Income Volatility

The main findings from a new EPI briefing paper on income volatility by Jacob Hacker and Elisabeth Jacobs:

The instability of family incomes has risen substantially over the last three decades. Although the precise magnitude of the increase depends on the approach to measuring income variance that is used, we estimate that short-term family income variance essentially doubled from 1969-2004. Much of the rise in income volatility occurred prior to 1985, and volatility dropped substantially in the late 1990s. It has, however, risen in recent years to exceed its 1980s peak.

The proportion of working-age individuals experiencing a large drop in their family income (50% or greater) has climbed more steadily—from less than 4% in the early 1970s to nearly 10% in the early 2000s. The probability of large income drops varies predictably with the business cycle. Yet it has also trended strongly upward over time. For instance, the 2001 recession, which was mild in macroeconomic terms, was associated with a higher chance of large income drops than the recession of the early 1980s, which was the worst economic downturn since the Great Depression.

There is an important distinction between family income (total earnings, asset income, and transfer income for all members of a family) and individual earnings. While the instability of individual male workers' earnings rose sharply between the 1970s and 1980s, it has been more or less stable since then, trending up and down with the business cycle through the 1980s and 1990s, and rising again in the early 2000s. This basic trend—a rise in earnings variability in the 1970s, little clear trend from the early 1980s to the late 1990s, and an upswing in the early 2000s—has been confirmed by numerous analyses, including a recent study by the Congressional Budget Office (CBO). Moreover, this same basic pattern can be seen in data from both the survey-based Panel Study of Income Dynamics (PSID) (which is used in this brief) and the administratively collected Continuous Work History Sample (CWHS) of the Social Security Administration (used by the CBO).

Contrary to assertions in the popular press, women's increased workforce participation has not been a major factor contributing to the rise in family income volatility. Female earnings have, if anything, become more stable since the 1980s. Male workers have experienced a larger and more sustained rise in earnings instability. Because men's earnings account for a larger percentage of total household income than do women's earnings, on average, rising instability in male earnings helps account for the increase in family income volatility. In short, the stabilizing influence on family income of the decrease in female earnings instability is overwhelmed by the rise in men's earnings instability.

In addition to the increase in male earnings variability, other likely causes of rising family income volatility include the growing variability of cash transfers and the limited cushioning effect of having a second earner in the household. Although the evidence is limited, there is reason to believe that a second family earner is less of a benefit in terms of income protection today than it was prior to the 1990s. Indeed, in 2004, if a male worker's earnings fell, on average his spouse's earnings fell as well, exacerbating, rather than offsetting, the loss.

While less educated and poorer Americans have less-stable family incomes than their better-educated and wealthier peers, the increase in family income volatility affects all major demographic and economic groups. Indeed, Americans with at least four years of college experienced a larger increase in family income instability than those with only a high-school education over the past generation, with most of the rise occurring in the last 15 years.

Finally, levels of family income volatility appear to be extremely high. Family income drops of 50% or greater affected nearly one in 10 non-elderly adults during the early 2000s. Meanwhile, earnings in the United States are also quite variable. The CBO's recent analysis of earnings variance using the CWHS suggests that around 15% of workers experience a drop in their earnings of 50% or greater every year—a level comparable to what we find using the PSID.

Part of the conclusion from an interesting recent IRP discussion paper from Neil Bania and Laura Leete:

....

In a logistic regression model of food insufficiency estimated for lower income (nonelderly) households, we find that income volatility—not just the mean level of household income—is a statistically significant determinant of food insufficiency. These effects are robust across different model specifications, with more variable income being associated with higher rates of food insufficiency. Furthermore, the relative importance of income volatility versus income level in determining food insufficiency increases as household income falls. For lower income households (below 150 percent of 35 poverty), income variability is a statistically significant determinant of food insufficiency while average (mean) income is not. These findings are consistent with models in which such households face either greater liquidity constraints or more binding constraints in spending that are associated with contractual expenditures.

