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American Households have not Stagnated

e21 | July 23, 2010
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Karl Smith at Modeled Behavior points out an interesting paradox. The incomes for workers in the middle quintiles of the income distribution appear to be relatively stagnant while the incomes for those at the very top are rising at about the rate of GDP. So if the wealthiest are only growing at the rate of the economy, and poorer workers are stagnating – where is that additional income generated by the economy going? A puzzling question when one assumes that based on those figures, surely workers in general, must be doing about as well as the economy.

This is a puzzle that Terry Fitzgerald at the Minneapolis Fed has explored in considerable detail. Here are some differing charts that illustrate the problem:

Chart 1 - Median Household Income Stagnates ...... While Per Person Income Rises

As mentioned earlier, this missing income cannot be disproportionately going to the rich, since their income growth appears to be no greater than that of the economy as a whole.

These two charts vary greatly and seem to show two very different pictures of American households. Chart 1, which many progressives prefer, shows families struggling to raise their incomes over a long period of time – basically stagnating. Chart 2, preferred by fans of economic liberty, shows steadily rising living standards over time.

So who is right? Fitzgerald digs in further and finds that these two charts are using information based on different data sources. Properly computed, American households are actually doing rather well. They look more like Chart 2 than Chart 1.

There are several sources of this discrepancy:

1. Inflation. The price indices used to compute per capita income are different from those designed to compute median household income. The price indices typically used for household income (Chart 1) are taken from a composite of sources, some of which take into account the prices faced by wage earners. The price index for national labor surveys (Chart 2) on the other hand, corrects prices on the basis of personal expenditures – the basket of goods consumed every year. These different series have different measures of inflation, and so result in different estimates of real income. A true apples-to-apples comparison results in a closer match between these two graphs, favoring the depiction in Chart 2.

2. Fringe benefits. Employers are increasingly likely to compensate workers in the form of fringe benefits, rather than cash income. In part, this is because certain fringe benefits, like employee-provided health insurance, are exempt from taxes. Estimates of household income do not take these into account, while they are an important part of the economy.

This is an important adjustment to consider, because we are frequently concerned with the overall quality of life for households, rather than the mechanism by which they consume goods.

Simply taking the first two points into account (using a common price index and counting fringe benefits) results in compensation that has grown 28% from 1976 to 2006 for the median worker, rather than stagnating.

3. Changing Composition of Households. Fewer people live in each household today than they did thirty years ago, and so gains in household income are divided against a greater number of households. While 64% of households consisted of married couples in 1976, this was true of only 51% of households in 2006.

Fitzgerald finds that every household type had large gains in income growth – gains obscured due to the changing composition of households. Married couples saw household income gains of 42% from 1976 to 2006, while single-female residences saw gains of 56%.

To be sure, inequality may account for some of the difference between household income and aggregate income. Fitzgerald estimates that Census income per person grew by 65%, while median income per person grew by around 50%. The remaining difference may be accounted for by a rise in inequality. But the important point is that households are not stagnating in the aggregate. America’s phenomenal productivity gains have reached its households.

In fact, these figures actually understate the welfare gains households have experienced in the past thirty years. Virtually every consumer product has improved dramatically in quality, and entire new industries have expanded the consumption opportunities available to households and individuals.

These are important facts to bear in mind when hearing political rhetoric that focuses on inequality and stagnation. In today’s tough economic times, this is a popular message. But it does not characterize the experience of most households. Policies that attack the wealth-generating abilities of the American economy will hurt, rather than help, those same households over the next thirty years.