Household Debt and Income Distribution

Our previous work argued that the official U.S. poverty definition is flawed because it ignores interest paid on household debt. When it was developed in the early 1960s, this was not a problem because U.S. households had little consumer debt. Today, most households have considerable consumer debt and are paying high interest rates on that debt. This paper argues that what is true of poverty is likewise true of income inequality indices, such as the gini coefficient and the percentage of middle-class families. Interest payments on past debt reduce the income that households have to maintain a certain standard of living. A problem (such as a bout of unemployment, the expenses of having a new baby, or a health problem) leads to borrowing that tends to reduce household living standards in the long run. This phenomenon is not captured in standard measures of income equality. We then use the Survey of Consumer Finances to correct this problem, estimating income inequality both before and after subtracting interest payments on consumer debt. Finally, we discuss why these different measures have increased over time and conclude with some policy proposals to deal with the problem of substantial consumer debt interest payments.