What happened to real incomes in the 1970s?

Here are the estimates for average and median total incomes based on tax file data (see this post for details):

I was comforted to see that the estimates for median incomes after 1976 have the same U-shape as those in the Statistics Canada tables :

The fact that the two data sources say basically the same thing about what happened after 1976 gives me some hope that the tax file data before 1976 shouldn't be dismissed out of hand. And if you take them seriously, then it the fact that the Statistics Canada tables only start in 1976 is extremely unfortunate. If you start in 1976, you start with a story of declining real median incomes, and that's the story we've all become accustomed to hearing. But the tax data offer a much more nuanced story.

The narrative suggest by the tax file data says that yes, there was a decline in real median after 1976, but that decline occured after a startling surge in the early 1970s : real median incomes increased by more than 36 per cent between 1970 and 1976.

That surge in real incomes is surprising. There's certainly nothing in real GDP data that suggests such an increase during the early 1970s:

GDP is both a measure of total output and income and the total income reported in taxable income files is just over half of nominal GDP; you'd expect such a large increase in the income reported in tax files to show up in the GDP.

I think what's going one here is not a divergence in the numerators of real GDP per capita and real income per capita so much as it is on the denominators. The GDP deflator is used to calculate real output, but measures of real income use the CPI. I'm pretty sure that most economists think that these two broad-based price indices are interchangeable, but they're not (see also this post).

The ratio of producer to consumer prices is the labour terms of trade (I understand that the term originates in the economic development literature). If you want to make a link between wages and productivity, then the output price is the relevant deflator in the calculation of real wages. But if you want to make a link between wages and welfare, then the CPI is the relevant deflator for determining workers' purchasing power. If producer prices increase while consumer prices stay the same, competitive firms will pass the price increase along to their workers, and since consumer prices haven't changed, workers' welfare increases. Similarly, if consumer prices increase and producer prices stay the same, nominal wages won't keep up with the cost of consumer goods and workers' welfare will fall.

Look at what happened to Canada's labour terms of trade in the 1970s:

The early 1970s saw a 10 per cent increase in the labour terms of trade, and this shows up as a sharp increase in the workers' purchasing power. This is the same thing as saying that real (in CPI terms) incomes increased dramatically.

You can see a similar surge in Canada's terms of trade (the ratio of the prices of exports and imports) in the early 1970s. This tells a similar story: - the prices of what Canadians were selling on world markets increased relative to the prices of what they were buying, thus increasing Canadians' purchasing power.

The sharp increase in the labour terms of trade led to a sharp increase in real incomes in CPI terms, but it only lasted a few years. The ratio of producer prices and consumer prices started to decline in 1976 - which also happens to be the first year of the Statistics Canada income tables.

The tax file data suggest a narrative different from the one we're used to hearing. Apart from a temporary burst in purchasing power that markets provided Canadian consumers in the 1970s, the long-term path of real incomes in the post-war era has been remarkably stable. Current real incomes are not far from the trend that was established in the 1950s and 1960s.

 

Comments

[Alexis H]

There's been evidence of some significant tax evasion in the higher tax brackets recently. Do you think that may be happening enough to mask a higher inequality when the data is calculated from tax returns? Do you think this factor has or has not gotten worse over the years?

[Stephen Gordon]

These data stop in 2010, so they can't speak to that.

[Dee]

We were a lot closer to Britain than the U.S. in those days. There was alot of goings on which could explain the bump.

Interesting post.

Thank you.