(Cross-Posted at www.progressivefix.com--I'm late putting these up on my blog...)

My last post tackled inequality trends in the U.S. and how progressives ought to think about them. Now I want to look at middle-class living standards. In the course of basically agreeing with Dalton Conley that progressives should be more concerned with poverty than inequality,Kevin Drum argues that what got lost from the Conley analysis is the stagnation of the middle class (“sluggish middle class wages in a country that’s been growing energetically for decades”). And yesterday he endorsed the views of economist Raghuram Rajan, who blames the financial crisis on “the purchasing power of many middle-class households lagging behind the cost of living.”

Kevin has always been one of my favorite bloggers, but I have to disagree with him here—both in terms of the level of income the typical American has and in terms of recent trends, a careful look at the data implies that the middle class is doing pretty well. The common belief among progressives that this isn’t the case causes us to misdiagnose what the nation’s most pressing economic problems are and to put forth an agenda that doesn’t resonate as strongly as we think it does.

My friend Steve Rose really deserves the most credit for trying to draw attention to the reality of middle-class living standards being better than the left believes. In a much-circulated 
report for PPI and in his analyses for Third Way, Steve showed that, for instance, when measured correctly, the typical working-age American’s income is much higher than official statistics imply.

Many progressives thought that Steve was somehow pulling a fast one, a view with which I strongly disagree, but let me make similar points in a more transparent way here. First, consider what many progressives consider “the good old days”—the height of the pre-1970s economic boom. In 1973, the median inflation-adjusted income was 
higher than it had ever been and higher than it would be again until 1978—$45,533 (in 2008 dollars). Call this the gold standard before, in the conventional progressive telling, things started going south.

How much did things go south? Well, in 2008 the median was $50,303. That’s right—about $5,000 
higher (after adjusting for changes in the cost of living). This improvement understates things because households also became smaller over time, and because the inflation-adjustment here probably overstates inflation. For instance, if one uses the Bureau of Economic Analysis’s Personal Consumption Expenditures deflator, the increase from 1973 to 2008 was about $7,700, or 18 percent. Not only does that still not adjust for declining household size, it also doesn’t include changes in taxes, non-cash benefits, the value of health insurance, and capital gains. Incorporating these adjustments shows an increase in living standards that is more like 40 percent.

Rather than household income, others on the left point to stagnation in men’s wages (women’s wages have increased dramatically by any measure). For example, the 
Economic Policy Institute estimates that the median male worker’s hourly wage was $16.88 in 1973 and $16.85 in 2007. However, EPI’s figures show that when fringe benefits are taken into account, the median male worker’s hourly compensation increased by somewhere between 5 and 10 percent over this period. And these estimates don’t use the PCE deflator. Nor do they account for changes in taxation and public benefits—the very means we use to mitigate low income.

To review, “stagnation” of household income or male wages means that after adjusting them for the rising cost of living, they are as high as they were in the glory days of the 1960s and early 1970s–they have actually increased. When analysts on the left concede these increases, they then move the goal posts and argue that wages have not grown as much as they should have. Typically, they contrast modest wage growth with more rapid productivity growth. But too often these analyses are done on an apples-to-oranges basis. Critics 
leftright, and center have all pointed out flaws with the kind of comparisons that EPI and others make. Careful analyses reduce the gap between productivity growth and wage and income growth, though they don’t necessarily eliminate it. At any rate, economic theory says that compensation will increase with productivity all else being equal, and all else has not remained static.

It is certainly true that wage growth has been slower since 1973 than in the two previous decades. But that isn’t a realistic bar to use. The U.S. was the only major economy left standing after World War II, and there was little foreign competition putting downward pressure on manufacturing wages and jobs. The period between WWII and 1973 was anomalous—it could not have been expected to have lasted.

