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Good News From the Congressional Budget Office

There have been a lot of news stories today about a study by the Congressional Budget Office that compares incomes earned in 1979 and 2007. The Associated Press describes the study’s findings:

The richest 1 percent of Americans have been getting far richer over the last three decades while the middle class and poor have seen their after-tax household income only crawl up in comparison, according to a government study.

After-tax income for the top 1 percent of U.S. households almost tripled, up 275 percent, from 1979 to 2007, the Congressional Budget Office found. For people in the middle of the economic scale, after-tax income grew by just 40 percent. Those at the bottom experienced an 18 percent increase.

These trends were the sign of a healthy economy (the economy got significantly less healthy, of course after 2007). As a result of technological innovation, increasing specialization and ever-widening global markets, the potential rewards for those who acquire exceptional skills and work extraordinarily hard have increased substantially. This is good, as those heightened incentives will cause more people to make the investment in education and hard work that is necessary to succeed. Moreover, those individuals’ efforts will help everyone else, as they innovate, hire employees and buy from vendors, and create wealth.

Income inequality increases during good times and decreases during bad times, as the CBO noted:

[T]he distribution of market income became more unequal almost continuously between 1979 and 2007 except during the recessions in 1990–1991 and 2001.

This pattern is seen during every recession. It is a good thing for the federal government, too, that incomes have increased at the higher end since 1979, as this has resulted in a huge inflow of tax revenues. One of the reasons for Washington’s current deficits is that upper incomes are depressed, so that a relatively low share of GDP is being paid in income taxes.

Stories about the “richest” 1%, 5%, 20%, or whatever are inherently misleading because they implicitly assume that those groups are static. Of course, they are not. The two biggest reasons why families are in one quintile or another are 1) age and 2) the number of jobs held by members of the household. At any given moment, by definition, only 20% of households are in the top quintile, but probably more than half of all households are in that quintile at some point. It is a great thing for incomes in the top quintiles to be much higher than those in lower quintiles. That means that workers are not stuck in dead-end jobs that pay the same at age 50 as at age 20, but rather are able to take advantage of training, education and a growing economy to move up the ladder. “Income inequality” is another term for opportunity.

The CBO noted another interesting trend–membership in the top 1% is more meritocratic than ever:

The composition of income for the 1 percent of the population with the highest income changed significantly from 1979 to 2007, as the shares from labor and business income increased and the share of income represented by capital income decreased. That pattern is consistent with a longer-term trend: Over the entire 20th century, labor income has become a larger share of income for high-income taxpayers, while capital income has declined as a share of their income.

In other words, the top 1% earn their money, they don’t clip coupons.

The CBO study will no doubt be seized on by liberals as a justification for higher taxes on the rich. But that is a non sequitur. The “rich” are already paying more than twice their fair share, as the top 1% earn about 17% of taxable income but pay around 37% in income taxes. If their incomes rise, their taxes do too–disproportionately. As noted above, increasing incomes at the upper end were a boon to the federal treasury until the latest recession brought those incomes down precipitously.

Greed and envy will cause many to put a negative spin on the CBO’s findings, but don’t be fooled: if the incomes earned by those who are most skilled, hard-working and successful begin to rise again, we will know that the economy is back on the right track.

STEVE adds: If you want to see John’s point gilded in brilliant fashion, see Richard Epstein discuss the CBO report on the PBS News Hour yesterday.  Somebody at PBS clearly screwed up letting this through.

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