be either negligible or even negative.

About the author

John Komlos is professor emeritus of economics and of economic history at the University of Munich, Germany. Born in Budapest during the Holocaust (1944), just as the Soviet army began its assault on the city, he became a refugee 12 years later during the revolution of 1956, and grew up in Chicago. He received PhDs in both history and in economics from the University of Chicago where Nobel-Prize winning economic historian Robert Fogel introduced him to the field of anthropometric history in 1982. Komlos devoted most of his academic career developing and expanding this research agenda, which culminated in his founding the field of economics and human biology with the journal of the same name in 2003.

Defying disciplinary boundaries, Komlos is among the very few scholars to publish in major journals of five disciplines: the American Economic Review, the American Historical Review, the American Journal of Human Biology, Statistical Methodology, and Mathematical Population Studies. Komlos was the first to explain why populations of the then-developed world became shorter at the onset of modern economic growth. He also discovered that after being the tallest in the world for 200 years, Americans became shorter than Western Europeans after the Second World War.

This is from his bio at the Harvard website. See his website for more information about his background and publications.

About the National Bureau of Economic Research (NBER)

Founded in 1920, the NBER is the nation’s leading nonprofit economic research organization, a private, non-profit, non-partisan organization dedicated to conducting economic research.

The Bureau’s associates concentrate on four types of empirical research: developing new statistical measurements, estimating quantitative models of economic behavior, assessing the economic effects of public policies, and projecting the effects of alternative policy proposals. The NBER is supported by research grants from government agencies and private foundations, by investment income, and by contributions from individuals and corporations.

For More Information

The study cites a wide range of sources. These of are of special interest…

• “Of the 1%, by the 1%, for the 1%” by Joseph Stiglitz, Vanity Fair, May 2011.
• “Increase in Suicide in the United States, 1999-2014” by Sally Curtin, Margaret Warner and Holly Hedegaard, National Center for Health Statistics, 2016.
• “America’s middle class is shrinking. So Who’s leaving it” by Drew Desilver, Pew Research Center, 14 December 2015.

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