Consumption and income inequality in the US since the 1960s

Bruce Meyer, James Sullivan 15 January 2018

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Concerns about rising inequality inform important debates on some of our most significant policy issues, including income tax policy, immigration, and globalisation. President Obama called inequality the defining challenge of our time, while the Trump administration cites high inequality as motivation for changes in immigration and trade policy.1 The debate over inequality relies almost exclusively on income data that indicate that inequality has increased sharply in recent decades. It turns out that these data paint an incomplete and at times distorted view of how inequality in economic wellbeing has changed in the US.

Why consumption?

Although income is the most common measure of the economic wellbeing of US households, there are a number of reasons why measuring how much people consume on food, shelter, transportation, and other goods and services provides a more accurate picture of their circumstances. Income typically fluctuates more than economic wellbeing because people can save when income is temporarily high and borrow when it is temporarily low. Income also fails to reflect consumption out of durables such as housing and cars. A retired couple living off the savings they accumulated over a lifetime may be living quite comfortably even if they have no income. Consumption measures will reflect the loss of housing services flows if homeownership falls; the loss in wealth if asset values fall; and the belt-tightening that a growing debt burden might require, all of which an income measure would miss. Furthermore, consumption is more likely than income to be affected by access to public insurance programs.  Thus, consumption will do a better job of capturing the effects of changes in access to credit or the government safety net. The data also show that consumption better reflects deprivation. In Meyer and Sullivan (2003, 2011a), we show that measures of material hardship or adverse family outcomes are more severe for those with low consumption than for those with low income, indicating that consumption does a better job of capturing well-being for these families.

Several researchers have documented the patterns in consumption inequality. The evidence from this literature is mixed, with some studies showing little change in consumption inequality over the past few decades and others showing a proportional rise equal to or exceeding that for income.2 These differences arise from the use of different data sources or definitions of consumption (i.e. total consumption or non-durable consumption), and different methods of addressing measurement error.

Addressing concerns about data quality

While the conceptual advantages of consumption are clear, previous studies have raised concerns about the quality of both income and consumption data. There is considerable evidence that income is substantially under-reported in national surveys, especially for categories of income important for those with few resources, and the extent of under-reporting has increased over time (Meyer and Sullivan 2003, 2011a, Meyer et al. 2015, Bee and Mitchell 2017). For example, only about half of all dollars transferred through the Temporary Assistance for Needy Families (TANF) programme, food stamps (SNAP), and pensions are captured in the main income surveys in recent years.

There is also evidence that at least some components of consumption are under-reported in surveys. However, recent research has shown that among the eight largest categories of expenditures, six are reported at a high rate in the Consumer Expenditure Interview Survey, the best source of data on household spending, and that rate has been roughly constant over time (Bee et al. 2015). These comparisons also indicate that spending collected through a recall survey compare more favourably to national aggregates than does spending collected via a diary survey that appears too burdensome to accurately complete.

One way to address concerns about the quality of consumption data is to focus on those components of consumption that are well measured, including food at home, rent plus utilities, gasoline and motor oil, the rental value of owner-occupied housing, and the rental value of owned vehicles. In order to draw conclusions about changes in consumption inequality from evidence on the well-measured components, it is critical that these components are equally important for high- and low-consumption households. It is also important that price changes for well-measured consumption mirror the changes for overall spending. In a recent paper (Meyer and Sullivan 2017), we show that both these conditions hold: well-measured consumption is roughly a constant share of overall consumption throughout the distribution, and the price of the bundle of well-measured goods has not changed noticeably relative to the prices for all goods.

Trends in income and consumption inequality

According to official measures, which are based on income, inequality has risen steadily in the US since the early 1970s (DeNavas-Walt and Proctor 2015). An important limitation of the official statistics is that they are based on pre-tax money income, which does not account for tax credits and in-kind transfers such as housing benefits and food stamps, which have increased sharply over time. Income inequality still rises for measures of income that more closely reflect family resources available for consumption, but the rise is less noticeable.3 Using our improved measure of consumption, however, a very different story emerges.

These differences are evident in Figure 1, where we report the ratio of the 90th percentile to the 10th percentile (the 90/10 ratio) for pre-tax money income, after-tax money income, and well-measured consumption (see Meyer and Sullivan 2017 for more details).[4] Since the early 1960s, the rise in after-tax income inequality as measured by the 90/10 ratio (26%) has significantly exceeded the rise in consumption inequality (7%). Furthermore, this much smaller percentage increase in consumption inequality started from a considerably lower base. In some decades, such as the 1960s and 1990s, income and consumption inequality moved in parallel, but in other decades the differences were sharp. In the 1980s, inequality for both measures rose, but the increase was much greater for income (28%) than for consumption (5%). After 2005, these measures moved in opposite directions, as income inequality rose sharply while consumption inequality fell.

