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What Has Happened to the Incomes of the Middle Class and Poor? Part 1

September 17, 2013

By Scott Winship

This article is part of a four part series "What Has Happened to the Incomes of the Middle Class and Poor?"

Part One: Incomes Over the Recession and Recovery

New income figures released by the Census Bureau today will inspire a wave of commentary about the sluggishness of the recovery and the decline in living standards that started with the recession. Going further back in time, many analysts will note that incomes remain below their peak from the late 1990s, lamenting the "lost decade" of the aughts. And looking back even further, some will decry the minimal growth in incomes since the 1960s or 1970s.

These assessments will seriously underestimate the strength and steadiness of income growth experienced not only by the middle class but by the poor. The current essay is the first in a series intended to better understand what has happened to household income over the short- and long-run. It covers the recession and recovery, the worst period for household income growth in fifty years according to official figures. Subsequent essays will cover the "lost decade" and longer-term trends in household income.

Today’s Census Bureau figures are the latest in a series of releases from several sources that provide an updated picture of income trends. Earlier this month, economist and inequality expert Emmanuel Saez published new income estimates based on tax returns, updating figures he and Thomas Piketty have compiled through 2012. Another update that bears on income trends is the comprehensive revision to the national income and product accounts, which occurred this summer. That revision improved the estimates of inflation as measured by the personal consumption expenditures (or PCE) deflator. Most experts believe that this measure is the best indicator of cost-of-living changes experienced by American households, and it is the one favored by the Federal Reserve Board and the Congressional Budget Office. (The Bureau of Labor Statistics and Census Bureau use a different measure but have been developing a new one available back to 1999. It tracks the PCE deflator remarkably closely.) All of the estimates I provide below, unless otherwise indicated, use the new PCE deflator.

To provide some necessary background, the official household income definition used by the Census Bureau is called "money income". It aggregates the incomes of all people living together in the same housing unit. Money income comes from two broad sources—the market and the government. Market income is comprised of cash income received in the private economy—mostly earnings, retirement benefits, investment income, and money from friends and family.* Government cash benefits include Social Security, unemployment benefits, workers’ compensation, welfare and Supplemental Security Income, educational assistance, payments to veterans, and public employee pensions. Noncash benefits are not included, which means that money income does not reflect the value of food stamps, Medicaid and Medicare, housing subsidies, or free or reduced-price school lunches and breakfasts. Nor does it include employer fringe benefits like health insurance or retirement contributions. Finally, money income is a "pre-tax" measure—it does not reflect the disposable incomes of households because most people pay taxes on at least some of their money income.

As others have noted, the official figures indicate that median household income fell by 8 percent between 2007 and 2012 after adjusting for inflation. That amounts to a startling drop of $4,600. It’s not quite right to say that the typical household made $4,600 less last year than it did in 2007, for two reasons. First, inflation-adjusted income fell only because of the 11 percent rise in prices as nominal incomes rose by a meager 2 percent. It is the purchasing power of what households earn that has fallen by $4,600, not the actual amount they receive. Second, the median household—the one in the middle—in 2007 was not the one in the middle in 2012.

Nevertheless, it has been a half-decade to forget, with the official income measure dropping by more and for longer than in previous recessions. The official figures suggest that after adjusting for inflation, the median is back at its 1990 level. Using the new PCE deflator for the inflation adjustment makes the drop look not quite as bad, indicating a 7 percent decline from 2007 to 2012 (to 1997 or 1998 levels).

To delve more deeply into income trends, I have analyzed the Census Bureau’s microdata through 2011. Since median income did not change between 2011 and 2012, the analyses should be informative of what happened through 2012, and at any rate, the noncash benefit and tax information I examine will not be available for 2012 until late October. The data indicates that the magnitude of the decline from 2007 to 2011 (7 percent) was basically the same if instead of focusing on the household income of the median household the question is shifted to the household income of the median person. (Since different households have more or fewer people, the trends for households and people need not be the same.) Nor is the trend affected by whether or not household income is adjusted for the number of people in the home the income must sustain.

However, as noted the official household income definition does not take into account noncash benefits from employers or the government, and it does not net out taxes. These adjustments can be made using the microdata. I added to the official measure the value of employer-provided health insurance and of food stamps, subsidized school lunches, housing subsidies, Medicare, and Medicaid. I also added in Earned Income Tax Credit (EITC) benefits and subtracted out federal and state taxes (before credits), payroll taxes, and property taxes. This broad measure tells us how well the safety net performed in preventing income losses.

Adding in the value of noncash benefits, median household income fell between 2007 and 2011, but only by 3 to 4 percent, depending on the unit of analysis, whether or not household size is taken into account, and how Medicaid and Medicare benefits are valued. Furthermore, taking taxes into account yields the surprising conclusion that median household income had fully recovered by 2011. (The estimates range from as much as a 1 percent decline when people are the units to a 1 percent increase when households are the units and health care is fully valued.) In short, while we certainly should mourn the income growth we didn’t get because of the recession, middle-class incomes are essentially back at their 2007 peak. By the way, that was an all-time peak.

