Thursday, October 27, 2011

Income Inequality in America - The 1 percent control 17 percent

The Congressional Budget Office (CBO) has released its study that examined the distribution of real household incomes of Americans and how that distribution changed or dispersed over the period from 1979 to 2007.  The study, entitled "Trends in the Distribution of Household Income Between 1979 and 2007" was undertaken at the request of the Chairman of the Senate Committee on Finance and looks at the distribution of household incomes before and after government taxes and breaks income down into its components including wages, capital income and business income (i.e. farms, partnerships etcetera).  Since the authors of the study used Census Bureau data, they could not go back past 1979 since income measures prior to that time were less consistent.  Let's get right into the study.

The CBO found that, over the past 30 years, both mean and median real (corrected for inflation) after-tax household incomes have risen as shown on this graph:

That should surprise no one.  Real mean income rose by 62 percent between 1979 and 2007 and median income (half of all households have more or less household income than the median) rose by 35 percent.  Since mean (or average) income can be influenced greatly by very high income households, the growing gap between median and mean suggests that households with incomes well above the median were growing more rapidly.  The uneven growth in after-tax income can also be explained by a rapid rise in income for the highest income households, very modest income growth for the middle 60 percent of the population and a very small increase in income for the bottom 20 percent of Americans. 

Here is a graph showing the cumulative growth in average after-tax income for the entire population divided into percentiles:

Note that the shaded areas represent economic recessions.  This graph shows that the distribution of household income in the United States became increasingly dispersed, that is, the share of income going to higher income households increased whereas the share of income to lower income households decreased.  This dispersion has risen pretty much continuously since 1979 with the exception of periods of recession.  Let's break the income groups down:

1.) Top 1 percent: After-tax real household income for the top 1 percent of Americans rose by 275 percent over the three decades.  Note that the incomes for the top 1 percent are quite volatile when compared to times of recession; during the recession in 2001, incomes dropped markedly but regained all of their losses and rose by more than 85 percent between 2002 and 2007. 

2.) Middle 60 percent (or 21st to 80th percentile): After-tax real household income grew by 37 percent between 1979 and 2007 with a very slow and steady rise over the entire period.

3.) Lowest 20 percent (1st to 20th percentiles or lowest quintile): After-tax real household income grew by only 18 percent over the three decade period with a large drop following the 1980 and 1981 to 1982 recessions where income dropped and did not recover until 1995.

Note as well that even the top quintile (81st to 99th percentile) of earners did not see a large increase in household income during the three decade period noting an increase of roughly 60 percent, well below what was experienced by the top 1 percent.

All of this adds up to a shift in the share of income received by each of the population groups.  The total share of after-tax income received by the 1 percent doubled over the three decade period, rising from 8 percent of the total to 17 percent of the total.  The share received by the highest quintile (excluding the 1 percent) rose only slightly from 35 to 36 percent.  The share received by the 60 percent "middle Americans" fell by 7 percentage points from 50 percent to 42 percent.  The share of after-tax income received by the lowest quintile fell from 7 percent to 5 percent over the three decade period.  Looking back, in 1979, the top 1 percent received roughly the same share of income as the lowest quintile; by 2007, the top 1 percent received that same share of income as the lowest two income quintiles combined (the lowest 40 percent of the population).  Here is a graph showing the changing share of the nation's income over the three decade period for each of the income groups discussed above:

As I discussed in a previous posting, the Gini index can be used to measure this phenomenon.  The Gini index is based on the relationship between the share of income and the share of population and has a range of values between 0 and 1.  Where the Gini index is 1, one household would receive all of the country's income.  Where the Gini index is 0, all of the households in a country would have equal incomes.  Where the Gini index increases over time, it is showing that household incomes are becoming increasingly unequal.  In the case of the United States, the Gini index was 0.479 in 1979; this rose to 0.590 in 2007 with the greatest increases in inequality between the years 2002 and 2005.  This means that 55 percent of America's income would have to be redistributed for perfect income equality.  The authors of the paper feel that this change is, in large part, related to the volatile nature of income from capital gains.  That said, income from capital gains tends to be greatest in high income households (think CEOs and their stock options).  Here is a graph showing that the highest income households (the smallest portion of the population) have the most fun collecting capital gains from the stock market:

Please note that the line of equality shows what the distribution of capital gains would be among the population if all income groups had equal incomes.  In the years between 2002 and 2007, more than 80 percent of the increase in the Gini index was derived from increases in income sourced from capital gains.

Why did income inequality grow over the past three decades?  The authors of the paper note that the technological changes of the past 30 years have necessitated the hiring of an increasingly skilled labour force which demanded higher wages.  Hourly wages for higher income workers rose at a faster rate than those for lower income, less skilled labourers.  While that is an interesting observation, the greatest portion of the most highly skilled workers reside in the top quintile, not the top 1 percent.  That tends to be the habitat of those who dwell in the corner offices on the top floor of Corporate America's headquarters.  As shown in this graph from our friends at the Institute for Policy Studies, the compensation packages for America's CEOs have risen at a rate that far exceeds the rate of income growth for their workers:

Keep in mind that in the 1970s, very few CEOs made 30 times more than their average worker.  That phenomenon definitely explains at least some of the increase in inequality.  The same could be said for many of America's non-CEO executives who have also been increasingly well compensated for their efforts.  One need look no further than the proxy statements for many American corporations to see just how out of line named executive officer compensation has become.  For example, think of the compensation paid to bank executive teams just prior to the Great Recession; multi-million bonuses and extremely rich stock options were far from a rare commodity on Wall Street.  In fact, executives, managers, supervisors and financial professionals accounted for 60 percent of the increase in income accruing to the top 1 percent between 1979 and 2005!

I think that's enough for this posting.  It is no wonder that there is growing anger across America.  What we suspected all along is, in fact, true.  Those of us who break a sweat while we work are, in large part, working to enrich the elite of America.  Unfortunately, it is the elite that have Washington's ear and they seem to be listening.

1 comment:

  1. Is there a relationship between CEO pay and the size of their responsibility, whether measured as gross revenue or corporate value. Are the companies these CEOs in charge of 10 or 20 times larger than they were 40 years ago? Just asking. There appears to be no relation between CEO pay and performance and certainly it isn't competition that is chasing there price up. the boards are incestuous is all.