....

A second important set of findings relates to the degree and source of income volatility itself. We find that income volatility in this sample is considerably larger for lower than for higher income households and that it increased between 1992 and 2003. Furthermore, this increase in volatility was largest for households in deep poverty and those at risk for welfare usage (with 64 and 78 percent increases, respectively). In simulating the probability of food insufficiency for households in deep poverty, we show that the increase in income volatility between the two time periods would double the impact of a one standard deviation negative income shock on predicted food insufficiency.

In order to examine the sources of increased household income volatility, we decomposed income into three components: earned income, AFDC/TANF income, and all other income. Our analysis indicates that the increase in volatility is largely attributable to the shift in the composition of income from welfare payments to earnings and other income sources among the poorest households and among welfare at-risk households.

....

Large recent increases in income volatility, taken together with the importance of volatility in determining food insufficiency for low-income households, suggests that the nexus of income level, income volatility, liquidity constraints, and access to a social safety net may be more generally important to the well-being of lower income households than previously recognized in this and related literatures. Various aspects of these relationships deserve continued attention.

I think a big part of the problem is that both Temporary Assistance income supplements and Unemployment Insurance aren't doing enough to smooth the income volatility of low-wage workers. People need to stop thinking of Temporary Assistance as primarily "welfare" for people without labor market experience and start thinking of it as a social insurance program for low-wage workers.

A while back I blogged about this statement by Hamiltonista Jason Furman:

The flexibility of the American labor force seems to be one reason that recessions have become less frequent and unemployment is less of a problem here than in Europe, notes Jason Furman, a leading Democratic economist. In this country, fast-growing companies can hire new workers without worrying that they are making a 30-year commitment.

I was reminded of it when I was scanning a new CBO report on earnings volatility, which includes the following among its conclusions:

The reduction in macroeconomic volatility over the past several decades does not appear to have translated into lower levels of variability in workers’ earnings.

I'm no economist, but the lack of any improvement in trends like earnings volatility (and, if Jacob Hacker and other sources are correct, an increase in overall income volatility, which the CBO didn't look at, but plans to), a dramatic increase in inequality, and slow wage growth for most of the workforce, goes a long way in explaining why most people don't think the economy is so hot, despite fewer recessions.

Christopher Bollinger and James Ziliak of the University of Kentucky find that the income volatility of single mothers has increased by 60 percent since 1995:

We use data from the Current Population Survey to document changes in the level, composition, and volatility of income over the past 25 years among single mothers with dependent children. We show that there have been dramatic changes in the level and composition of income across the income distribution during the welfare reform era, with substantial substitution away from most transfers and towards labor market earnings and tax credits. Post welfare reform, fewer than half of mothers at the 10th percentile of income, which falls at about one-half the poverty level for a 3-person family, received any income from TANF, SSI, SSDI, or earnings. We identify a rise in income volatility of about 60 percent among all single mothers after 1995, and this growth in instability appears to have affected all segments of the single mother population. Quandt-Andrews tests of structural change with unknown change point indicate that the trend break in volatility is centered around 1996, which coincides with passage of PRWORA. During the same period, however, TANF income volatility declined substantially. A leading candidate for the rise in income volatility among single mothers is rising earnings volatility, though the statistical evidence is not conclusive.

Their finding that the volatility of income from Temporary Assistance declined substantially isn't surprising, since so few single mothers with very low incomes actually receive income supplements from the program any more. If Temporary Assistance was working like it should, it would smooth overall income volatilty. But this would mean that more parents would need to get it when their other sources of income dip, something that would require both policy and attitudinal change (by policymakers and administrators, who right now seem to think that the fewer people Temporary Assistance actually helps, the better it works).

This is very important research, and in my view, a better approach to assessing Temporary Assistance's effectiveness as a social insurance program than alternative static approaches that focus on whether unemployed persons living in "extreme poverty" receive Temporary Assistance.