It appears the poor have also made it back to their pre-recession levels. The twentieth percentile of income lies below 80 percent of households and can be thought of as a sort of poverty line. Officially, the twentieth percentile fell by 8 percent from 2007 to 2012 (and by the same magnitude from 2007 to 2011). Using the PCE deflator for inflation adjustment, I find a drop of 7 percent. Once again, the change doesn’t depend on looking at households or persons or adjusting for household size. When noncash benefits are added, the incomes of the poor either fell by as much as 7 percent (same as before) or rose by as much as 2 percent. When taxes—and the EITC—are accounted for, the incomes of the poor probably recovered fully. The various estimates differ only depending on how Medicare and Medicaid are valued, with the range running from a 3 percent drop to a 4 percent increase.

The estimates of Piketty and Saez and the Congressional Budget Office, based entirely or primarily on tax data, provide additional insight into the trajectory of incomes since 2007. While one cannot look at the poor or middle class using the Piketty-Saez estimates, they do provide average income figures for the bottom 90 percent of tax returns (with nonfilers incorporated). Their data—after I adjust them using the new PCE deflator—show income falling by 11 to 12 percent from 2007 to 2012 (depending on whether or not realized capital gains are included). Nearly all of that came between 2007 and 2009.

Their income measure does not include any noncash benefits and only includes cash benefits from the federal government if they are taxable. It does not account for any taxes. It is thus best thought of as a rough measure of market income. Another caveat is that tax returns are not households. Nevertheless, the CBO market income estimates correspond closely with the Piketty-Saez results. They indicate a 9 or 10 percent decline in median household income from 2007 to 2009 (the most recent year available), depending on whether income is adjusted for household size or not.

Given that CBO market income includes employer-provided health insurance (as well as employer pension contributions and the employer’s contribution to payroll taxes), the implication of these market income figures is that middle-class incomes have recovered entirely because of federal tax and transfer policy. Indeed, the CBO estimates show that while the middle fifth of households ranked by market income saw a 9 percent drop in market income from 2007 to 2009, their post-tax and –transfer income fell by just 1 percent. The middle fifth of households ranked by pre-tax, post-transfer income saw a 4 percent decline in that measure of income but only a 1 percent decline in their post-tax and –transfer income. In the Census Bureau data, pre-tax post-transfer income fell by 2 to 3 percent from 2007 to 2009 and post-tax and –transfer income either fell by as much as 2 percent or was flat.

The CBO data includes results for the bottom fifth of households, and the story is even more dramatic there. The market income of the bottom fifth of households ranked by market income fell 23 percent from 2007 to 2009, but the post-tax and –transfer income of those same households rose by 6 percent. The bottom fifth of households ranked by pre-tax, post-transfer income fell by only 1 percent, and their post-tax and –transfer income rose by 3 percent. Deducting the value of employer- and federally-provided health insurance, incidentally, does not affect the results.

The only anomalous result in these data sources is that when Piketty and Saez look just at the bottom 90 percent of tax returns with wage income, they find average wage income rising by two percent between 2007 and 2011 (the latest year in their data for that measure). This increase contradicts the other evidence of pre-tax and –transfer income declines. It may indicate that those declines were largely due to declining labor force participation and that confining analyses to households with earners would show that even pre-tax and –transfer income saw little change during the recession for households with someone who was employed. Incidentally, it does not appear that the aging of the baby boomers is an important part of this story because the Census Bureau trends do not indicate greatly different trajectories for those under age sixty and those sixty and older.

In short, while the middle class—and especially the poor—saw declines in market income after 2007, the safety net appears to have performed just as we would hope, mitigating the losses experienced by households. By 2011, the safety net had returned middle-class and poor households’ incomes to the highest levels ever seen. Since then, the situation has likely improved. Disposable income among the poor and middle class is probably at an all-time high.

Of course, neither the left nor the right is likely to be happy about this conclusion. The left worries that if things are getting better, public support for helping the poor will wane and their "middle-out" agenda will look misguided. The right does not want to concede that the safety net may have achieved income security. In response, the left might reply that things would be even better today if we had had more stimulus, while the right might say that safety net programs’ work disincentives prevented greater improvement. It is undoubtedly the case that policy could have produced at least a somewhat better result, though if we are honest, we have no idea how or by how much.

* David Henderson of the Hoover Institution brought to my attention that this distinction between "market" and "government" income is not quite this neat because of the earnings and pensions of public employees. Regardless, the earnings and pensions of private and public employees alike are included in the Census Bureau’s "money income." Similarly, in the CBO analyses, "market income" includes both the earnings and pensions of public employees.

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