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Distribution of Income by Frank Levy

T he distribution of income lies at the heart of an enduring issue in political

economythe extent to which government should redistribute income from those


with more income to those with less.

Whether government should redistribute income is a normative question, and each


persons answer will depend on his or her values. But for many people, answering
the normative question requires understanding the facts about the current income
distribution. The term income distribution is a statistical concept. No one person is
distributing income. Rather, the income distribution arises from peoples decisions
about work, SAVING, and INVESTMENT as they interact through markets and are
affected by the tax system. The 1990s and early 2000s witnessed the
establishment of a growing body of work, increasingly precise, describing how the
income distribution has changed. This work can be summarized in three points:

The distribution of pretax income in the United States today is highly unequal. The most careful studies suggest

that the top 10 percent of households, with average income of about $200,000, received 42 percent of all pretax

money income in the late 1990s. The top 1 percent of households, averaging $800,000 of income, received 15

percent of all pretax money income.

In the longer view, the path of income inequality over the twentieth century is marked by two main events: a sharp

fall in inequality around the outbreak of World War II and an extended rise in inequality that began in the mid-

1970s and accelerated in the 1980s. Income inequality today is about as large as it was in the 1920s.

Over multiple years, family income fluctuates, and so the distribution of multiyear income is moderately more equal

than the distribution of single-year income.


Distribution of Income by Frank Levy

Trends in Inequality

The most frequently cited statistics come from the U.S. Census Bureaus Current
Population Survey (CPS), the monthly household survey best known as the source
of the official UNEMPLOYMENT rate. Since 1948, the March edition of the CPS has
collected household income information for the previous year, as well as the
personal characteristics of household memberstheir age, EDUCATION, occupation,
and industry (if they work), and other data that help give insight into changing
income patterns. Although this makes the CPS an indispensable statistical source, it
has disadvantages as well. The CPS uses a restricted income definition: pretax
money receipts excluding capital gains. This definition is further restricted by a
cap, currently $999,999, imposed on reported annual earnings for reasons of
confidentiality.1Together, these problems mean that CPS estimates of inequality
omit the effects of taxes, nonmoney income such as government and
private HEALTH INSURANCE, and the portion of individual earnings that exceeds the
cap.

A second source of inequality statistics is the U.S. Treasurys Statistics of Income


(SOI), which summarizes income reported on federal income tax returns. SOI data
contain no personal data on taxpayers such as age or education, and they cannot
describe the precise shape of the lower part of the income distribution. 2 The
strengths of SOI data are their ability to accurately describe the upper part of the
distributionSOI income data are not cappedand to extend this description
back to 1917, thirty years before CPS statistics begin.

Table 1 contains selected information on CPS measures of family and household


income inequality since World War II.3The upper panel describes income patterns
across families: living units occupied by two or more related persons. The lower
panel describes income patterns across households: all occupied living units
Distribution of Income by Frank Levy

including families, persons who live alone, unrelated roommates, and so on. To
form each distribution, the sample of families (or households) is listed in order of
increasing income. The Census then calculates the fraction of all family income
going to the quintile (one-fifth) of families with the lowest incomes, the quintile of
families with the second-lowest incomes, and so on, as well as the share going to
the highest 5 percent of families (who also are included in the top quintile).

The CPS data in Table 1 trace a J-shaped evolution of postWorld War II inequality.
In 1947, the top quintile of families received $8.60 for every dollar of income
received by the bottom quintile. This ratio fell gradually through the 1950s and
1960s until 1969, when it reached $7.25 to $1.00the low point of inequality.
Beginning in the late 1970s, the ratio began to rise again until, by 2002, it had
increased to $11.36 to $1.00, significantly greater than in 1947. Household data tell
a similar story.

To make these trends more concrete, Table 1 includes the 1947, 1979, and 2001
income levels that divide each quintile from the next. Similar data are presented for
households, and all income levels are expressed in 2003 dollars. Between 1947 and
the mid-1970s, income grew rapidly at all points in the distribution, resulting in
both rising living standards and moderating inequality. After the mid-1970s,
average income grew much more slowly, and the growth that did occur was
concentrated in the distributions upper half. Between 1979 and 2001, the income
dividing the first and second family quintiles grew slightly, from $22,280 to $24,000
(7.7 percent), while the income dividing the fourth and fifth quintiles grew from
$74,470 to $94,150 (26.4 percent). Now, as in the 1970s, a majority of families
would describe themselves as middle class, but the middle class is now a larger,
more diverse concept than it once was.4

