Saturday, February 25, 2006

Survey Of Consumer Finances: An Income Anomaly

by Tom Bozzo

One oddity of the Survey of Consumer Finances release was that between 2001 and 2004, median "real" household income went up, very slightly, while the mean declined. It is possible to read too much into the result, as the difference ($1,700) is statistically insignificant (about 0.72 standard errors). The $700 difference in the median is also statistically insignificant. Still, it's unusual given the rich-get-richer story one usually tells about Bushonomics, as Matthew Yglesias notes at Tapped.

Mean incomes are influenced by the enormous incomes earned by the very rich. That is, there are hedge fund managers who make a thousand times more money than a typical upper-income professional, who in turn only makes a couple to a few times more than a white collar office drone or a skilled tradesperson, etc. The mean of my income and that of a successful hedge fund manager doesn't give a very accurate reading on how well I'm doing. The median, as a "robust" statistic, gives a better indication of how a typical household is doing when incomes are highly skewed. The implication of an increase in the median accompanied by a decrease in the mean, then, is somewhat reduced income inequality.

The result is clearly driven by declines in median income among high income and wealthy households. The average income of households in the top ten percent of the income distribution fell from $322,400 in 2001 to $302,100 in 2004; similarly, the top ten percent of households in net worth saw average incomes fall from $273,100 to $256,000.

So is the conventional wisdom wrong? No.

First, the survey data show that the wealthy (top 25%) are the only groups exhibiting increases in median real incomes. The lower three quartiles (bottom 75%) each show decreases in both the mean and the median. This suggests that the sampling variation issue with the overall median and mean may indeed be driving the anomaly.

Also, Income tax data suggest that income from realized net capital gains may be driving the mean income decline for the wealthy. They own most financial assets — as of the 2001 survey, the top ten percent held 88% of individual stocks, 79% of mutual fund balances, and 72% of all financial assets (the comparable 2004 data are not yet available). Between 2001 and 2003, there's a decline in reported income that is driven, in large part, by lower reported capital gains and related income categories — the Bush tax complexification makes exact comparisons a bit difficult. That's true even though 2003 was a good year for the stock market. That decline appears to be concentrated in returns that report high incomes.

Last, the rich have managed to get richer despite the income blip, with a larger increase in mean real net worth (~6%, to $3.11 million) than the median (~3.1%, to $1.43 million) for the top 10% of the net worth distribution.

So no tears.
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