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Article Excerpt
I. INTRODUCTION
Rising income inequality in the United States over the past quarter century is well documented (see, e.g., Gottschalk 1997; Krueger 2003; Levy and Murnane 1992; Piketty and Saez 2003). Whether and by how much this change in inequality is associated with a change in economic performance is an important question, yet recent empirical work has been largely inconclusive. Positive relationships between income inequality and economic growth have been found by Partridge (1997, 2005) using a panel of states and by Forbes (2000) using a panel of countries. Empirical work by Panizza (2002) and Quah (2001), however, has found little or no stable relationship between inequality and growth; the results appear to be extremely sensitive to the econometric specification.
Additionally, Barro (2000) has found evidence that the relationship is nonlinear, with inequality being positively related to growth among wealthier countries like the United States but negatively related to growth among low-income countries.
Much of this recent empirical literature was initiated by the important work of Deininger and Squire (1996), who constructed a large cross-national panel of inequality measures containing several time-series observations for each nation spaced over multiple decades. A parallel empirical literature also emerged using U.S. state-level data, with income inequality measures typically spaced at 10-yr intervals (see, e.g., Panizza 2002; Partridge 1997, 2005). Both the state-level and the cross-national empirical literatures benefited by exploiting the more advanced panel data econometrics afforded by the large-N, small-T panel dimensions.
In this paper, we offer a new, more comprehensive panel of state-level income inequality measures and use this panel to reevaluate the empirical inequality-growth relationship. (1) This panel has the unique feature of being large in both N and T, with annual observations of the 48 contiguous states for the entirety of the postwar period 1945-2004. For nearly all the states in the panel, the share of income held by the top decile experienced a prolonged period of stability after World War II, followed by a substantial increase during the 1980s and 1990s. These state-level trends appear to closely replicate the overall trends in aggregate U.S. inequality found by Piketty and Saez (2003).
Exploiting the large and balanced size of our inequality panel, we explore the long-run relationship between inequality and growth via three alternative dynamic panel error-correction estimators: the fixed effects (FE) estimator, the mean group (MG) estimator of Pesaran and Smith (1995), and the pooled MG estimator of Pesaran, Shin, and Smith (1999). The greater homogeneity of state-level data helps mitigate the difficulty in adequately capturing structural differences across international panels of earlier studies such as Forbes (2000) and Barro (2000). Corruption levels, labor market flexibility, tax neutrality, tradition of entrepreneurship, and many other factors are only poorly measured, if at all (Barro 2000, 1011), and these sources of heterogeneity are much more likely to contribute to omitted variable bias across countries than across states. The results from our analysis indicate that the long-run relationship between the top decile share of income and economic growth is positive in nature. Moreover, an evaluation of several alternative income inequality measures suggests that this positive relationship is driven primarily by the concentration of income in the upper end of the income distribution.
The structure of the paper is as follows. Section II presents the new panel of annual state-level inequality measures and includes an important discussion of its key limitations. Section III then offers an empirical investigation on the impact of income inequality on the growth rate of real income per capita. Finally, Section IV offers a brief set of conclusions.
II. TRENDS IN STATE-LEVEL INEQUALITY
This paper offers a rich new panel of annual income inequality measures for the 48 states over the period 1945-2004 (N = 48, T = 60). Descriptive statistics for all the variables used in the analysis are presented in Table 1. Our inequality measures are derived from tax data reported in Statistics of Income published by the Internal Revenue Service (IRS). The pretax adjusted gross income reported by the IRS is a broad measure of income. In addition to wages and salaries, it also includes capital income (dividends, interest, rents, and royalties) and entrepreneurial income (self-employment, small businesses, and partnerships). (2) Notable income exclusions include interest on state and local bonds and transfer income from federal and state governments. Further details on the construction of the inequality measures are provided in Appendix A.
Figure 1 presents the annual trends in real income per capita and income inequality averaged over the 48 states. Shaded areas show periods of recession as defined by the National Bureau of Economic Research (NBER). The solid line (left scale) shows the yearly trend in the logarithm of real income per capita. Average state-level real income per capita in 2004 ($31,908) was over three times greater than that in 1949 ($10,320 in 2004 constant dollars), the lowest year in the period. The thick dashed line (right scale) shows the yearly trend in the share of income held by the top 10% of the population. The top decile share of income has grown substantially over this 60-yr period, from a low of 28% in 1953 to a high of 43% in 2000.
Aggregate U.S. trends in income inequality from IRS income data have been explored before, most notably by Piketty and Saez (2003, 2006), who construct several time-series measures of U.S. top income shares spanning the period 1913-1998. Piketty and Saez find that income inequality in the United States has displayed a distinct U-shaped pattern. In the early part of the century, inequality declined substantially, particularly during the Great Depression and World War II (see also Goldin and Margo 1992). After three decades of post-World War II stability, large increases in inequality began in the 1980s, with a significant part of this increase occur ring after the Tax Reform Act of 1986, and continued throughout the 1990s (see also Gottschalk 1997; Krueger 2003; Levy and Murnane 1992).
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The new state-level inequality panel we present appears quite consistent with the aggregate U.S. data of Piketty and Saez. Comparing our measure of the top 10% share of income averaged across the 48 states (shown in Figure 1) to the total U.S. share presented in Piketty and Saez (2003, 11), the mean share of income for the period of commonality (1945-1998) is 32.7% in our panel and 34.0% in the time-series data of Piketty and Saez. The minimum annual share of income is 28.2% in our sample and 31.4% in Piketty and Saez (both occurring in 1953), while the maximum annual share is 41.9% in our panel and 41.4% in Piketty and Saez (both occurring in 1998). Moreover, the Pearson's correlation coefficient between the two series is 0.980, while the Theil U statistic is 0.044. (3)
The distinguishing feature of our panel is the construction of annual inequality measures for each of the states. State-level inequality panels have been used before, notably by Panizza (2002) and Partridge (1997, 2005), though these panels are spaced at 10-yr or longer intervals. Figure 2 shows the individual state-level trends in the top 10% share of income and the log of real income per capita. Overall, many of the individual states appear to replicate the general trend and level of U.S. inequality discussed above. The lowest level of income inequality over the 60-yr period occurred in West Virginia (with an average top decile share of income of 30.5%), while the largest level of inequality occurred in Florida and New York (37.7% and 37.5%, respectively)....
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