THE WIDENING INCOME GULF
by Isaac Shapiro and Robert Greenstein

from the Center on Budget and Policy Priorities

Congressional Budget Office data issued this summer indicate that after-tax income has increased dramatically since 1977 for the highest-income one percent of the population but risen only modestly for those in the middle of the income spectrum and declined for those in the bottom fifth. The CBO data, which start in 1977 and include projections for 1999, are widely regarded by analysts as the best data available on income and tax trends. These data include various forms of income that standard Census data miss, such as capital gains income and income from the Earned Income Tax Credit.

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The CBO data indicate that after-tax income is more heavily concentrated among the richest one percent of the population - and also among the most affluent 20 percent of the population - than at any time from 1977 to 1995, the years for which historic CBO data are available. (CBO data are not available for years before 1977 or for 1996 through 1998. Census data on before-tax income are available going back to 1947; they show that before-tax income is at least as concentrated today at the top of the income scale as at any other time in the past half-century.)

An analysis of the CBO data finds:

Among the 20 percent of the population in the middle of the income spectrum, average after-tax income is projected to rise a very modest eight percent between 1977 and 1999. This is an increase of less than one-half percent per year. Among the bottom fifth of households, average after-tax income is anticipated to fall nine percent from 1977 to 1999. (The CBO income measure is adjusted for family size. This report uses "fifth of households" and "fifth of population" interchangeably. All changes over time mentioned in this report are in inflation-adjusted terms.)1

In contrast, among the top 20 percent of households, average after-tax income is projected to increase a robust 43 percent in the 1997-1999 period. Among the top one percent of households, average after-tax income is projected to more than double, jumping 115 percent. CBO projects the top one percent of the population will have average before-tax income of $786,000 in 1999 and average after-tax income of $516,000.

As a result, the distribution of income has changed markedly. In 1977, the top one percent of U.S. households received 7.3 percent of the national after-tax income. In 1999, this group is projected to receive 12.9 percent of the income, a higher percentage than in any other year CBO has examined. Most of the growth in incomes at the top of the income scale, as well as most of the growth in income disparities between the affluent and other Americans, occurred between 1977 and 1989.

The top 20 percent of households is projected to receive 50.4 percent of the national income in 1999, slightly more than half. This, too, would be a record for the years for which CBO data are available. The remaining 80 percent of the population is expected to share the other half of the national household income this year.

The share of national after-tax income going to the 60 percent of households in the middle of the income spectrum - the broad middle class - is expected to be at the lowest level CBO has recorded since 1977. The share projected to go to the bottom fifth of households is close to a record low.

Income disparities have widened to such a degree that in 1999, the richest one percent of the population is projected to receive as much after-tax income as the bottom 38 percent combined. That is, the 2.7 million Americans with the largest incomes are expected to receive as much after-tax income as the 100 million Americans with the lowest incomes.

Indeed, just the increase in the income of the top one percent of the population since 1977 is estimated to substantially exceed the total income of the bottom 20 percent of the population this year.

While most of these trends have been driven by underlying economic developments, a significant share of the increase in the after-tax income of the top one percent of the population is due to substantial net tax cuts that high-income households have received since the late 1970s. Even with the tax increases on high-income households that the 1990 and 1993 deficit reduction packages contained, these households pay a substantially smaller percentage of their income in federal taxes today than they did in 1977. If the richest one percent of households paid the same percentage of income in federal taxes in 1999 as this group paid in 1977, these households would pay an average of at least $40,000 more in taxes this year. In other words, these households have received an average tax cut of more than $40,000. This $40,000-plus average tax cut for the top one percent of households is greater than the entire average before-tax income of the middle fifth of households, which is projected to be $38,700 per household in 1999. (These and all other dollar figures in this analysis are in 1999 dollars.)

Wealth Disparities are Much Larger than Income Disparities
These findings underscore the extent to which income has become more concentrated in the United States. Federal Reserve Board and other studies show that the top fifth of households possesses an even larger share of the national wealth than of the national income. Edward Wolff of New York University has complied data on the distribution of wealth in the United States over the past 75 years. These data indicate that wealth has become more concentrated in recent years than at any other time since the Great Depression.2 Wolff's findings, based in substantial part on the Federal Reserve Board's Surveys of Consumer Finances, indicate that:

• In 1995, the wealthiest one percent of households owned 39 percent of the nation's wealth. By contrast, the CBO data show the one percent of households with the highest incomes receiving about 13 percent of the nation's after-tax income. The share of the nation's wealth possessed by the top one percent is three times as large as their already large share of national income.
• The wealthiest 20 percent of households owned 84 percent of the nation's wealth in 1995. By comparison, the 20 percent of households with the highest incomes receive a little more than 50 percent of the national after-tax income.
• The bottom 80 percent of households owned only 16 percent of the nation's wealth, significantly less than half the wealth the wealthiest one percent of the population possessed.
• Wealth was already more concentrated among the top one percent and top 20 percent of households in 1995 than at any time since the Depression. Wolff's projections for 1997, reflecting the rise in the stock market, indicate the concentration has become more dramatic since 1995.

APPENDIX I

The Congressional Budget Office Data vs. Census Data
The CBO data reflect a fuller measure of income than the Census data do. The CBO data include capital gains income. They also take into account the effect of federal taxes, including the Earned Income Tax Credit. The standard measures of income that the Census Bureau publishes do not consider taxes and do not include capital gains income.