The other way to judge middle-class living standards in the U.S. is to compare them to those in other countries. The Luxembourg Income Study shows that at most points in the income distribution (the 25th percentile, the median, the 75th percentile), income in the U.S. exceeds that in nearly all European countries, including Sweden, the model for many on the left. (The most accessible evidence on this is in a 2002 article in the journal Daedalus by Christopher Jencks.) Determining how to incorporate publicly provided benefits such as education and health care is very complicated, but the evidence we have indicates that American middle-class living standards are at worst comparable to those in European nations.

Trying to persuade the middle class that it is worse off than it is potentially has harmful side effects. For one, as economist Benjamin Friedman and sociologist William Julius Wilson have argued, people are more generous when they feel they are doing well. When they feel economically threatened, they are more inclined to protect what they have than to help others. What’s more, widespread economic malaise can be a self-fulfilling prophecy, preventing people from making the individual choices that ensure, for instance, a strong recovery from recession. In terms of policy, the belief that the middle class is doing poorly can lead to scarce public resources being diverted to those doing relatively well rather than being used to help those truly in need. And politically, it can lead to a tone-deaf and unpersuasive populism that does little to help Democrats win in swing districts and close elections.

Again, the point here is that progressives should care about the facts. Up next…the poor.


 

(Cross-Posted at
www.progressivefix.com -- I'm late adding these to my blog....)

Happy New Year everyone! I am very late to this debate, but I wanted to weigh in on the conversation launched by Dalton Conley’s pre-holiday 
American Prospect article on progressivism and inequality. In case you missed it, Conley argued that progressives shouldn’t care that much about inequality and that we should instead care about the poor. Inequality, he showed, has grown between the rich and the middle, but not between the middle and the poor. Bruce Bartlett, weighing in from the right, agreed.

I’ll address the living standards of the middle class and the poor in subsequent posts, but let me add my two cents about inequality trends in this one. 
An analysis I conducted back in November showed that what has likely happened is that the very top—the top one-half of one percent—has pulled away from everyone else, though the increase from 1980 to 2009 has probably been fairly modest. Whether this has been a good or bad thing—or aside from trends, whether higher inequality in the U.S. than elsewhere is a good or bad thing—ought to depend on three questions, empirical and normative, none of which we have much of a handle on.

First, how does letting the rich get richer affect the absolute living standards of everyone else? As Alan Reynolds has argued, measures of inequality tend to reinforce a fixed-pie conception of national wealth—gains by the rich come at the expense of everyone else. But of course, the pie is not fixed in size, and it may be that allowing the rich to get a greater share of the pie makes for a bigger pie and bigger slices for everyone (a point made by Bartlett). Think about Rawls’s maximin rule—that any inequality that results in the worst-off being better off is just. It’s not necessarily the case that greater inequality must help out those who fall behind, but it’s certainly plausible.

Second, how does letting the rich get richer affect the relative deprivation experienced by everyone else? There are two questions here. When the rich get richer, people at the bottom and even in the middle may get priced out of certain goods and services, as prices get bid up by the wealthy. On the one hand, it may be that yachts become less affordable to the non-rich, which presumably no one would get too worked up about. On the other hand, if the price of an Ivy League education or prime neighborhoods becomes unaffordable to the non-rich, that would have bigger implications. Beyond the issue of being priced out of goods and services, inequality may make the non-rich feel less well off—even if their absolute living standards improve. If the Nissan Sentra you own is nicer than the Chevy Cobalt you used to have but feels no better since more people are driving Jaguars than in the past, then there’s room for debate about whether you are “better off”.

Third, if inequality makes most people better off in absolute terms (by making the pie bigger) but makes them feel worse off in relative terms (if their bigger piece feels smaller than before because of how much bigger others’ slices have gotten), then how much weight are we to give each effect? Unlike the other two considerations, this one has empirical and normative dimensions. You may think that being better off but feeling worse off is a net change for the worse, while I may think that it’s only being better off that matters. 
Robert Frank has made the case—not entirely convincingly, in my view—for the former view.

If you’re looking for the answer to these questions in a blog post, then my heart goes out to you. What I will say is that a situation in which the top 1 in 200 pulls away from the bottom 199 is quite a bit different than a situation in which the top 40 pulls away from the bottom 160, since relative deprivation is likely to be a bigger problem in the latter case.

