2000-25

August 25, 2000

Have Californians Kept Up in the 1990s?

Although by most measures the California economy has been outperforming the U.S. economy for nearly five years, a number of statistics on family income suggest that Californians are losing ground relative to others in the U.S. Data on income growth show that while median family income outside of California grew by more than 8% between 1989 and 1998, median family income in California declined by 4%. This divergence in outcomes has not been limited to income growth at the median. In 1998, a greater number of Californians lived in poverty, a smaller number were in the middle class, and a majority had family incomes below those of comparable families living outside of California.

Such statistics have struck a nerve among policymakers, researchers, and the public, and have prompted many to ask whether the government should take a more active role in guaranteeing the equality of outcomes among the population. However, before considering policy prescriptions designed to reduce income differences between California and the rest of the nation, it is important to understand why family incomes in California have deviated from those in other states. This Economic Letter reviews recent research by Daly and Royer (2000) that examines the extent to which demographic and business cycle differences account for the divergence of California from the rest of the U.S. in the 1990s.

Tracking and measuring income

Studies of income growth typically rely on data from the March Current Population Survey (CPS). The March CPS is an annual survey of a nationally representative sample of more than 50,000 U.S. households (5,000 households in California) containing detailed questions about household composition and sources of income. These data can be used to trace changes in the distribution of real income in California and the rest of the U.S. between 1969 and 1998. Recognizing that income fluctuates with the business cycle, this analysis focuses on family income in three peak years–1969, 1979, 1989–and 1998, the latest year of data available.

Income in this analysis refers to combined pre-tax, post-transfer real resources of all members of a family. To control for the fact that $20,000 a year provides a higher standard of living for a single person than it does for a family with multiple members, all incomes are adjusted by family size. An easy way to make this adjustment is to divide total family income by the number of individuals in the family. However, to account for the possibility that economies of scale exist for larger families (“two can live relatively more cheaply than one”), the analysis assumes that a family of two requires 1.4 times the income of a family of one and that each additional person increases the family’s income needs by 0.25. All incomes are valued in 1998 dollars using the Personal Consumption Expenditure Index (PCE).

Trends in relative family income

Looking at statistics on income growth over time suggests that Californians have not experienced the same gains in income during the most recent expansion as have families elsewhere in the nation. However, these statistics reveal little about the absolute levels of income in these areas or how the standard of living in California compares to that of families living outside of California. This type of information is important to understand more fully how the absolute and relative well-being of families in California compares to other U.S. families. A simple way to assess the differences in income levels between California and the rest of the U.S. is portrayed in Figure 1. The figure shows the dollar difference in real adjusted family income between California and the rest of the U.S. by percentile with each line representing one of the four business cycle peak years used in the analysis: 1969, 1979, 1989, and 1998. Where the line is above zero, families in that percentile in California had higher real incomes than families in the rest of the U.S.; where the line is below zero, families in California had lower real incomes than families elsewhere in the nation.

As Figure 1 shows, in each of the years except 1998, families in California had higher real adjusted incomes than families elsewhere in the United States at every percentile of the income distribution. The dollar difference in income levels between California and the rest of the nation was largest in 1969. As the relative income gains outside of California surpassed those realized by Californians, the dollar difference between incomes in the state and elsewhere in the nation decreased. In 1969 a family at the 50th percentile of the income distribution in California earned about $2,418 more than the median family living elsewhere in the U.S. In 1989, the difference still was positive but had fallen to about $1,877. The change was even greater for families at the bottom of the income distribution. In 1969, a family at the 10th percentile of the California income distribution had about $1,400 more than an equivalent family living elsewhere in the U.S. By 1989, this difference had shrunk considerably; the difference in family income at the 10th percentile was about $370 in 1989.

However, the most striking result in Figure 1 is the change in California’s experience during the 1990s. In 1998, only families in the top 70th percentile or above of California’s income distribution had real adjusted incomes greater than their counterparts elsewhere in the U.S. Families occupying the remaining percentiles of California’s income distribution had lower real incomes than those at equivalent percentiles elsewhere in the nation. It should be noted that when adjustments are made for the differential cost of living in California and the rest of the U.S., the magnitudes of the differences in 1969, 1979, and 1989 are smaller, and the magnitude of the difference in 1998 is greater (Reed, Haber, and Mameesh 1996 and Reed 1999).

