Government benefits cushion middle class, poor from income blows

Various measures of the income gap between the rich and everyone else show that inequality soared to record highs after the Great Recession. But what those measures do not reveal how a battery of government benefits ranging from unemployment aid and middle-class tax cuts to Medicaid and food stamps substantially cushioned the economic blow on the middle class and poor.

Median family income in the United States, for example, fell by 6.7 percent between 2007 and 2010 due to the recession, according to the Census Bureau. But after adjusting for a series of tax cuts and expanded benefits enacted by Congress in the wake of the recession, the total income loss for families in the middle of the income spectrum was only 0.8 percent, according to Gary Burtless, economist at the Brookings Institution.

“The tax system and government transfers shelter American households from part of the market income losses they suffer in a recession,” he said. “As a result of these programs, the spendable incomes of poor and middle class families have been better insulated against recession-driven losses than the incomes of Americans in the top 1 percent.”

The richest Americans, or those in the top 1 percent of family incomes, actually experienced huge income losses of more than a third during the recession between 2007 and 2009, due to the collapse of U.S. equity markets. But the well-off recovered those losses just as quickly afterwards due to the stock market’s spectacular rally since hitting bottom in March 2009.

“The long-term trend toward greater inequality is driven mainly by turbo-charged gains in market income at the very top of the distribution,” said Mr. Burtless. “The market incomes of the top 1 percent are extraordinarily cyclical. They soar in economic expansions and plunge in recessions.”

Middle class incomes, by contrast, derive mostly from wages and grow and shrink by smaller amounts. Moreover, the generous tax cuts and spending supplements offered by the government not only cushion the blow to middle-class incomes from a recession but have the effect of reducing income inequality in both good times and bad, even as market forces work to increase it.

A common measure of income disparity, known as the Gini index, takes into account only income from wages and market gains and recently hit a record high of .499 in the U.S. (A measure of 1.000 on the index reflects the maximum rate of income inequality.)

But after taking into account the taxes paid by the rich and income transfers enjoyed by the poor and middle-class, that measure shrinks to .380 — close to the levels that prevailed in the 1960s before the income gap started a long upward climb to today’s high levels, the Organization for Economic Cooperation and Development calculated last year.

One consequence of the government’s growing role in mediating the income gap is it is providing a growing share of income for middle-class households as well as the poor.

The nonpartisan Congressional Budget Office reported last month that “in-kind” benefits such as health care and unemployment aid provided by the government as well as employers accounted for only 6 percent of after-tax incomes for middle-income families in 1980, but those benefits had grown to 17 percent of incomes by 2010.