Thursday, October 21, 2010

Explaining Income Inequality

Click to enlarge.

There's a lot of discussion on the topic "income inequality," especially concerns about "increasing income inequality" (223,000 Google hits) and "rising income inequality" (432,000 Google hits).  There's apparently not as much discussion on "explaining income inequality" (18,800 Google hits), a topic this post addresses. 

The chart above (click to enlarge) shows selected characteristics of U.S. households by income quintiles (and the top 5%) for 2009, using data from the Census Bureau (here and here). Here is a summary of some of the differences between low-income and high-income households in America:

1. On average, there are more income earners per household in highest-income households (2.05 earners for the top fifth) than earners in the lowest-income households (0.48 for the lowest fifth).

2. Married-couple families represent a much greater share of the top income quintile households (79%) than lowest quintile households (18%).

3. More than 3 out of 4 households in the top fifth of households are in their prime earning years between 35-64 years old, compared to only 43% of households in the bottom fifth. The lowest quintile households are more than 1.5 times as likely to be younger (under 35 years) as the highest quintile households (23.4% to 14.8%), and more than three times as likely to be old (65 years and over) as the top fifth (33.3% vs. 9.9%).

4. Almost 4 times as many top quintile households are working full-time (78%) compared to the bottom quintile (20.8%), and more than five times as many households in the bottom quintile are not working (65%) as households in the top quintile (12.2%).

5. Households in the top quintile are almost seven times more likely to have a college degree than bottom quintile households (72.8% vs. 10.8%). 

Bottom Line: The highest-income quintile has four times more people working per household than the lowest quintile (2.08 earners vs. 0.48), and individuals in those households are far more likely to be well-educated, married and working full-time in their prime earning years.  In contrast, those individuals with low incomes are far more likely to be less-educated and working part-time, and either very young or very old living in single-parent households.  Given these significant differences in household characteristics, it's not too surprising that there are huge differences in incomes among American households.  It's also very likely that those individuals in the highest quintile were once in the lower quintiles before they acquired job experience and education, and they'll likely be in a lower quintile again when they retire.  

Understanding the factors explaining income inequality would also help explain why income inequality changes over time.  For example, compared to previous years, in 2009 there were both: a) more single-parent households, and b) more married, dual-earner households, following trends going back to the 1960s, and both of those trends would explain rising income inequality over time.

Thanks to Diana Furchtgott-Roth for the idea.

16 Comments:

At 10/21/2010 9:49 PM, Blogger morganovich said...

one other thing to consider is that income is not the same as lifestyle.

if you earn well and save a lot then retire on low income, you can still live very well.

income in a given year is not necessarily the whole picture.

 
At 10/22/2010 5:23 AM, Blogger juandos said...

"if you earn well and save a lot then retire on low income, you can still live very well"...

So one would think if all things were equal...

Wouldn't national debt and Fed QE games devalue savings portion though though?

 
At 10/22/2010 8:19 AM, Blogger morganovich said...

juandos-

yes, it would. that is a big part of why it's such a bad idea.

 
At 10/22/2010 9:51 AM, Blogger Ironman said...

Mark,

It's very possible that large demographic shifts account for nearly all of the observed increase in so-called income inequality.

We can actually show that's the case. First, here's a graph showing the number of births in the U.S. since 1909, which also indicates generational membership (aka "baby boomers, Generation X, etc.)

Next, here are lifetime income trajectories by education level in the U.S. For all groups combined, peak income earnings occurs between Ages 45 and 54.

Now, here's the thought experiment that applies to today's perceived problem with "rising" income inequality. What happens to income inequality when:

A. The very large baby boom generation has entirely entered its peak earning years, with the "leading" members just beginning to exit the workforce through retirement. So we have lots of people making the top incomes of their lives.

B. The very large Generation Y is still entering the U.S. workforce. So we have lots of people making the lowest incomes they'll see during their lives.

C. The much smaller Generation X falls in between, whose numbers are much, much less than either the preceding baby boom generation or the following Generation Y. So there are much fewer people in the middle earning middle-level incomes (today).

The answer is that an increase in measured income inequality is all but assured, due only to these generational changes taking place in the U.S. workforce. I strongly suspect that if you had a measure of income inequality that controlled for major demographic changes like these, it's unlikely you would see any meaningful change.

 
At 10/22/2010 9:55 AM, Blogger geoih said...

You mean if people work more, have more skills, and have more experience, they make more money? I would have never guessed that.

 
At 10/22/2010 10:16 AM, Blogger Jason said...