Figure 1 income and consumption inequality (90/10 Ratio), 1961-2016

Notes: Figures are updated results from Meyer and Sullivan (2017). Consumption data are from the CE and income data are from the CPS. Well-measured consumption includes spending on food at home, rent (for renters), rental equivalent (for homeowners or those in government or subsidized housing), utilities, service flows from owned vehicles, and spending on gasoline and motor oil. After‐tax Money Income is calculated as Pre‐tax Money Income plus the value of tax credits such as the EITC, less state and federal income taxes and payroll taxes. All measures are adjusted for differences in family size using the NAS recommended equivalence scale. Resources are measured at the family level and person weighted. See Meyer and Sullivan (2017) for more details.

Figures 2 and 3 show that income inequality has risen for the top (90/50 ratios) and bottom (50/10 ratios) of the distribution, but increases in consumption inequality are only evident for the top. That the patterns of consumption and income inequality at the top are fairly similar from the early 1960s to 2005 suggests that under-reporting of consumption by the rich is not behind the differences.

Figure 2 Income and consumption inequality (50/10 Ratio), 1961-2016

Notes: See notes to Figure 1.

Figure 3 Income and consumption inequality (90/50 Ratio), 1961-2016

Notes: See notes to Figure 1.

Our evidence of only a modest rise in consumption inequality over the past five decades contrasts sharply with evidence from tax data that an increasing share of the nation’s income is going to the very highest income families (Piketty and Saez 2003); though several papers using broader and more consistent measures of income in tax data do not show large increases in the top 1% income share (Auten and Splinter 2017, Larimore et al. 2017). Our analyses are distinct from these studies that focus on the highest income households. We do not include the extreme tails of the distribution because resources are likely to be poorly measured in survey data for these observations. Tax returns alone are also unsuitable for measuring incomes at the bottom since they miss non-filers and important sources of income such as TANF, SSI, SNAP and housing benefits, which are not taxable.

What explains these sharp differences in inequality patterns?

Many factors likely contribute to the differences between income and consumption inequality. As discussed above, there is considerable evidence that income sources that are particularly important for those at the bottom of the distribution are significantly under-reported in surveys and the extent of under-reporting has grown over time.  A story of declining relative quality of income data at low percentiles is consistent with our results that show a much more noticeable rise in the 50/10 ratio for income than the 50/10 ratio for consumption over the past three decades. In addition, the divergence between income and consumption inequality measures is particularly evident for single parent families, a group that receives a disproportionate share of transfer income.

For families with substantial asset holdings, changes in asset values could affect consumption even if income is unchanged.  Thus, the sharp decline in asset prices after 2006 –first housing and then financial assets – could explain why consumption inequality fell at the start of the Great Recession even though income inequality did not. This explanation is supported by evidence of spending by asset holdings, which shows that between 2006 and 2010 – a period of sharply falling asset prices – consumption rose for the lowest asset quintile, while it fell for the top four.

Implications

Most of the discussion around recent trends in inequality highlights growing dispersion. However, the evidence from consumption data indicates that changes in inequality in economic wellbeing are more nuanced than a simple story of rising dispersion throughout the distribution. Rather, in the bottom half of the distribution there is little evidence rising consumption inequality, and in the top half of the distribution the rise in consumption inequality has been much more modest than the rise in income inequality, particularly since 2000.  In light of the deficiencies of income and the contrast with consumption, policymakers should look beyond income when assessing the need for policy changes. 

References

Aguiar, M and M Bils (2015), “Has Consumption Inequality Mirrored Income Inequality”, American Economic Review 105(9): 2725-2756. 

Armour, P, R Burkhauser, and J Larrimore (2014), “Levels and Trends in U.S. Income and its Distribution: A Crosswalk from Market Income towards a Comprehensive Haig-Simons Income Approach”, Southern Economic Journal, 81(2), 271–293.

Attanasio, O P, R Battistin, and H Ichimura (2007), "What Really Happened to Consumption Inequality in the United States?," in E E Berndt and C R Hulten (eds), Hard-to-Measure Goods and Services: Essays in Honor of Zvi Griliches, National Bureau of Economic Research.

