Measuring Trends in Income Variability

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Abstract

Using PSID data from 1968 to 2005, we find that the volatility of family income has increased over time (a trend that is robust to a large variety of modeling choices) but the trend in individual income volatility is less clear. Measurement error cannot fully account for these facts, but the increasing covariance of individual incomes within the family (driven by increases in the correlation of head and spouse earnings, due largely to the increased proportion of families with two earners) can.

Introduction

Concerns about the economic security of American families play a prominent role in contemporary political discourse. Driving the debate over economic security is a body of polling data indicating that, over the past two to three decades, Americans have become increasingly concerned about their ability to maintain their economic status. Between 1982, the trough of a major recession, and 1998, the peak of the dot-com boom, the percentage of Americans who reported being somewhat or very worried about being laid off nearly quadrupled, rising from 12 to 46 percent. Though fears eased somewhat in the early 2000s, the equivalent figure in 2007 was still 35 percent¹. Similarly, a recent study by the Pew Research Center (Taylor et al. 2008) revealed that nearly 80 percent of Americans believed it was more difficult for middle class families to maintain their standard of living today than it was five years ago. These findings are quite dramatic, and have inspired a number of recent efforts to quantify changes in the economic risks facing American families, most often using the longitudinal variability (often called volatility) of income over time as a proxy for income risk.

The results of these studies, however, remain less than clear cut. Recent reports claim that the income variability Americans experienced tripled during the 1990s and other reports claim income variability remained unchanged. Some of the differences in recent estimates can be traced to differences of definition of income (e.g. individual earnings or family income), or to data (it is unclear what the best data source is since each has limitations), or to differences in method, and it can be difficult to assess what differences in results we should expect from different methods. The remainder of this paper outlines the major choices the various estimates incorporate and some of their consequences.

We can’t directly measure income risk (for example, what the variance of next year’s income is for a given person at a point in time) since various outcomes that might have come about but didn’t are never observed. We can measure income variability (movements up and down over time), and this is similar to how volatility is measured for other variables, such as stock prices. We use the terms variability and volatility interchangeably throughout, but eschew the terms stability and instability, since these have a very distinct statistical meaning.

We find that the major difference arises between estimates that use family income and those that use individual income or earnings, and that the volatility of individual income may or may not have increased over the last 30 years, depending on how it is measured, but that the volatility of family income looks to have risen by a quarter or more over the same time. The estimated rise in family income volatility is remarkably robust to a variety of changes to specification and definition, whereas the estimated trend in own earnings volatility depends on details of the estimation procedure.

¹Kulesa (2007). Kulesa is global research director for ISR, and was discussing in October 2007 the Towers Perrin-ISR annual survey, conducted in the summer of 2007. The survey is conducted across more than 400,000 employees and asks for a yes/no response to the statement “I am frequently concerned about being laid off.”

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The nonpartisan Urban Institute publishes studies, reports, and books on timely topics worthy of public consideration. The views expressed are those of the authors and should not be attributed to the Urban Institute, its trustees, or its funders.

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