More to the point, reflexive soak-the-rich tendencies among progressives are unjustified—the details and the facts matter, unless you simply are opposed to inequality regardless of whether it might help the bottom and middle.

Middle-class living standards next…

 
If there's one thing we know about the American economy, it's that inequality has sky-rocketed, right?  If there was ever any question, it appears to have been laid to rest by the widely-cited research of Thomas Piketty and Emmanuel Saez.  Piketty and Saez used IRS data to do what surveys cannot—measure the incomes of the richest of the rich.  Their finding that the share of income captured by the richest Americans has increased sharply since 1980 is cited all over the blogosphere (see, for instance, Paul Krugman's inaugural blog post) and throughout academia and the media.  The richest ten percent of taxpayers, for instance, received 33 percent of income in 1980 but 46 percent in 2007, and the share of the richest one percent grew from 8 to 18 percent.

But these figures exaggerate the rise in inequality.  How do I know?  Because Piketty and Saez, to their credit, have made their figures easily accessible for other researchers to examine, and several have used these figures to qualify the claims that Krugman and others make about rising inequality.  The problem is that these lines of inquiry have failed to be connected or put in the context of the latest inequality research.

Let's start by pointing out that the sharp apparent rise in income inequality that Piketty and Saez find is confined to households (tax returns, actually) in the top one-half of one percent.  The following chart, based on their spreadsheets, shows that the income share of the richest half-of-a-percent increased from 5.5 percent to 14.4 percent from 1980 to 2007.  In contrast, the income share of the second-richest half-of-a-percent increased only from 2.7 to 3.9 percent, and the income share of the next richest 4 percent increased from 13 percent to 15 percent.  The share of the next richest 5 percent was actually steady at 12 percent over the period.

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This fact deserves restating: even by the raw Piketty and Saez numbers, only the richest 5 percent of the richest ten percent of Americans saw disproportionately large income growth on a scale that is significant—folks who had the equivalent of $300,000 or more in today's dollars back in 1980 but who had over $600,000 in 2007.

Putting aside for another day the decline in inequality that occurred through the early 1970s, what is of interest here is the rise in inequality that accelerated after 1980.  The first thing to note about the post-1980 increase is the large jump from 1986 to 1988.  Piketty and Saez's IRS estimates are based on individual income tax returns, and they are therefore sensitive to tax law changes that affect what gets reported on these returns and when.  A long line of research notes that the Tax Reform Act of 1986, by lowering top marginal income tax rates below corporate tax rates caused a decline in income reported by "taxable corporations" (on corporate tax returns) and a corresponding rise in income reported by "Subchapter S" corporations (on individual income tax returns).  This represents pure and simple shifting of where large incomes are reported, from one type of tax form to another, but it shows up in the Piketty and Saez data as an increase in income concentration. 

This shift to S-Corporation income actually began in the early 1980s as a result of the Economic Recovery Tax Act of 1981, and it continued after 1988, a point made most cogently by Cato Institute senior fellow Alan Reynolds.  Reynolds, whose arguments on the nation's op-ed pages sometimes have the flavor of buckshot being fired out of a cannon, nonetheless has been unfairly dismissed by the left in his critique of inequality research.  In the following chart, I use Piketty and Saez's figures to illustrate a point Reynolds makes: that growth in the share of income reported by top filers has disproportionately consisted of growth in S-Corporation income (see the "entrepreneurial income" trend).

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Entrepreneurial income includes not only S-Corporation income but income from sole proprietorships and partnerships, however S-Corporation and partnership income were a negligible share of top incomes prior to 1982.  In order to obtain a consistent trend in inequality, these two sources of income (which shifted from being reported on corporate tax returns to individual income tax returns over time) must be removed after 1981.  I do so below using other spreadsheets from Saez.

The tax changes in the 1980s and 1990s probably had other important effects on how taxpayers reported income—and when.  Lowered income tax rates make it more likely that the very rich will take their compensation as taxable income rather than nontaxable fringe benefits and that they will take "nonqualified" stock options (reported on individual income tax returns) rather than incentive stock options (reported as capital gains and not included in the above figures).