Attanasio, O, E Hurst and L Pistaferri (2015), “The Evolution of Income, Consumption and Leisure Inequality in the US, 1980-2010”, in C Carroll, T Crossley and J Sabelhaus (eds), Improving the Measurement of Consumer Expenditures, University of Chicago Press.

Auten, G and D Splinter (2016), “Using Tax Data to Measure Long-Term Trends in U.S. Income Inequality”, Working Paper, Office of Tax Analysis, US Treasury Department.

Bee, A and J Mitchell (2017), “Do Older Americans Have More Income Than We Think?” SESHD Working Paper, US Census Bureau.

DeNavas-Walt, C and B Proctor (2015), “Income and Poverty in the United States: 2014”, Current Population Reports, P60-252, September.

Fisher, J, D S Johnson and T M Smeeding (2014), “Inequality of Income and Consumption in the U.S.: Measuring the Trends in Inequality from 1984 to 2011 for the Same Individuals”, Review of Income and Wealth doi: 10.1111/roiw.12129.

Heathcote, J, F Perri, and G L Violante (2010), “Unequal we stand: An empirical analysis of economic inequality in the United States, 1967–2006,” Review of Economic Dynamics 13(1): 15-51.

Krueger, D and F Perri (2006), "Does Income Inequality Lead To Consumption Inequality? Evidence and Theory", Review of Economic Studies v73(1): 163-193.

Larimore, J, R V Burkhauser, G Auten and P Armour (2017), “Recent Trends in U.S. Top Income Shares in Tax Record Data Using more Comprehensive Measures of Income Including Accrued Capital Gains”, NBER Working Paper No. 23007.

Meyer, B D, W K C Mok and J X Sullivan (2015), “Household Surveys Household Surveys in Crisis", Journal of Economic Perspectives 29(4): 199-226.

Meyer, B D and J X Sullivan (2017), “Consumption and Income Inequality in the U.S. Since the 1960s”, NBER Working Paper No. 23655.

Meyer, B D and J X Sullivan (2012a), “Identifying the Disadvantaged: Official Poverty, Consumption Poverty, and the New Supplemental Poverty Measure,” Journal of Economic Perspectives 26(3): 111-136.

Meyer, B D and J X Sullivan (2012b), “Winning the War: Poverty from the Great Society to the Great Recession,” Brookings Papers on Economic Activity, Fall: 133-183.    

Meyer, B D and J X Sullivan (2011), “Further Results on Measuring the Well-Being of the Poor Using Income and Consumption,” Canadian Journal of Economics 44(1): 52-87.

Meyer, B D and J X Sullivan (2003), “Measuring the Well-Being of the Poor Using Income and Consumption”, Journal of Human Resources 38(S): 1180-1220. 

Piketty, T and E Saez (2003), “Income inequality in the United States: 1913-1998”, Quarterly Journal of Economics 118(1): 1-39.

Slesnick, D T (2001), Consumption and Social Welfare,  Cambridge: Cambridge University Press. 

Endnotes

[1] https://www.ohio.com/akron/pages/trump-blames-immigrants-for-income-inequality; https://www.washingtonpost.com/opinions/tax-reform-is-the-best-way-to-tackle-income-inequality/2014/01/10/112710ea-68ca-11e3-a0b9-249bbb34602c_story.html?utm_term=.54aabb731110.

[2] For studies of consumption inequality, see Johnson and Shipp (1997), Slesnick (2001), Krueger and Perri (2006), Heathcote et al. (2010), Attanasio et al. (2007), Attanasio et al. (2015), Aguiar and Bils (2015).

[3] For other studies of pre-tax and after-tax income inequality, see Heathcote  et al. (2010), Fisher et al. (2015), Armour et al. (2014). Adding non-cash benefits (such as the value of food stamps and housing and school lunch subsidies as calculated by the Census Bureau) leads to slightly lower inequality, but the changes over time are similar to those for after-tax money income (Meyer and Sullivan 2017).

[4] The statistics are based on the authors’ calculations. All income data are from the Current Population Survey and all consumption data are from the Consumer Expenditure Interview Survey.

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Topics:  Poverty and income inequality

Tags:  Inequality, consumption, US

McCormick Foundation Professor, University of Chicago Harris School of Public Policy

Rev. Thomas J. McDonagh, C.S.C. Associate Professor of Economics, University of Notre Dame

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