Household Income and Red Velvet Oreos

Part I: Today we are reviewing the most recent analysis of household income data from the trustworthy, non-partisan Congressional Budget Office, courtesy of the report, The Distribution of Household Income and Federal Taxes, 2011, published November 12, 2014.

Part II: Tomorrow we will summarize the distribution of federal taxes. If you can't wait until tomorrow, please see the CBO report. 

Politically agnostic: The CBO presents this data "mostly" free of political slant or editorial, and I attempt to do the same. Political pundits and policy analysts on both sides of the aisle tend to pick out the one or two statistics or charts that support their view, ignoring the larger context in favor of table pounding polemics. That's rubbish. These are the facts, with some caveats for interpretation provided as necessary. 

What's a household?

The CBO aggregates and analyzes income and tax data by household - meaning, people who share a household unit regardless of their relationship. By contrast, the Internal Revenue Service generally reports income by "taxpaying unit". A married couple filing jointly is a single taxpaying unit, whereas a married couple living with an adult child may be considered two taxpaying units but a single household. Total household income is adjusted for household size, then the normalized household income data is put on a distribution. 

The rationale for considering income and taxes on a household basis is that (a) most households make joint economic decisions; (b) a larger household generally needs more income to support a given standard of living; and (c) economies of scale do exist in some types of consumption - particularly housing. From the CBO report (edited for brevity):

CBO chose to adjust for household size by dividing household income by the square root of the number of people in the household, counting adults and children equally. Households were then ranked by adjusted income and grouped into quintiles (or fifths) of equal numbers of people. Because household sizes vary, different quintiles generally have slightly different numbers of households.

That adjustment implies that each additional person increases a household’s needs but does so at a decreasing rate. For example, a household consisting of a married couple with two children and an income of $80,000 would have an adjusted income of $40,000 ($80,000/√4) and would have the equivalent economic ranking of a single person with an income of $40,000 or of a childless married couple with an income of $56,600 ($56,600/√2 is almost $40,000).

In 2011 there were roughly 121 million households in the U.S., with about 24 million households per quintile. The table below shows the minimum threshold for total household income in 2011 for each category, based on household size. For example, a single person living alone that made at least $77,800 in 2011 was in the top 20% (highest quintile) in terms of standard of living. The CBO estimates that a family of four would need household income of $155,500 to maintain the same standard of living.  

YMMV: It is important to note that one of the things not accounted for are differences in geography that impact prices of goods and services, the cost of housing, wages, and how that impacts teh relative standard of living. A four-person household in New York City living on $90k probably does not feel as "middle class" as the same household in Topeka, Kansas. 

If you're thinking "yikes! I'm really broke!" then bear with me. Your situation is not as grim - nor most other people's as flush - as those numbers would suggest.

What is included in household income?

More than you think. In fact, probably a lot more than you see in your W-2, or as gross income on your tax statement. The CBO includes in household income:

• Labor income = cash wages and salaries, including amounts allocated to 401(k) plans; employer-paid health insurance premiums; the employer's share of Social Security, Medicare and federal unemployment insurance payroll taxes; and the share of corporate income taxes borne by workers. 
• Business income = net income from businesses, farms, partnerships and S corps.
• Capital gains = realized profits from the sale of assets.
• Capital income excluding capital gains = Interest, dividends, rental income, and the share of corporate income taxes borne by owners of capital. 
• Other income =  primarily retirement income from pensions, annuities, distributions from 401(k)s and the like. 
• Government transfers = includes payments from Social Security, unemployment insurance, Supplementary Security Income, Temporary Assistance for Needy Families, veteran's programs, workers' compensation, other state and local government assistance programs. 
• In-kind benefits = includes the cost of Supplemental Nutrition Assistance Program vouchers, school lunches, housing assistance, Medicare, Medicaid and the Children's Health Insurance Program, among others. 

Why are the cost of employer-paid health insurance premiums, payroll taxes included as household income? Because there is economic consensus that employers pass along these costs by paying lower wages than they would otherwise pay. It's sort of ok - the CBO seems to net it out on the other side by also allocating the employee taxes paid to households taxes as well. It's confusing to me, but you can read the report for more details.

Changes in the distribution of household income over time.

There is no denying that the rich are getting richer - as the highest quintile has made enormous gains in average household income, while the rest of the income distribution more or less treads water. 

But before you start gnashing your teeth about how rich doctors, lawyers and wall street bankers are (and they are, those jerks) let's take a closer look at the breakdown of income gains in of that top 20%. 

That's pretty amazing, really. The vast majority of the income gains have not accrued to "the top 20%" of households, but to the top 1% - or households with total income that averaged about $1.4 million in 2011, down from $2.0 million in 2007. 

How do people make that much money?

About 1.1 million households are in the top 1% (since there are 121 million households in the U.S.). Surprisingly, only about one-third of that total household income comes from labor income, e.g. wages and salaries. The other two-thirds comes mostly from capital gains, capital income and business income. Think stock and stock options granted to top corporate executives, very successful business founders, partners and owners, and others where the bulk of income does not come from salary and cash bonus. At least that's my best guess.

Also not surprisingly, these ultra high income households are heavily clustered along the northeast corridor from Washington DC to Boston, and in southern California. (The geographic distribution is not included in the CBO report, but you can google and find it - I think it pops up on Business Insider with some regularity.)

What about taxes?

So tomorrow we will look at how much in federal taxes all these groups pay. If it makes you feel any better (it doesn't for me, but you're probably a better person than I am), those people in the top 20% and the top 1% pay a tremendous amount in taxes, and their total tax burden has increased on average over time compared to the other 80% whose tax burden has declined. "Fair" is not a word I like to use in this context nor a topic I'm willing to address at this time. But the data is objective and we will review more of it tomorrow.   

Red velvet Oreos!!

According to media reports, the long-rumored, finally confirmed debut of the quintessential southern dessert flavored Oreo will be just before Valentine's Day, and available on your grocer's shelves for about 6 weeks. 

I plan on having some red velvet Oreos and a Coke. That's "Co-oak", two syllables, for those of you not from the south. Also can be referred to as "Co-Cola", three syllables, not "Coca-Cola". Words that are pronounced as single syllables are reserved for calling hunting dogs in the field - Pearl! Duke! Bing! (short for Bingo). Words of four syllables or more are typically strings of shorter words run together, like "yeradangfoolidgit."