To measure income inequality, one must first ask what one is looking for. Income might be pre-tax earnings, or it might be take-home pay after taxes. Pre-tax income provides a better measure of overall changes in the economy; post-tax income provides a better measure of the effect of the government’s tax and welfare policies. Taking it a step further to include the government’s entire safety net would have one include non-cash, in-kind government transfers, such as food stamps, school lunches, and subsidized housing.
All of these measures are of interest. We’d like to know whether recent changes in the economy have increased income inequality, and we’d also like to know what the government has done about it through its tax and welfare policies. For the moment what I want to know is whether current economic trends, excluding taxes and government safety nets, can explain the rise of inequality. I’ll subsequently look at what the government has done to adjust for this through its tax policies and welfare benefits.
Measuring Pre-tax Earnings
Pre-tax income might be raw income, one’s salary before taxes (including business income from partnerships and pass-through S corporations). Then there are capital gains, the benefit derived from the appreciation of one’s assets. Capital gains in turn might either be realized (where an asset is sold above cost during a fiscal year) or unrealized (where the asset isn’t sold but has simply appreciated in value).
It’s not really possible to measure pre-tax income shorn of how it’s affected by government policies. When marginal tax rates are higher than 90 percent, as they were in the 1950s, the very rich are going to slack off and earn less, or at least report less income on their tax returns.
Have we seen a run-up in pre-tax income inequality, then? The short answer is yes, at the very top end. If income were equally divided across households and we all earned the same, the top 5 percent of earners would get 5 percent of the country’s income. That’s never been the case, however, and especially today. Between 1968 and 2011, the top 5 percent’s share rose from 16.3 to 22.3 percent.4 That’s quite striking, but when Thomas Piketty and Emmanuel Saez looked more closely at the data they found that the strongest sense of inequality comes from the wealthiest million-plus American households, the much-reviled one percent who earned more than $394,000 in 2012.5 That’s an average Wall Street salary, more than what federal judges and 90 percent of law firm partners make. It’s also more than the average salary of a doctor with a medical specialty. As seen in Figure 4.1, the one percent take home about 17 percent of everyone’s earnings, and 20 percent when realized capital gains are included.
FIGURE 4.1
The One Percent’s Share of Total U.S. Family Pre-tax Income, 1913 to 2009
SOURCE: Facundo Alvaredo, Anthony B. Atkinson, Thomas Piketty, and Emmanuel Saez, The World Top Incomes Database, at http://topincomes.g-mond.parisschoolofeconomics.eu/.
Even amongst the one percent, there are enormous income disparities between the 1.35 million households earning $394,000 or more and the 135,000 households earning $1.6 million or more a year. The latter are the 0.1 percent. They include professionals at the top of their field, business executives, and your average NHL hockey player. The one percent earned 20 percent of the country’s household income, but of that nearly half went to 0.1 percent. Then there’s the 0.01 percent, who make more than $5.5 million a year, 100 times more than the median American (at the midpoint of the distribution). There are 13,000 of them, and they include finance executives, asset managers, and your average New York Yankee ballplayer. Together, they walked off with 4.5 percent of the household income of all Americans.
It wasn’t always been like this, and Figure 4.1 portrays the roller-coaster the one percent have been on. The Roaring Twenties were a great time for them, one of instant millionaires and of Great Gatsbys who rose from obscurity to riches. Beginning with the Great Depression and the New Deal, however, their share of the income stream fell by more than half, only to rise again after 1980 and return to heights not seen in 60 years. The 1950s and 1960s were a halcyon period of relative income equality, interposed between the bookends that preceded and followed them, with the one percent’s share increasing from 10 to 20 percent of the national income over the last 30 years.
By itself this might explain why income inequality became a hot issue in 2012, but that wasn’t the half of it. It wasn’t simply that the one percent became wealthier—it’s that no one else seemed to move up very much, even after progressive taxes meant to shift wealth from the rich to the poor. The non-partisan and highly-respected Congressional Budget Office (CBO) reports that the top one percent enjoyed real after-tax income gains (including realized capital gains) of 275 percent over 1979–2007. The 81st to the 99th centile gained only 65 percent, and Americans in the middle of the distribution at the 21st to the 80th centile gained only 37 percent. For the 20 percent of Americans in the lowest quintile, the increase was only 18 percent.6
More recently, the wealth gap became greater still. After the Great Recession of 2007, the one percent took a hit. Much of their earnings come in the form of realized capital gains, which shrank because of the decline in share prices. Nevertheless, over 1993–2011 they enjoyed real pre-tax income gains of 57.5 percent, ten times more than the 5.8 percent of the bottom 99 percent.7 The one percent fared even better over 2009–11, when all the income gains went to them. Their income grew by 11.2 percent while that of the remaining 99 percent fell by 0.4 percent.8
Apart from inequalities in income streams, there are stark differences in American wealth holdings. Thomas Piketty estimates that the top ten percent of wealth holders own more than 70 percent of the country’s assets, and that the top one percent hold more than 30 percent.9 That’s down from Gilded Age heights of 1910 (80 percent for the top ten percent, 45 percent for the top one percent), but it’s still a remarkably unequal split in wealth.10
The American middle class has been hardest hit in all of this. The very rich are doing well, and the poorest Americans are propped up by a generous welfare system as we’ll see in Chapter 11. At the bottom end of the income distribution, people are also finding jobs. It’s the jobs in the middle that have cratered, a phenomenon economists call “jobs polarization.” Highly paid jobs have expanded, but then so too have poorly paid, low-skilled jobs.11 We’re talking about hands-on jobs such as food service workers, janitors and gardeners, cleaners, home health aides, hairdressers and beauticians. They don’t require a high degree of education, they’re not unionized, and they won’t make you rich, but the jobs are there. It’s all very well to be in the one percent, but one still needs people to mow the lawns and mop the floors, and that’s not going to be done by computers or machines. What we haven’t seen, however, is job growth for the kinds of people whose high school diploma used to get them a decently paying factory job.12
Today, America has the smallest middle class in the First World, defined as households with an income between 75 and 150 percent of the country’s median (midpoint) income. Only 38.6 percent of Americans are in that category, fewer than in Sweden (59.7%), Canada (46.2%), Britain (45%), and all of the twenty-four other First World nations surveyed.13 There’s also been a shift of wealth to the very rich in all advanced economies, as seen in