Income Changes over the Business Cycle: Was the Great Recession Different?

...timely federal tax cuts, combined with increases in food stamps and other in-kind transfers ... greatly cushioned the blow of falling incomes...

To a much greater degree than in the three previous economic downturns, the fall in median income during and after the Great Recession was accounted for by rising joblessness rather than by falling wages, according to Accounting for Income Changes over the Great Recession (2007‒2010) Relative to Previous Recessions: The Importance of Taxes and Transfers (NBER Working Paper No. 19699). Moreover, the study's authors, Jeff Larrimore, Richard Burkhauser, and Philip Armour, find that timely federal tax cuts combined with increases in food stamps and other in-kind transfers normally not captured in Census Bureau income statistics, greatly cushioned the blow of falling incomes, limiting what would have been a 7.0 percent decline in median incomes over the 2007-10 period to a 4.1 percent decline. In contrast, tax increases in the sharp recession of 1979-82 compounded the worsening economic conditions, turning a 5.8 percent decline in median income into a 6.6 percent drop.

The authors show that this helps explain the surprising finding that when government taxes and in-kind transfers are added to the income normally captured by the Census Bureau, the actual decline in median income was smaller during the Great Recession than during the recession of 1979-82. They note that "previous decomposition studies have not included the role of either tax policies or in-kind transfers, [so] they will greatly understate the increasing role that government policies have played in mitigating median post-tax household income declines and understate the resources that were available to the bottom half of the distribution of Americans over the Great Recession."

This importance of government tax credits and in-kind transfer income is most pronounced when looking at the bottom quintile of the income distribution. A measure of income that only includes market income (wages, rents, dividends, etc.) and in-cash government income (unemployment insurance, Social Security benefits, etc.) - what the authors call "pre-tax" income - fell by 12.3 percent for households in the bottom quintile. But after accounting for government tax policies and in-kind transfers like food stamps (SNAP), mean "post-tax" income declined only 4.1 percent. During the 1979-82 period, in contrast, the nearly 14 percent decline in mean pre-tax income for the bottom quintile was hardly affected by after-tax and in-kind transfers.

The post-tax effects on the mean income of households in the top quintile were more subtle but still positive. The authors find a 4.2 percent decline in pre-tax income, compared with a 3.1 percent decline in post-tax income. In 1979‒82, for the top quintile, pre-tax income fell 1.4 percent and post-tax income declined by 2.8 percent.

One of the starkest contrasts between 1979-82 and 2007-10 involves the earnings of male workers who were heads of households. Mean earnings of full-time workers dropped 3.9 percent in the earlier period; they actually rose 0.9 percent in the later period. The biggest single difference in the government's response to the two sharp recessions was tax policy. In the high inflation era of 1979-82, tax brackets were more progressive than in the later period and they weren't indexed for inflation. Households were therefore pushed into higher brackets (so-called bracket creep) and paid more taxes even when their real incomes weren't rising. But the Great Recession spawned tax rebates and cuts under the Economic Stimulus Act of 2008 and the American Recovery and Reinvestment Act of 2009; these boosted median post-tax income by 2.0 percentage points.

Almost as important as tax changes to mitigating the 2007-10 downturn were public transfers, especially increases in unemployment benefits, workers' compensation, veterans' benefits, and food stamps. Adjusting for changes in household size, mean public transfers per person rose 24.8 percent from 2007 to 2010, more than twice the increase from 1979 to 1982, and boosted post-tax median income by 1.7 percentage points.

--Laurent Belsie