Inequality estimates based on the U.S. Treasurys SOI data expand on this picture.
At the outset, SOI data do not cap high incomes, so household income inequality
Distribution of Income by Frank Levy

as reported in the SOI is significantly larger.5 Using capped statistics, the CPS
reports that the top one-fifth of households receives 49 percent of all pretax money
income. The SOI estimates, more accurately, that the top one-tenth of households,
with average annual income of about $200,000, receives 42 percent of total pretax
money income. The top 1 percent of households with average annual incomes of
about $800,000 receives 15 percent of all pretax income. With their longer
historical perspective, SOI statistics also show that inequality in the 1920s and
1930s was as high as it is today. Beginning in 1938, the income share of the top
one-tenth of households fell from 43 percent to about 32 percent, where it
remained until the deep blue-collar recession of the early 1980s. At that point,
inequality began its return to the levels of the 1920s and early 1930s. 6

Table 1 Family and Household Income Distributions (Census Definitions)

*. Original table rearranged and bracketed headings added here for clarity.

. Data available only since 1967.

A. Shape of the Family Income Distribution (share of all family income going to each one-fifth [quintile] of
families)

First Second Third Fourth Fifth Top 5 Upper bound of Quintile (2003 dollars) Lower
Quintile Quintile Quintile Quintile Quintile percent bound of
(Lowest (Highes (Containe top 5%
Income t d in Fifth
) Income) Quintile)

[1st] [2nd] [3rd] [4th] [5th]*

1947 5.0 11.9 17.0 23.1 43.0 17.5 $11,08 $17,89 $24,26 $34,42 na. $56,506
8 3 3 7

1959 4.9 12.3 17.9 23.8 41.1 15.9


Distribution of Income by Frank Levy

1969 5.6 12.4 17.7 23.7 40.6 15.6

1979 5.4 11.6 17.5 24.1 41.4 15.3 $23,17 $38,10 $53,97 $74,32 na. $119,243
1 2 9 9

1989 4.6 10.6 16.5 23.7 44.6 17.9

2001 4.2 9.7 15.4 22.9 47.7 21.0 $24,96 $42,77 $65,00 $97,91 na. $170,668
0 2 0 6

B. Shape of the Household Income Distribution (share of all households income going to each one-fifth
[quintile] of households)

First Second Third Fourth Fifth Top 5 Upper bound of Quintile (2003 dollars) Lower
Quintile Quintile Quintile Quintile Quintile percent bound of
(Lowest (Highes (Containe top 5%
Income t d in Fifth
) Income) Quintile)

[1st] [2nd] [3rd] [4th] [5th]*

1967 4.0 10.8 17.3 24.2 43.8 17.5 $14,00 $27,30 $38,76 $55,26 na. $88,678
2 3 6 5

1979 4.2 10.3 16.9 24.7 44.0 16.4 $16,45 $30,60 $47,01 $68,31 na. $111,445
7 5 8 8

1989 3.8 9.5 15.8 24.0 46.8 18.9

2001 3.5 8.7 14.6 23.0 50.1 22.4 $17,97 $33,31 $53,00 $83,50 na. $150,499
0 4 0 0

The Causes of Inequality

In one sense, the growth of inequality in the last part of the twentieth century
comes as a surprise. In the 1950s, the bottom part of the income distribution
contained large concentrations of two kinds of families: farm families whose in-kind
Distribution of Income by Frank Levy

income was not counted in Census data, and elderly families, many of whom were
ineligible for the new SOCIAL SECURITY program. Over subsequent decades, farm
families declined as a proportion of the population while increased Social Security
benefits and an expanding private pension system lifted elderly incomes. Both
trends favored greater income equality but were outweighed by four main factors.

Family structure. Over time, the two-parent, one-earner family was increasingly replaced by low-income single-

parent families and higher-income two-parent, two-earner families. A part of the top quintiles increased share of

income reflects the fact that the average family or household in the top quintile contains almost three times as

many workers as the average family or household in the bottom quintile.

Trade and technology. Trade and technology increasingly shiftedDEMAND away from less-educated and less-skilled

workers toward workers with higher education or particular skills. The result was a growing earnings gap between

more- and less-educated/skilled workers.

Expanded markets. With improved communications and transportation, people increasingly functioned in

national, rather than local, markets. In these broader markets, persons with unique talents could command

particularly high salaries.

