How the US middle class lost ground over the last 4 decades

A comprehensive new report released by the US Congressional Budget Office (CBO) depicts a remarkable transformation of the American economy over the past four decades, revealing a deepening divide in which the wealthiest households have dramatically expanded their economic participation, while the middle class has steadily lost ground.

According to the data, which covers the period from 1979 to 2022, the distribution of national income has tilted sharply towards the top. The report shows that the richest 1% of households increased their share of income before transfers and taxes from 9% in 1979 to 18% in 2022, doubling their share of the economic pie.

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The hollowing out of the middle class

While the top prospered, the rest of the economic ladder struggled to maintain its position. The CBO found that as the richest 1% grabbed a greater share of market income, the share going to the bottom quintile fell from 5% to 4%. This means that most of the compression occurred in the middle.

Even after considering the stabilizing effects of the social safety net and the tax system, the middle class saw its relative status decline. The share of after-tax income held by the “central three quintiles” fell 6 percentage points over the 43-year period. In the opposite direction, the portion of income after taxes allocated to the richest 1% doubled, from 7% to 14%.

The disparity in growth rates is even more evident when looking at the ultra-rich. Although average income has grown for all groups since 1979, the acceleration at the top has been unparalleled. The income of the highest quintile more than doubled and, for the top 0.01% of earners, the average income after taxes grew more than seven times.

Factors of inequality

The report identifies market income — especially capital gains — as a key driver of this divergence. Capital gains make up a much larger share of income for households at the top of the distribution, leading to huge financial jumps during boom years.

As a consequence, increases in market income at the top have driven much of the overall rise in income inequality observed since the late 1970s.

The federal government tried to mitigate this increase in the gap through the tax and transfer system. The CBO notes that the degree to which taxes and transfers reduce inequality has actually increased over the past four decades.

However, the structure of federal revenue changed along with income. Because the richest now account for such a large share of total income, they also pay a larger share of the national tax bill: the top quintile accounted for 70% of all federal taxes in 2022, up from 55% in 1979.

As Penn Wharton Budget Model director Kent Smetters recently told Fortune, “what people don’t realize is how progressive the U.S. income tax system is,” by far the most progressive in the OECD. With such a progressive tax system, he added, “it’s very difficult to raise much” because the wealthy already pay such a disproportionate share.

The CBO found that over this 43-year period, dependence on government assistance increased among the poorest Americans. For the lowest income quintile, Medicaid and Chip benefits have jumped from just 9% of their income in 1979 to 48% in 2022.

Post-pandemic volatility

The CBO also presented a portrait of the volatile economy immediately following the Covid-19 pandemic. In 2022, average income after transfers and taxes fell for all income groups compared to the previous year.

For lower-income households, this drop was caused by the end of temporary pandemic-era policies, such as the expansion of the child tax credit and emergency refund credits. For the richest, the 2022 decline resulted from a sharp drop in realized capital gains, after a record in 2021.

Despite the temporary fluctuation in 2022, the long-term trend remains clear. The Gini coefficient, a standard measure of income inequality, shows that the gap between the rich and the rest of the country is significantly greater today than it was in 1979.