It is unclear how much changing tax rates distort the trends shown in the figures above.  Several adjustments seem defensible.  Most importantly, the 1986 to 1988 increase likely represents a shift in the trend line due to greater reporting of income on individual tax returns that has no basis in actual inequality trends.  The United Kingdom, for instance, showed no such break, even though inequality was steadily rising.  In that case the pre-1988 trend line should be shifted upward, which I do using the 1987 to 1988 change in the Census Bureau's Current Population Survey (CPS), as reported by Richard Burkhauser and his colleagues.  As I will show below, the Burkhauser estimates track the IRS estimates quite well.  The only other adjustment I make concerns the spikes in 1990 and 1992.  These spikes are responses to tax changes in 1986 (the end of the three-year vesting period for nonqualified stock options taken in 1987 occurred in 1990) and anticipated changes in 1993 (the Clinton tax increase, fear of which led to more income reported in 1992 ahead of the hike).  I adjust those points downward based on what happened in Canada over the period, using additional data from Saez's website.

Doing so largely erases a discrepancy between the figures based on IRS data and those based on the CPS.  Burkhauser and his colleagues, using the CPS and correcting for the censoring of high incomes that the Census Bureau implements out of concern for survey respondents' privacy, recently tried to replicate Piketty and Saez's results.  They were able to closely match the trends from 1967 to 2006 for the four percent of households just below the richest one percent.  The same was true for the next richest five percent of households.  Only among the richest one percent were they unable to produce the same trend as Piketty and Saez.

My adjusted estimates, however, match up fairly well with Burkhauser's figures:
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When these same adjustments are made to the trend for the income share of the top one-half of one percent, the increase from 1980 to 2007 is from 6.1 to 10.9 percent—a 4.8-point increase over 27 years rather than the 8.9-point increase in the unadjusted data.  Finally, note that the post-1994 trend closely follows the ups and downs of the stock market.  That implies that in 2008 the income share of the top half-of-a-percent likely fell along with the stock market to around 9 percent—just a three-point increase since 1980.

The figures presented thus far do not include realized capital gains, public cash and in-kind transfers, employee health and retirement benefits, employee contributions to retirement plans, or taxes.  The Congressional Budget Office has their own income-share estimates based on IRS data and other sources that include all of these items.  The figure below adds the CBO trend to the previous chart.

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The share of the top one percent rises 8.6 points, from 7.7 to 16.3 percent.  The trend line follows the others reasonably closely with several exceptions.  The spike in 1986 reflects investors taking capital gains ahead of the tax increase on gains that went into effect in 1987 (which also depresses the 1987 data point).  The other notable departure from the other trend lines is that the rise and fall of the top share with the stock market after 1994 is even more dramatic due to the inclusion of capital gains.  The S&P 500 stood at its 2002 level at the end of 2008, implying that in 2008 the top 1 percent received about 11 to 12 percent of income.  Thus, its share grew about 4 points over 28 years.

What about other estimates of inequality?  The CPS indicates that the Gini coefficient—a continuous measure that is higher when top shares of income are larger—for household income increased by about 16 percent from 1980 to 2008.  Is that increase big or small?  For context, it is about the same as the rise in median household income over the period (14 percent).

Another way to measure inequality is to look at the ratio of income at one point in the distribution to income at another point in the distribution.  For example, the 90/10 ratio compares the income of the household at the 90th percentile—the one with income larger than 90 percent of all households—to the income of the household at the 10th percentile.  This ratio increased from about 9 to about 11 from 1980 to 2008.  The 80/50 ratio rose from 1.8 to 2.0, while the 50/20 ratio was 2.4 in both years.  In other words, the increase in inequality was about the rich getting richer and not about the poor getting poorer.  Indeed, consistent with the income share results, it was about the very rich getting richer—the 95/50 ratio rose from 2.9 to 3.6, a much bigger increase than for the 80/50 ratio.  If it were possible to construct a 99.5/50 ratio, the point would likely be even clearer.