Immigration. In 2002, immigrants who had entered the country since 1980 constituted nearly 11 percent of the

labor force (seeIMMIGRATION). A relatively high proportion of these immigrants had low levels of education and

increased the number of workers competing for low-paid work. 7


Distribution of Income by Frank Levy

These factors, however, can explain only part of the increase in inequality. One
other factor that explains the particularly high incomes of the highest-paid people is
that between 1982 and 2004, the ratio of pay of chief executive officers to pay of
the average worker rose from 42:1 to 301:1, and pay of other high-level managers,
lawyers, and people in other fields rose substantially also.

Does Measurement Matter?

As noted above, both CPS and SOI statistics measure pretax money income. These
measurements are deficient for three reasons. First, increases in governmental aid
to the poor have been concentrated in nonmoney benefits such as Medicaid and
food stamps and through tax credits under the Earned Income Tax Credit (EITC).
Nonmoney benefits are excluded from standard statistics, and EITC tax credits are
typically underreported. Second, an increasing proportion of wage-earners total
compensation goes to health insurance and pension benefitswhich are not
counted in standard statistics. Third, taxes themselves modify the income
distribution.

The U.S. Census has attempted to correct these definition problems for recent years
by estimating the household income distribution under alternative income
definitions. Table 2shows the effect in 2001 of moving from the standard Census
definition (pretax money excluding capital gains) to an adjusted definition that
includes the estimated effects of capital gains, taxes, the EITC, and the monetary
value of private and governmental nonmoney benefits. The result is a substantial
reduction in inequality, with the ratio between incomes in the top and bottom
quintiles falling from $14.31:$1.00 to $10.40:$1.00. Similar adjustments for
selected earlier years indicate that better income measurement reduces inequality
in any single year. Even under the adjusted definition, though, the trend toward
increasing inequality in the 1980s and 1990s remains, but at a slower pace.
Distribution of Income by Frank Levy

Table 2 Shape of the Household Income Distribution Under Alternative Income Definitions for 2001 (share
of income going to each quintile of households)

*. Original table rearranged and bracketed headings added here for clarity.

. Standard Census Income is defined as pretax money income excluding capital gains.

First Quintile Second Third Fourth Fifth Quintile Upper bound of quintile (2003
(Lowest Quintile Quintile Quintile (Highest dollars)
Income) Income)

[1st] [2nd] [3rd] [4th]*

Standard 3.5 8.7 14.6 23 50.1 $18,618 $34,780 $55,105 $86,914


Census
income

Adjusted 4.5 10.3 15.6 22.6 47 $21,334 $35,485 $51,747 $75,195


Census
income

Note: Adjusted Census Income is based on pretax money income


including estimated capital gains, less all taxes paid plus the estimated
receipt of the Earned Income Tax Credit plus the imputed value of in-
kind income from employer-provided health insurance and government
nonmoney benefits like food stamps, Medicare and Medicaid, and free
school lunches.

Table 3 Mobility Within the Family Income Distribution

Quintile in 1998
Distribution of Income by Frank Levy

First Quintile (Lowest Second Third Fourth Fifth Quintile (Highest


Income) Quintile Quintile Quintile Income)

First Quintile in 53.30% 23.60% 12.40% 6.40% 4.30%


1988

Fifth Quintile in 3.00% 5.70% 14.90% 23.20% 53.20%


1988

Source: Katherine Bradbury and Jane Katz, Are Lifetime Incomes Growing More Unequal? New Evidence on
Family Income Mobility,Federal Reserve Bank of Boston Regional Review 12, no. 4 (2002).

Inequality and Mobility

A second offset to estimated inequality is economic mobility. Because most family


incomes increase as peoples careers develop, long-run incomes are more equal
than standard single-year statistics suggest. Table 3 summarizes the results of one
study of recent family income mobility.8Among families in the bottom quintile in
1988, half were in the bottom quintile ten years later, a quarter had moved up to
the second quintile, and a quarter had moved to the third or higher quintiles.
Families in the fifth quintile (highest incomes) show a similar mobility over time.

The Economic Case for Inequality of Wages and Incomes

David R. Henderson

Is inequality of wages and incomes bad? The question seems ludicrous. Of course
inequality is bad, isnt it? Actually, no. What matters crucially is how the inequality
came about.

Inequality of wages and incomes is clearly bad if it results from government


privileges. Many people would find such an outcome unjust, but even more
Distribution of Income by Frank Levy

important to many economists is that such inequality sets up perverse incentives.


