Per capita GDP in the US grew 118 percent over the past 43 years. At the bottom 25th percentile, real income for full-time, full-year, prime age workers only rose 13.5 percent; at the top 99th percentile, it grew by 166 percent and the top 1 percent grew 322 percent. A new RAND Corporation study on inequality finds that if incomes were as equitably distributed today as they had been in 1975, the share of annual income taken home by the bottom 90 percent of Americans workers would have been higher by 17 percentage points—$2.5 trillion.

Income inequality is an aspect of economics that resonates with many Americans: It feels like the rich are getting richer, while the rest are having a hard time just getting by. But is it truly getting worse? Calculating this has proven both challenging—and divisive—for economists.

In our new working paper, we enter the fray with an analysis that asks: What would income distribution look like today if incomes grew apace with the economy?

For the period after World War II, we find, incomes and the economy have similar growth rates. Then, starting around 1975, incomes for the bottom 90 percent of individuals grow more slowly than the economy as a whole as incomes for the top 10 percent grow faster. Had the bottom 90 percent kept up with GDP growth, they’d have collectively taken home $2.5 trillion more in income in 2018.

To estimate this, we examine total taxable income (earned income from job, business, or farm, plus the income from interest, rent, and dividends) as measured by the 1976-2019 Current Population Survey (CPS) Annual Social and Economic Supplement (ASEC). We ignore post-tax transfers. We use the personal consumption expenditure (PCE) price index to put income from earlier periods in today’s dollars. And because the CPS doesn’t publish specific incomes above a certain level (for privacy and accuracy reasons, a practice referred to as top-coding) we propose a new method for estimating income above the top one percent.

It is important to enumerate these definitional choices because one part of what makes income inequality research so divisive is just how many such decisions must be made—what is included in income, whose income is measured, how it is adjusted, and more. There are also nontrivial measurement challenges. Most researchers have access only to public data sets, which do not include estimates of taxes or enumerate income above a certain amount.

Overlying all those technical issues is a conceptual one: What should the distribution of income in the US look like? Some ideal is assumed (implicitly or explicitly) by the points of comparison chosen.

The conceptual framework in our paper is income growth. This measures not only the income gap between the top and bottom earners, but also the difference between how fast incomes at the top and bottom are growing. As our comparison point, we use economic growth, measured through per capita GDP. In other words, as the economy grew from 1947 to 2018, did that tide continually lift all—or even most—boats?

As shown in Figure 1, the thirty years after World War II resemble a “picket fence” of relatively similar growth rates across business cycles for rich and poor alike. After 1975, that is replaced by “hills” in which income growth increases with income. In the 2001-2007 business cycle, income hardly increases for any group, if it does at all.

income growth
Figure 1: Growth in Annualized, Real Family Pre-tax, Pre-transfer Income by Quantile. Source: Authors’ calculations from US Census Bureau, Current Population Survey Annual Social and Economic Supplements, Tables F-2 and F-7; and Bureau of Economic Analysis, National Income Product Accounts.

We develop a measure, which we call omega, that is the difference between two growth rates: the observed rate and a target rate. Although we chose per capita GDP for our target rate, it could be anything—the growth rate of consumer prices, for instance, or health care prices, or the income growth of a specific group (say, the top one percent). Constructing omega allows for a quick way to compare various groups’ income growth rates relative to a target. It also allows construction of counterfactual income, what income would have been had the observed rate matched the target rate.

In some ways, per capita GDP is not an ideal target rate. To start, it includes capital depreciation but excludes non-wage compensation (like health insurance), both of which become a larger issue starting around 1975. Arguably, the former would overestimate growth in the economy and the latter would underestimate growth in income. These are fair objections. Yet, per capita GDP is economically meaningful as a benchmark. It was also broadly achieved for three decades following World War II by the bottom 90 percent, and is still being achieved by the top five percent today.

Read the rest of Kathryn A. Edwards and Carter C. Price’s article here at ProMarket