Factors contributing to California’s divergence from the U.S.

It is natural to ask what caused California to diverge from the rest of the U.S. in 1998. A number of factors are candidates, including differential changes in industrial structure, regional economic conditions, and demographic characteristics. While each of these is important, Daly and Royer focus on two: differential changes in the population structure and differences in business cycle timing.

To understand the extent to which changes in the demographic characteristics of California’s population have caused the income distribution in the state to deviate from that in the rest of the U.S. in the 1990s, Daly and Royer perform a simple reweighting exercise that imposes the demographic structure of the rest of the U.S. on California. The results are shown in Figure 2, which compares the dollar difference in adjusted family income by percentile in California and the U.S. in 1998 (as in Figure 1) to the dollar difference in family income between California and the rest of the U.S. when the U.S. age, sex, race, and education structure is applied.

Again, the thick solid line shows that under the actual (unadjusted) distribution of income in California, only families in the top 70th percentile or above of the California income distribution had real incomes higher than equivalent families living outside of California. In contrast, under the demographically adjusted distribution (dotted line), families from the 45th percentile and above in California have real adjusted family incomes higher than their counterparts living elsewhere in the U.S. Thus, adjusting for demographic differences moves the income gains and real adjusted family income levels in California much closer to those experienced by families outside of California. This being said, even when these population characteristics are accounted for, sizeable differences remain in outcomes between California and the rest of the U.S. during the 1990s.

Daly and Royer look at business cycle effects because California experienced a much longer and deeper recession in the early 1990s than did the rest of the U.S. Measured by changes in payroll employment growth, the U.S. economy outside of California began to recover early in 1992, when job growth turned positive, and less than one year later, total employment for the U.S. excluding California had surpassed its pre-recession peak. In California, payroll employment continued to contract until early in 1994. In addition, the number of jobs lost in California during the prolonged recession made for a slow return to pre-recession levels of employment. Total payroll employment did not surpass its pre-recession peak until January 1996. According to these data, California’s expansion is about two years behind the rest of the nation’s.

To account for this difference, Daly and Royer compare the income distribution in California in 1998 to that for the rest of the U.S. in 1996. Putting the results from the business cycle and demographic adjustment together, the thin solid line in Figure 2 shows the dollar difference in income for California and the rest of the U.S. in 1998. Recall that since Daly and Royer are adjusting for differences in business cycle timing in California, the comparison is between California incomes in 1998 and incomes in the rest of the U.S. in 1996. The exercise in Figure 2 is to compare the unadjusted line (thick solid) to the line with the simple demographic adjustment (dotted) and to the line with both the business cycle and demographic adjustment included (thin solid). The results support the hypothesis that business cycle timing matters. Combined, the business cycle and demographic adjustments succeed in lifting the real income level of Californians at nearly every percentile of the income distribution above the income values of those living outside of California.

Summary

At first glance, the income statistics on California suggest that seven years of economic expansion have left state residents worse off than those residing elsewhere in the U.S. Whether one compares income growth or income levels, families in California appear to have “fallen behind.” An examination of the causes for these disparities suggests that demographic and cyclical factors play a significant role in determining the differences between California and the rest of the U.S. Changes in the composition of California’s population relative to the rest of the U.S. account for between one-third and one-half of the differences in measures of income distribution between the two areas. Further adjusting for differences in business cycle timing explains virtually the entire observed difference between family income in California and the rest of the U.S.

Mary Daly
Senior Economist


References

Daly, M., and H. Royer. 2000. “Cyclical and Demographic Influences on the Distribution of Income in California.” FRBSF Economic Review, pp. 1-13. http://www.sf.frb.org/economic-research/econrev/2000/article1.pdf

Reed, D. 1999. “California’s Rising Income Inequality: Causes and Concerns.” Public Policy Institute of California. http://www.ppic.org/main/publication.asp?i=71

Reed, D., M. Haber, and L. Mameesh. 1996. “The Distribution of Income in California.” Public Policy Institute of California. http://web.ppic.org/content/pubs/report/R_796DRR.pdf

All URLs accessed August 15, 2000.

Opinions expressed in FRBSF Economic Letter do not necessarily reflect the views of the management of the Federal Reserve Bank of San Francisco or of the Board of Governors of the Federal Reserve System. This publication is edited by Sam Zuckerman and Anita Todd. Permission to reprint must be obtained in writing.

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