Friday, October 14, 2011

Some observations about declining incomes and rising income inequality

There have been many reports in recent weeks regarding declining incomes as well as rising income inequality.  For example, a report by Sentier Research shows the behavior of median real household income since 2000:

The significant drop since the end of the recession reveals the continuing effects of the Great Recession.  Why did it spike midway through the recession?  One reason was that there was deflation and the figures are inflation-adjusted (so deflation pushes real income up).

What about the distribution of income?  Menzie Chen (Econbrowser) provides a chart showing changes in the income share of the top 5% and top 1% of earners during the last century (based on data from Saez/Piketty). 

The peak in the income shares for both groups occurred immediately prior to the Great Depression, declined until about 1950 and then remained relatively flat until 1980.  They rose slightly until the mid-1980s before spiking up in the late 1980s, following the tax reform act of 1986, before leveling out for a few years.  They began a steady climb up beginning in 1993 until 2000, declined during the early 2000s before rising again.  Why did the income share of the top earners rise so much in recent decades?  Looking at the data (see table 7 from Saez/Piketty) , a major reason is the increasing role of entrepreneurial income in the earnings of top earners, rising from about 10% in the late 1970s to mid 1980s, to over 30% in recent years (entrepreneurial income includes profits from S-corporations, partnerships, and sole proprietorships).

Menzie Chen also provides a chart that illustrates estimates of changes in the distribution of wealth

Similar to income, the share of wealth of the top 1% peaked right before the Great Depression and declined until about 1950.  It stabilized for a period of time before beginning a new decline in the mid-1960s until 1980.  Though it rose in the early 1980s, it was relatively stable from 1985 to 2000 before rising again in the mid-2000s.  Wealth does not show as much of a rise in inequality as income (though wealth inequality appears to have risen somewhat in recent years).

A major increase in inequality is a serious concern, particularly during times of decling real incomes.  However, it's important to explore the sources of inequality as well as the costs/benefits of policies designed to address poverty or inequality.