Commenting on the state of the economy at a Habitat for Humanity construction site in Oakland, Calif., former president Jimmy Carter recently said that “the disparity between rich people and poor people in America has increased dramatically” and that “the middle class has become more like poor people than they were 30 years ago.” These sentiments are commonly echoed across the country as the effects of the most damaging economic slump since the Depression continue into their sixth year.
The Census Bureau’s “Income and Poverty” report, released in September, underscored that the economic recovery has largely failed to reach the poor and middle class. However, there is a subtle but substantive difference between stating that inequality is worse today than it was 30 years ago, and that people are worse off today than they were 30 years ago. Rising inequality does not preclude an improvement in standards of living at the bottom of the income distribution.
Stepping back from the traditional debate about income inequality, Kevin Hassett and I recently co-authored a study that focuses on changes in material standards of living over the last 30 years. Consumption of goods and services is often a far better measure of household welfare than is income. What we buy and consume with our income directly adds to our utility and happiness, and it also has a direct impact on our standard of living.
Several factors add to the attractiveness of using consumption rather than income as a measure of welfare. First, people are able to maintain a steady rate of consumption over their lifetime, while they are obviously less able to have a stable income over a lifetime. Incomes may be exceptionally low when people are very young or very old, and high during the prime working-age years, but individuals can maintain steady consumption and standards of living by borrowing in low-income periods and saving in high-income periods. Second, household income varies greatly depending on how we measure and define it. The much-cited inequality data constructed by economists Thomas Piketty and Emmanuel Saez use pre-tax, pre-transfer income data from the tax records of filers and include realized capital gains. Richard Burkhauser, on the other hand, argues that the true measure of income should focus on the Haig-Simons definition of income: We need to include accrued capital gains on housing and other wealth along with earnings and transfer incomes to get at what people actually think of as income. The CBO provides a post-tax and post-transfers definition of income but does not include accrued capital gains. Depending upon the measure used, analysts reach widely differing conclusions about the state of income inequality. Consumption is easier to understand as a concept, and while we can debate how best to measure it, too, economists have arguably reached more of a consensus about what constitutes consumption for a typical household.
In our study, we used data from the Consumer Expenditure Survey (CEX) and the Residential Energy Consumption Survey (RECS). The CEX provides a good overview of consumption of “nondurables” by American households. In 1984, households in the top income quintile accounted for 37 percent of total expenditures, while households in the bottom quintile accounted for 10 percent. Hence the ratio of top to bottom consumption was approximately 3.7:1. In 2010, that ratio increased to 4.4:1. On average, over the entire period, the ratio is 4.3:1 with a standard deviation of 0.22. Therefore, using this measure, we find that consumption inequality has increased only marginally over time. The gap was widest in 2005, when the share of consumption for the top was 39 percent relative to 8 percent at the bottom, or 4.9:1. In the recent recession, it appears that households at the bottom increased their share by 1 percentage point, relative to their 2005 share, while the share for the top either declined or remained steady. In the 2001 recession, the ratio declined as well, suggesting that recessions tend to foster a more even distribution.