Income and earnings variability

June 30, 2008

The variability of individual earnings and household income (that is, how much a worker's earnings or a household's income bounces around from year to year) has become a topic of much interest to analysts and the policy community. Today, CBO issued a comprehensive paper on the topic. The study follows up on our earlier work on earnings and income variability -- see here.

The paper issued today examines variation over the past two decades, both for individuals and for households, using data from the Social Security Administration (SSA) and the Census Bureau. The bottom line from the analysis is that a substantial fraction of workers experience large changes in their earnings from one year to the next, though the trend in earnings variability has been roughly flat since the mid-1980s. A somewhat smaller percentage of households see large changes in their income; that trend has also been roughly flat over the same period. (Some other recent studies relying on other data sources have suggested increases in the volatility of household and family income, but various problems in the surveys used in those studies may be contaminating those results. The administrative data upon which CBO relies tend to be more consistent over time and more accurate in general than many survey results.)

Individual Earnings

CBOs new analysis of the extent to which workers earnings vary from year to year builds on our previous work. Despite slight differences in the age ranges examined and the methods used, the results are consistent with those in the earlier analyses. The main findings of the current analysis, which covers the period from 1984 to 2003, are:

  • A substantial fraction of workers ages 25 to 55 experience large changes in earnings from one year to the next. For example, about 40 percent of workers experienced a change in earnings of 25 percent or more between 2002 and 2003. More than a quarter of those workers experiencing large changes in earnings move into or out of employment covered by Social Security.
  • Women, younger workers, and workers with lower earnings experience large changes in earnings more frequently than their counterparts.
  • Overall, the year-to-year variability of earnings has changed little since the mid-1980s.

Household Income

Changes in overall economic well-being are better captured by a broader measure than individual earnings. Because many people live in households with other earners or have nonlabor income (including, for example, unemployment insurance or interest income) that may mitigate or exacerbate the economic effect of any changes in his or her own earnings, CBO extended its work on variability in individual earnings to include an analysis of variability in household income. The main findings from that analysis, which covers the period from 1984 to 2005, are:

  • Large changes in household income from year to year are somewhat less common than large changes in individual earnings. For example, about 25 percent of U.S. households experienced a 25 percent or larger change in income from 2004 to 2005.
  • Overall, the fraction of households experiencing large changes in income has been relatively constant since the mid-1980s. Income tends to vary more for low-income households and for households headed by younger people, by those with less education, and by those who are not married.
  • Changes in earnings are a major contributor to the changes in household income.

Although household income is a broader measure of peoples resources than individual earnings and is therefore likely to better capture some notion of overall well-being, some aspects of well-being and measures of financial resources are not considered here. For example, by looking only at before-tax income, the analysis misses the effects of taxes in a given year and the effects of changes in taxes over time on purchasing power. The tax system tends to smooth out variability at the household level by reducing year-to-year fluctuations in after-tax income. At the same time, however, the tax system imposes costs on the economy by distorting the decisions that households make about how much to work, how much to save, and how to receive their compensation. Also, the analysis does not investigate the relationship between household assets, such as savings or equity in a home, and variability in household income. Finally, the analysis does not examine the effect of changes in household income on other measures of household well-being, such as consumption or the health of household members.

The paper was written by Molly Dahl and Jonathan A. Schwabish of CBOs Health and Human Resources Division, and Thomas DeLeire, formerly of CBO. Molly was about to give birth to her first child as the paper was finished, and it was a close race to see whether the paper or her child would see the light of day first. (The baby won-- congratulations to Molly on the new addition to her family!)