The failure to account for capital gains income in its standard series means that the Census Bureau information understates income at the top; another aspect of Census data has the same bias. Census Bureau data reflect a mechanism known as "top coding." Census data, for instance, recognize only the first $1,000,000 of earnings from a worker's primary source of employment. If an individual earns more than that the individual is recorded as having earnings of exactly $1,000,000.

CBO is able to estimate all earnings, including those above the Census cutoff. CBO also is able to account for capital gains income and taxes because of its use of Statistics of Income data from the Internal Revenue Services.

The CBO data differ in one other notable respect from the data the Census Bureau issues - CBO assigns households to income quintiles in a somewhat different manner than the Census Bureau does. The Census Bureau groups households strictly by the amount of income they have, so that the 20 percent of households with the lowest incomes become the bottom fifth, or quintile. CBO, on the other hand, accounts for the fact that larger households have greater income needs than smaller households. Accordingly, it adjusts each household's income according to the household's size, using economy-of-scale factors, before assigning the household to a quintile. This method accounts for the fact that a $20,000 income is far more ample for a single-person household than for, say, a household of five.

More specifically, CBO uses adjusted family income (AFI), which is family income divided by the poverty threshold, and CBO arranges households from low to high on the basis of this measure. So, for example, when the report says that according to the CBO data, the fifth of households in the middle of the income spectrum is projected to experience an increase in average after-tax income of eight percent from 1997 to 1999, that means that AFI (income adjusted for family size) is projected to increase by eight percent over that time period. Most economists consider AFI to be a superior measure of economic well-being.

APPENDIX II

Income Distribution, In-kind Benefits, and State and Local Taxes
The standard Census data on income, as well as the CBO data analyzed here, do not include the value of in-kind benefits. Since low- and moderate-income households receive more assistance from government in-kind benefits than high-income households do, these benefits moderate income disparities somewhat. But the effect is small. Even if such benefits are included, the share of national income these households receive remains quite modest. In addition, the inclusion of in-kind benefits has little effect on the trends in the distribution of income over time; income disparities have grown sharply over the past two decades whether or not in-kind benefits are considered.

This can be seen by examining various experimental measures of income that the Census Bureau employs. These measures, which currently provide information for years from 1979 to 1997, incorporate several types of income not included in the official Census income data - capital gains income, in-kind benefits, and the effects of federal income and payroll taxes, including the Earned Income Tax Credit.

Under all of these experimental income measures, income disparities have grown substantially since 1979. That is, growth in in-kind benefits has not been large enough to alter the trend of widening income inequality. Under the most comprehensive of these experimental measures, income disparities were wider in 1997 than at any other time since 1979. (Technically, disparities appear to have been wider under the Census experimental data in 1986 than in 1997. The 1986 data, however, are distorted and not a useful basis for comparison.)3

Moreover, the share of national resources that the bottom fifth of households receives does not increase that much when in-kind benefits are considered. Even when an expansive measurement of in-kind benefits that includes some valuation of Medicare and Medicaid benefits is used, the share of national income received by the bottom fifth of households rises by only 0.7 percentage points. When Medicare and Medicaid are excluded from measures of income as many experts believe they should be, but other in-kind benefits are counted, the share of national income the bottom fifth receives increases by 0.4 percentage points.

State and Local Taxes
While the inclusion of in-kind benefits would slightly moderate the extent of income disparities for any year, the inclusion of state and local taxes would operate in the opposite direction. The CBO data on after-tax income, as well as the Treasury Department and Joint Tax Committee data cited in the report, reflect income after federal taxes are subtracted; they do not subtract state and local taxes. Since state and local taxes are generally regressive - that is, low- and middle-income households pay a larger share of their income in these taxes than upper-income households do - the distribution of after-tax income would be shown to be more uneven if state and local taxes were taken into account.

Endnotes:

1. Here and elsewhere in the report, references to changes in after-tax income over time refer to changes in family income after an adjustment is made for family size (see Appendix I for a description of this adjustment). The average adjusted family income for a group in a certain part of the 1999 income spectrum, such as the 20 percent of households in the middle of the income spectrum, is compared to the average adjusted family income for the group in the same part of the income spectrum in 1977.

In this report, reference often is made to a group consisting of 20 percent of households or a fifth of households. The CBO data series actually divides the population into five groups or fifths with equal numbers of people, not equal numbers of households. For simplicity, we use the phrase "fifth (or 20 percent) of households" and "fifth of the population" interchangeably.

2. Edward N. Wolff, Top Heavy: A Study of the Increasing Inequality of Wealth in America, A Twentieth Century Fund Report, 1995, and Edward N. Wolff, "Recent Trends in Wealth Ownership," for Benefits and Mechanisms for Spreading Asset Ownership in the United States, forthcoming.

3. The 1986 data reflect a one-time jump in capital gains income that year, as high-income investors rushed to sell assets and "cash in" their capital gains before substantially higher capital gains tax rates took effect in 1987 as a result of the 1986 Tax Reform Act. The data for 1986 consequently reflect an artificially elevated level of income among those at the top of the income scale and provide a skewed picture of the share of the national income that high-income households were receiving in the mid-1980s. If the 1997 experimental data are compared to 1985 or 1987, income disparities are found to have been significantly wider in 1997 than in the mid-1980s.

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