As if ordered up directly by the Obama White House and Occupy Wall Street, the Congressional Budget Office has produced a timely report looking at income inequality. The CBO found that between between 1979 and 2007, average real after-tax household income grew by 275 percent for the top 1 percent of households, 65 percent for the next 19 percent, just under 40 percent for the next 60 percent, and 18 percent for the bottom 20 percent.
Blogger Derek Thompson of TheAtlantic.com, always worth reading, draws this conclusion from the CBO study:
This is complicated stuff, and I’d be lying to you if I said I understood all of it. But let’s all agree about square one. Income inequality is not a myth, so what do we think we should do about it? If we can’t agree on the question, we’ll never find an answer.
Like Obama and OWS, Thompson is worried. I am far less so. Here’s why:
1. Liberals frequently claim the average American family has been losing ground for the past three decades—or at least since Ronald Reagan took the presidential oath in January 1981. (As if the 1970s with its sky-high Misery Index was a great economic time.) The CBO refutes this. Its data show real median after-tax household income (half of all households have income below the median, and half have income above it) grew by 35 percent over the past three decades.
Indeed, look at this chart from Jim Sullivan of Notre Dame and and Bruce Meyer of the University of Chicago (via recent presentation at AEI):
2. The CBO fails to factor in that American households in the top income quintile have, on average, almost five times more family members working than the lowest quintile. (Analysis by AEI blogger Mark Perry.) Those folks are also far more likely, as Perry notes, than lower-income households to be well-educated, married, and working full-time in their prime earning years. Perry also notes that “individuals are not stuck forever in a single income quintile but instead move up and down the income quintiles over their lifetimes.” (Indeed, a Treasury study on income mobility found that starting in 1996, half of taxpayers who started in the bottom 20 percent had moved to a higher income group by 2005.)
3. Price indexes for the poor rise more slowly than for the rich, causing most empirical measures of inequality to overstate the growth of real income of the rich vs. the poor.
4. Apples-and-oranges kinds of issues—such a differences in household size and inflation indexes—has led highly respected Northwestern University professor Robert Gordon to conclude that the “rise in American inequality has been exaggerated both in magnitude and timing.”
5. The Minneapolis Federal Reserve concluded—after taking into account household size and differing price indexes—median household income for most household types increased by 44 percent to 62 percent from 1976 to 2006. In addition, its research shows that median hourly wages (including fringe benefits) rose by 28 percent from 1975 to 2005.
6. As technological change accelerates and becomes more pervasive, the market will reward workers with more education and skills. As CBO notes: “Numerous researchers have concluded that, on balance, the technological changes of the past several decades—and perhaps the entire past century—increased employers’ demand for workers with higher skills and more education. That increase, along with a smaller increase in the supply of workers with higher skills and more education, generated substantial gains in the relative wages of more-educated worker. In the past decades, inequality has been going up everywhere.” It is a global phenomenon.
7. And why did the top 1 percent do particularly well? One potential explanation from CBO: “The compensation of ‘superstars’ (such as actors, athletes, and musicians) may be especially sensitive to technological changes. Unique characteristics of that labor market mean that technical innovations, such as cheap mass media, have made it possible for entertainers to reach much wider audiences. That increased exposure, in turn, has led to a manyfold increase in income for such people.” The CBO also mentioned “changes in the governance and structure of executive compensation, increases in firms’ size and complexity, and the increasing scale of financial-sector activities” as possibilities.
My bottom line: a) income inequality has increased somewhat in recent decades, but not exploded; b) that increase is natural given technology and globalization; c) incomes could have risen faster with a better educated workforce (that also didn’t have to compete with an influx of workers from Asia), but did O.K.; d) we need to boost education to keep up with advancing technology and productivity; e) the past decade was one of slow growth followed by a nasty recession. No argument there. Looking forward, America will need a pro-growth tax system, smarter regulation and far better human capital (helped by higher teacher pay in exchange for eliminating tenure, more skilled immigration, etc.). That way, incomes won’t just be more equal, they’ll be growing.