Is the Middle Class Really In Trouble?

I’ve heard almost constantly from people on the left side of the political sphere that the middle class in the United States is in a crisis.  President Obama and other Democrats have drawn an increasingly bleak picture of the outlook of the middle class.  In 2009, President Obama stated that “middle class Americans have been working harder, yet not enjoying their fair share of the fruits of a growing economy.”

 

This argument has never passed the smell test for me, and I finally heard a convincing counter-argument from a non-partisan source.  I first heard this argument in the podcast EconTalk, a great weekly economics podcast, when Russ Roberts interviewed Dr. Richard Burkauser.

Richard Burkhauser, a professor of economics at Cornell University, and the author of a new paper published in the March 2012 issue of the peer-reviewed National Tax Journal entitled, “A ‘Second Opinion’ on the Economic Health of the American Middle Class,” disagrees with the traditional interpretation of income data.  He says that there are several areas in which other economists fall short.

Tax Units or Households?

Much of the previous studies have focused on data gleaned from IRS records.  These are separated into “tax units.”  However, using tax units as a standard of measure is tricky, says Burkhauser.

The distinctions between tax units and households as sharing units or between the resources counted within them as income are somewhat abstract and may appear to be trivial. As a result, literatures that differ in their income measurement or sharing units are often viewed interchangeably. Indeed, it is often the case that an individual’s tax unit and household unit are exactly the same. A tax unit typically consists of an adult, his or her spouse, and any dependent children. Such a tax unit would include all members of “traditional family arrangement” households. However, there are increasingly exceptions to such traditional households. For example, cohabiters, roommates who share expenses, children who move back in with their parents or older parents who live with their adult children will contain more than one tax unit.”

Burkhauser also says that using tax records as a basis for study is dangerous because “the inclusion of taxes and transfers, in addition to the value of employer provided health insurance benefits, Medicare and Medicaid further impacts the observed trend in resources available to the middle class.”

Pre-Tax Pre-Transfer, or Post-Tax Post-Transfer?

What the heck does that mean?  Well, if you measure the income of someone before taxes have been taken out, does that really give you a good picture of how much goods and services that person can obtain?  Not really.  Similarly, if you look at a person’s earned income only, and not health benefits that are provided by their employer, and not any other benefits that they might be getting from the government (Medicare or Medicaid benefits, Social Security benefits, tax returns, etc.), you’re not going to get a very complete picture of their economic well-being.

Most, if not all, of the previous studies that have been done on income inequality have used pre-tax, pre-transfer data to come to their conclusions.  However, using that data can result in some skewed results, as shown in the below chart:

Table 1: Comparing the total growth from 1979-2007 using each sharing unit, size-adjustment, and income series combination.

  Tax Unit Household Size-adjusted Tax Unit Size-adjusted Household
Pre-tax, pre-transfer

3.2%

12.5%

14.5%

20.6%

Pre-tax, post-transfer

6.0%

15.2%

17.0%

23.6%

Post-tax, post-transfer

9.5%

20.2%

25.0%

29.3%

Post-tax, post-transfer + Health insurance

18.2%

27.3%

33.0%

36.7%

Source: “A Second Opinion on the Economic Health of the American Middle Class,” compiled from Public Use March CPS data.

Says Burkhauser about these stats,

“… when we broaden the sharing unit to the household, account for economies of scale in household consumption, and recognize that the payment of taxes or the receipt of tax credits as well as government transfer income and in-kind benefits all impact the economic resources available to individuals, we find the story changes. Specifically, when using our broadest measure of available resources—post-tax, post-transfer size-adjusted household income including the ex-ante value of in-kind health insurance benefits—median income growth of individual Americans improves to 36.7 percent over the period from 1979 and 2007, and by 4.8 percent between 2000 and 2007. Similarly, these choices impact the observed distribution of income and the extent to which incomes at the top of the distribution are growing faster than those of the middle and lower classes.”

So middle class income is increasing?

Yes, middle class income is increasing.  Democrats that tell you that middle class income has been stagnant for 30 years are citing studies that are founded on the wrong assumptions (as listed above), using tax units (instead of households), and using pre-tax and pre-transfer income as standards, instead of using measures that more accurately describe the purchasing power of middle class families.

However, one obvious question that I have after reading this study is this: if we have to use post-tax, post-transfer data in order to come to the conclusion that the middle class is actually doing OK in terms of income, doesn’t that then mean that the middle class income is, at least partially, growing because of government redistribution?  If middle class families are getting transfers from government each year, and those transfer enable them to have a higher standard of living, isn’t that an argument in favor of government redistribution?  Yes, it probably is.  However, it also makes one wonder if the government had not been run with such redistributive policies in those years, would the outcome have been different?  And, if so, how?  The United States, for much of it’s existence, has been a relatively capitalistic society, with relatively little redistribution.  In those years, we’ve gone from a nation of political refugees, to a developed nation with a median income that is at the top of the world.  If we had not had the same policies as we’ve had, would median income have increased faster?  Or would the evil, wealthy people have kept all that extra money for themselves?

How much of that success should we attribute to policies (tax and otherwise) before 1970, and how much of the success should be attributed to near-term policies?  Liberals who would like to see the U.S. adopt more redistributive policies will likely put more emphasis on the recent, more redistributive policies, while conservatives will put more emphasis on earlier periods.  Two things I have questions about:

  1. Has there been a study done on increases in median income through different periods of time?  This study (by Burkhauser) only studied the period 1979-2007.  Is there one that has studied a wider range of periods, comparing one period to another?
  2. Has there been a study done of a more recent free market?  For instance, the Heritage Foundation, a conservative think tank, releases an annual Index of Economic Freedom, which identifies the most economically free nations.  Hong Kong and Singapore have topped the list in recent years (the United States, ranked 10th, is rated only “Mostly Free”).  Have there been any studies done on these most economically free nations (according to a conservative source)?  The only thing I found with a short internet search was this “case study” by the Freeman Online.

Questions: How does this new study affect your view of economic policy?  Are you surprised at its findings?