All great points. While I think that discussions over income inequality are misguided, the big discussion though is over how the incomes of the top quintile are growing so fast while the middle quintiles are not. Conservatives should be most concerned about this trend because it could imply that conservative principles are not working. In fact, many conservative thinkers (i.e. Alan Greenspan) are starting to address this.

 
At 10/22/2010 10:23 AM, Blogger morganovich said...

ironman-

that is a REALLY interesting analysis.

thanks.

i suspect that that demographic barbelling is being pushed even further by the economic downturn - the ones who get hit hardest as those on the lower rungs with fewer indispensable skills and the higher unemployment rates that comes with them.

 
At 10/22/2010 10:50 AM, Blogger Buddy R Pacifico said...

Prof. Perry, Very interesting and informative chart.

Maybe Ironman or someone else knows if virtually all wage earners in the lowest and second fifths (40%) pay no fed income taxes at all.

Upward mobility is obviously much more likely for those who get and stay married and have the kids after college or trade school.

 
At 10/22/2010 11:52 AM, Blogger Tom said...

The real income hog in society is not the rich but big government, now consuming 63% of our GDP, according to Americans for Tax Reform. If we cut government in half, we'd double the income available. We're Europe now.

One big problem with "income disparity" figures is they don't count welfare payments as a plus, nor taxes paid as a minus. They hide the massive exchange of money created by ... big government.

Income disparity figures are lies, basically.

 
At 10/22/2010 12:19 PM, Blogger randian said...

Conservatives should be most concerned about this trend because it could imply that conservative principles are not working

When did slapping down the successful become a conservative principle?

 
At 10/22/2010 11:55 PM, Blogger Mr. Whippet said...

This comment has been removed by the author.

 
At 10/22/2010 11:55 PM, Blogger Mr. Whippet said...

The only figure in this chart that has any significance is the 5% number - 307 million population - not all of working age obviously - but 5% of that is roughly 15 million - they can't spend enough to grow an economy that could achieve near full employment. All the wealth creating vehicles - cash, stocks, bonds, real estate - are in the hands of relatively few people - those with the capital are capitalizing on those without - it takes money to make money - what you have here is a vicious circle of poverty that you are hoping can be written off to education and marital status.

 
At 10/23/2010 9:43 AM, Blogger Thomas said...

Several factors should/could be used that would ameliorate the "disparity", divide the household income by # of earners (evaluate earners as individuals rather than life style choice), and deduct the taxes paid and add the welfare/tax rebates received for each earner as suggested in earlier post

 
At 10/23/2010 10:55 AM, Blogger Deborah said...

There is no question that that these three things are important to overall economic health of a household, but it is fallacy to say that this explains the growing income inequality.

I merely have to look to my youth and how youth have it today to see the gross income inequality of today's youth compared to what it was like when I was young.

I am an education and many times I have done this example with my students. In 1980 I earned $7/hour at age 18 working in bank doing clerical and customer service work. Tuition at Simon Fraser University was $18/credit hour. It is now about $200/credit hour. I say to my students, (7/18)*200 = $73/hour. I was considered a low income earner yet my relative buying power towards university was about $70/hour compared to the costs today. Additionally, the number of new fees and unnecessary fees students are charged these days is unreal.

These three things do not explain all of the growing income inequality. The gross redistribution of wealth is also an strong contributing factor, as is the ability to make the choices I had in my youth.

Also, this data does not incorporate the long term outcome of what is happening to today's youth coming out of university with debt loads approaching what the youth of my day had in mortgage.

 
At 10/23/2010 12:36 PM, Blogger randian said...

Inflation in university tuition isn't a reflection of your earning power. That is, you didn't get poorer. What happened is that both the cost and price of universities have greatly outpaced inflation over your lifetime, owing to the fact that they are basically units of the government and have no market constraints on their costs.

 
At 10/23/2010 7:15 PM, Blogger Ron H. said...

"?I am an education and many times I have done this example with my students. In 1980 I earned $7/hour at age 18 working in bank doing clerical and customer work."

Deborah, What possible lesson are you providing your students with that irrelevant anecdote about the higher cost of education? There's no question that the cost of education has increased over time much more than almost anything else. I would expect that after you give this little lesson in how gloomy their future looks, your students will ask: "So what, Teach, what does this little story have to do with me or the real world?"

By the way, if you earned $7/hr in 1980, you were making the medium income. Not bad for a newly hired 18 year old. Why do you consider that low?

I'm not sure what your point is, but it doesn't seem to relate to income inequality as described in this post.

You didn't indicate what subject you teach, but hopefully your students are later exposed to someone who has a better grasp of economics.

 

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