Instead of producing valuable products and services for their fellow citizens, as
people tend to do in free economies, people in societies based on government-
granted privileges devote much of their effort to pleasing, or outright bribing,
government officials. In many African countries, for example, such as Cte dIvoire,
Ghana, and Zaire, there are stark inequalities because the government has the
power to take a high percentage of the wealth of the already poor and give a large
amount of it to government officials or their cronies. And in many Latin American
countries, for many decades a few families have had most of the wealth and have
used government power to cement their privileges.

But inequality in wages and incomes in relatively free economies serves two
important social functions. First, it gives people strong incentives to produce so as
to make higher incomes and wages. Second, it gives people, and not just young
people, strong incentives to get training or education that will allow them to
perform well in higher-wage jobs. In his January 1999 Richard T. Ely lecture,
economist Finis Welch put the point as follows:

Wages play many roles in our economy; along with time worked, they determine labor income,
but they also signal relative scarcity and abundance, and with malleable skills, wages provide
incentives to render the services that are most highly valued. (Welch 1999, p. 1)

Further Reading

Mbaku, John Mukum. Bureaucratic Corruption in Africa: The Futility of Cleanups. Cato Journal 16,
no. 1 (1996): 99118.

Rothbard, Murray. Egalitarianism as a Revolt against Nature. Available online


at:http://www.lewrockwell.com/rothbard/rothbard31.html.

Welch, Finis. In Defense of Inequality. American Economic Review89, no. 2 (1999): 117.
Distribution of Income by Frank Levy

About the Author

Frank Levy is the Daniel Rose Professor of Urban Economics in MITs Department of Urban Studies and

Planning.

Further Reading

Charles, Kerwin Kofi, and Erik Hurst. Correlation of Wealth Across Generations. Journal of Political
Economy, 111, no. 6 (2003): 11551182.

Fortin, Nicole M., and Thomas Lemeiux. Institutional Changes and Rising Wage Inequality: Is There a
Linkage? Journal of Economic Perspectives 11, no. 2 (1997): 7596.

Gottschalk, Peter. Inequality, Income Growth and Mobility: The Basic Facts. Journal of Economic Perspectives 11,
no. 2 (1997): 2140.

Johnson, George E. Changes in Earnings Inequality: The Role of Demand Shifts. Journal of Economic
Perspectives, 11, no. 2 (1997): 4154.

Saez, Emmanuel. Income and Wealth Concentration in a Historical and International Perspective. In Alan J.
Auerbach, David E. Card, and John M. Quigley, ed., Public Policy and the Income Distribution. New York:
Russell Sage Foundation, 2006. Also available
athttp://emlab.berkeley.edu/users/saez/berkeleysympo2.pdf.

Topel, Robert. Factor Proportions and Relative Wages: The Supply Side Determinants of Wage Inequality. Journal
of Economic Perspectives 11, no. 2 (1997): 5574.

Footnotes
1.

That is, earnings greater than $999,999 are reported as $999,999.

2.
Distribution of Income by Frank Levy

SOI data are combined with NATIONAL INCOME ACCOUNTs estimates of total personal income received in the

economy to calculate the share of all personal income received by the top 1 percent of households, the top 10

percent of households, and so on. Because many lower-income households do not pay federal income taxes, the

SOI cannot provide similar detail on, say, the share of income received by the 10 percent of households with the

lowest incomes.

3.

Household and family income data are available online

athttp://www.census.gov/hhes/income/histinc/histinctb.html.

4.

The connection between class and the income distribution is complicated by the fact that the distribution includes

families of all ages, ranging from married students to retirees, while our stereotype of a middle-class income is

based on families in their prime earning years.

5.

The SOI data are based on tax filing units, a concept that is reasonably close to the Censuss definition of

household.

6.

See Thomas Piketty and Emanuel Saez, Income Inequality in the United States, 19131998, Quarterly Journal of

Economics 118, no. 1 (2003): 139.

7.

See Robert Lerman, U.S. Income Inequality Trends and Recent Immigration, American Economic Review 89, no. 2

(1999): 2338.
Distribution of Income by Frank Levy

8.

Katherine Bradbury and Jane Katz, Are Lifetime Incomes Growing More Unequal? New Evidence on Family Income

Mobility, Federal Reserve Bank of Boston Regional Review 12, no. 4 (2002) 35.

The cuneiform inscription in the Liberty Fund logo is the earliest-known written appearance of the word "freedom" (amagi),
or "liberty." It is taken from a clay document written about 2300 B.C. in the Sumerian city-state of Lagash.