There is one more final piece of evidence that implies that even the apparent increases in the 80/50 and 90/10 ratios is illusory and that incomes became significantly concentrated among the richest of the rich.  The CPS trends in the Gini coefficient and in the various ratios assume that the purchasing power of households has increased at the same rate for rich, middle-income, and poor households.  That is, they assume that all households experience the same cost-of-living changes.  A recent study, by Christian Broda and John Romalis, however, casts doubt on the validity of this assumption. 

Broda and Romalis used a massive private database of purchases involving bar-coded products to construct separate cost-of-living indexes for the poor, the middle class, and the rich.  They then adjusted incomes for inflation for these groups using the distinct indexes, rather than assuming that inflation has grown equally across income groups.  The result?  The cost of living has grown less for the poor than for the rich, and when this difference is taken into account, the 90/10, 90/50, and 50/10 ratios appear not to have grown in recent years (see Table 14A of their paper).  The data used in this study only go back to 1996 and only cover bar-coded purchases, but the authors provide reasons to think that the patterns they find extend to earlier years and other goods and services.  If they are right, then it would reinforce the income-share results finding that the growth in inequality has been confined to the richest of the rich.

Discussion of income inequality trends generally proceeds as if some sizable fraction of the population were getting richer (the top 10 percent, or the top 1 percent) while everyone else is getting poorer.  In reality, the "poorest" 90 percent of the top 10 percent—and even the "poorest" half of the top 1 percent—have not seen outsized income gains over the past 30 years.  It is only the top one-half-of-one-percent that has received a rapidly increasing share of income.  Furthermore, the increase in concentration at the very top has been smaller than the most-cited figures have implied.  For example, using a comprehensive measure of income, the top one percent probably received about 8 percent of income in 1980 and about 12 percent in 2008. 

Nor have the poor fallen behind the typical household.  Indeed, they may not even have fallen behind the 90th percentile.  If this finding holds up, then it would seem that resentment toward the top one-half-of-one-percent should have grown equally among households with contemporary incomes as high as half a million dollars and households below the poverty line.  Put another way, if rising inequality is unfair, then it may be that it has been as unfair for the 90th or 95th percentile as it has for the 10th percentile.

It is not immediately clear what to think about income concentration being confined to the very top.  Would it be worse if income were becoming increasingly concentrated in the top half of the distribution at the expense of the bottom half or if it were becoming increasingly concentrated in Bill and Melinda Gates's household at the expense of everyone else?  Does the answer change depending on whether the "losers" are experiencing strong income growth or not?  On some level, as long as incomes are rising for everyone, it matters little how much more the Gates's income is rising.  They cannot price others out of markets for goods and services by themselves.  On the other hand, if the top fifth of the income distribution is pulling away from the bottom 80 percent, then the consequences for those falling behind could be profound.  The top fifth might be able to sort themselves into the best neighborhoods with the best schools, and they might bid up the cost of higher education to the point where the best schools become unaffordable to most families.

The evidence indicates that patterns of inequality more closely resemble the Gates scenario than the bifurcation scenario.  It is unlikely that the rise in inequality, then, has had much practical impact on the quality of life of middle-income or poor Americans.  The exception would be if rising inequality had spawned competitive spending patterns to maintain relative standing in such a way that families end up worse off as a consequence of trying to keep up with the Joneses.  For now, however, this possibility remains largely untested.

Finally, the magnitude of the increase in inequality and its nature might be of little practical importance even as the level of inequality has deleterious effects.  In other words, what may be relevant is that the top ten percent has received at least a third of all income in every year since 1980, not that it increased from a third to nearly half by 2007.  But if that were the case, it would have different implications for American society, politics, and economics than if growing inequality is a trend to be viewed with alarm.  Indeed, we would be in worse trouble if the levels of inequality prior to the run-up of recent decades were as consequential as the level we have today, for we are unlikely to ever see inequality levels so low in the foreseeable future.