Economists are investigating the causes and policy implications of a changing income distribution in the U.S.
Understanding the distribution of people across incomes and the implications of policies for this distribution have long been central concerns for economists. Perhaps surprisingly then, a unified and comprehensive description of the U.S. income distribution has been lacking and is only now beginning to emerge.
In the last few years, economists have combined survey, tax, and national income data to gain a more complete picture. Linking those data sets and presenting income distribution data require certain technical assumptions. Should the focus be on the distribution of individuals or of households across incomes? Should it be on pretax or post-tax incomes? Should adjustments be made for household size? How should inflation be controlled for?
Averaging across studies suggests steady after-tax income growth for the median earner of about 1 percent a year between 1979 and 2014. However, top earners had significantly greater income growth, with the top 10 percent capturing close to 50 percent of total growth between 1979 and 2014. The evidence points to rising income inequality, but the extent of that rise remains a matter for debate. More needs to be done in standardizing methodologies, tracking individuals as they progress through the income distribution, identifying mobility bottlenecks, explaining emergent facts, and understanding their causes.
Around 60 percent of national income in the U.S. is distributed as wages and salaries, with the rest paid out as rents, interest, or dividends, or retained within firms.
Much attention has focused on wages and salaries, which have become both more unequally distributed and a smaller share of national income.
It is useful to think of people as portfolios of skills, some natural and some acquired. The wage and salary distribution is shaped by the relative supplies and demands for skills. The drivers of skill supply and demand are complex and include technological and organizational change, dampened labor market competition, international trade, and evolving patterns of worker flows across geographic, occupational, and skill space.
Disentangling the role of these different factors in creating and disrupting labor market opportunities and driving relative wages is one of the fundamental challenges for modern economics — a challenge Tepper School economists are pursuing vigorously through the new “Inclusive Growth and Prosperity” initiative.
In the face of these forces, how should tax policy be (re)designed? There are two challenges in answering this. The first is to establish goals. Everyone can agree to a reform that makes us all better off. Moving beyond this and selecting among outcomes that benefit some at the expense of others requires trading off different people’s welfare. Economists leave this tradeoff to ethicists or the political process. Instead, they focus on how a given aggregation of preferences can be best converted into policy.
This leads to the second challenge: To what extent can a particular group be assisted without disrupting incentives for effort and initiative? In practice a policymaker cannot easily observe a person’s inherent skills and opportunities, only the economic outcomes that are created when these are combined with effort. A tax redistribution from high to low incomes that benefits the unlucky inevitably dampens incentives for skill acquisition, job search, and work. Mitigating chance distorts choice and economic activity. The key question is: By how much? This is a hard question since economists cannot run controlled experiments to evaluate the impact of alternative policy choices. Instead they must combine data on past tax policies with economic models to evaluate the response to proposed reforms. Building such models, cultivating them with data, and guiding policymakers toward better-designed policy are central components of the mission of the Inclusive Growth and Prosperity initiative. —
by Christopher Sleet, Professor of Economics, Head of Economics