The latest analysis of family income by the Congressional Budget Office (CBO) understates the rate at which inequality has risen over the past 35 years. CBO’s analysis fails to capture the full extent of the increase in income inequality due to the way it treats Medicare and Medicaid spending.
The newly released analysis of family income from the CBO shows the same picture as previous versions: since 1979 the upper fifth of households have pulled ahead from everyone else. Specifically, the CBO shows that the average income of the upper fifth of households grew 95 percent between 1979 and 2014, some 1.9 percent per year, while the lower four-fifths grew 26–28 percent, a mere 0.7 percent annually.
But the CBO’s family income picture understates the rate at which inequality has increased over the past 35-year period in two ways.
First, many households in the top fifth of income are closer to the bottom four-fifths than they are to those in the top 5-- and especially the top 1-- percent. The average income, before taxes and transfers, of the top percentile of households more than tripled since 1979, growing 3.4 percent per year; the average income of the 80–90th percentiles grew only 1.2 percent per year over this period.
Second, the CBO includes public benefits such as Social Security and Medicare in this measure, reserving transfers for means-tested benefits such as Medicaid and the Supplemental Nutrition Assistance Program (SNAP). While this definition allows the CBO to assess more carefully the impact of means-tested programs, it understates the degree to which the market incomes of the top have grown relative to those in the middle. Market income of households in the 40–60th percentiles grew by only 9.1 percent total over 35 years — just under one-quarter of one percent annually.
The CBO then presents data on the growth in income after taxes and transfers. While taxes and transfers had little impact on income growth among the top fifth percentile (97 percent, up slightly from 95 percent), the income after taxes and transfers of the 20–80th percentiles rose 42 percent, and that of the bottom fifth grew 69 percent — compared to pre-tax and transfer gains of 28 and 26 percent, respectively. By these measures, taxes and (means-tested) transfers successfully narrowed a fair bit of the increase in inequality by redistributing downward, especially to the bottom quintile of the income distribution.
Much of this redistribution — particularly at the bottom — is a result of Medicaid. While some of the increase in Medicaid spending represents improved health care services, much of it is due to the explosion in health care costs in the United States. In 1979, Germany was spending 94 percent as much per person on health care as the United States; by 2014 Germany spent only 57 percent as much per person on health care.
Medicaid has been more successful than the United States’ private sector at controlling costs, but the fact is that much of the increase in Medicare and Medicaid benefits does not represent a real increase in household income for beneficiaries, but rather for the doctors and drug companies providing the services.
Thus, rather than breaking out taxes and means-tested transfers from total income, we use the CBO data to distinguish market income and all tax-and-transfer income, with Medicare and Medicaid broken out separately. We also use the ratio of per capita spending in Germany to the US as a benchmark. Our calculations assume that the share of spending on programs that actually improve people’s health is equal to the percentage of Germany’s per capita spending relative to US spending. The rest is assumed to be paying for waste in the US health care system. Rather than considering all types of households, we separately consider each of the three types of households for which the CBO provides data.
As the CBO data shows, efforts at redistribution have compensated for only a fraction of the increase in inequality. Considering that real per-capita GDP has grown 75 percent over the 35 years studied, growth in income at the top has been rapid, while incomes at the bottom and middle have increased very little. Rapid increases in health care costs have meant increased Medicare and Medicaid spending benefitting the market incomes of the top more than the after-tax-and-transfer incomes of the bottom. Even fully counting the high cost of health care as income, growth for most households has lagged per-capita GDP — let alone kept pace with the top 1 percent.
Clearly, policy must focus more heavily on incomes before taxes and transfers if the majority is to share equitably in economic growth.
 This calculation is complicated somewhat by the fact that a household in the middle quintile was more likely to be retired in 2014 than in 1979.
 Note that in 1979, US life expectancy was 73.9 years, compared to 72.8 years in Germany; by 2014 the roles had reversed, with German life expectancy at 81.2 years compared to 78.9 years in the US. There is no evidence that the increased spending has bought the United States better health outcomes. Life expectancy at age 65 and infant mortality are also better in Germany. Its health care system is also comparable by a wide range of narrower outcome measures, like cancer survival rates.