Income Progress across the American Income Distribution, 2000-2005

Summary  – Since the end of the last recession the American economy has grown at a moderate pace. Standard measures of income progress show decent levels of overall improvement. GDP per capita measured in constant prices increased 1.5% a year from the end of the most recent business cycle peak in 2000 through 2006. In the same six-year period real disposable income per person rose 1.4% a year, and real personal consumption per person increased even faster – 2.1% a year. Of course, income gains were considerably faster in other recent periods, including the late 1980s and late 1990s. Those periods did not include a recession, however. If we look at income gains at the same point in the last economic recovery, the gains of the past six years look reasonably good. Between 1989 and 1995, for example, real GDP per capita increased only 1.1% a year and real disposable personal income rose just 0.8% a year.

The recent gains in average income and consumption do not seem to be making much impression on average Americans. A CBS News poll in mid-April 2007 shows that large majorities of adults believe the U.S. middle class is falling behind. When asked whether life for the middle class over the past 10 years has gotten better, worse, or remained the same, 59% of respondents said the situation of the middle class has worsened. Only 30% thought life for the middle class has gotten better. (CBS News, “CBS Poll: The Middle Class Squeeze,” downloaded May 8, 2007).

There are three main reasons economy-wide income gains in the current recovery do not translate into an impression of improved well-being for most members of the middle class. One reason is that in a dynamic economy many individuals experience income reverses even when the economy is growing. Millions of workers lose their jobs or see their real wages fall every year, though the economy may be expanding. The income reverses of some Americans should be more than counterbalanced by income gains experienced by prospering families, however. A second reason respondents may be gloomy about their income progress is that some income gains or improvements in consumption are not very obvious. For example, a large part of the gain in consumption and a portion of the recent rise in labor compensation has been fueled by rapid increases in medical consumption and employer-paid health insurance premiums. These consumption gains are reflected in aggregate consumption statistics, and the premium increases are reflected in statistics on real compensation. Since we do not see this consumption reflected in our money incomes and because workers seldom know how much their employers are paying for insurance premiums, most of the consumption and income gains arising from health care are invisible to most Americans. Indeed, many people are increasingly fearful about their ability to obtain good insurance if they lose their jobs or become seriously ill.

Finally, incomes are growing less equal. Over the past quarter century Americans at the top of the income distribution have seen much faster income growth than people in the middle class. If average income grows 1% a year and top earners enjoy gains of 2% a year, many people in the middle and bottom will see their incomes grow much more slowly than 1% a year. Top income earners experienced sharp income declines in the last recession, but in the last couple of years their incomes have rebounded strongly. This reinforces the impression that the gains from prosperity have flowed disproportionately to people at the top rather than in the middle of the distribution. On an after-tax basis, however, Americans across the distribution have derived notable benefits from recent tax cuts. For many middle class families the cuts have made the difference between suffering a loss and experiencing a gain in spendable income.