The Life Cycle of Earnings

How do individual labor earnings evolve over the course of a person's life? If you have ever asked yourself "Should I expect my income to increase this year?" and "By how much?" this post might interest you. In a very elegant study, Guvenen, Karahan, Ozkan and Song have tried to answer these questions and more, using over 200 million tax data observations from Social Security Administration (between 1978 and 2010). If you ever thought tax data was not public, this (and my last post) might suggest that they are not. Don't worry. Only a few people are allowed to use this information, and even then they are not allowed to actually see the name of the person behind each income observation.

Looking at employed people between the ages of 25 and 60, they focus on how much earnings grow every year in average. A first look at the data is provided in Figure 1. Taking the average among all the population, yearly income peaks around 50 years old, with an increase as high as 127% from age 25.

Figure 1: Average (Log) Earnings by Age.

If you are past age 50 and have not seen such an increase, you might be wondering what's wrong with yourself. Before entering into such a depressing state of mind, please read a few more lines. This average income path hides a lot of variation across different people. More importantly, it is strongly influenced by the very top earners. Figure 2 shows that the median worker only shows a 38% increase in his earnings between age 25 and 55. It is the very top earners who influence the 127% number before. For example, the Top 1% shows 1500% increase in their earnings in that same period. More than 300 times the median increase in earnings...

Figure 2: Earnings Growth (25 to 55) by Lifetime Earnings.

Another interesting finding is that income does not peak at the same age for everyone. Even though the average person's income peaks around the age of 50, this is not the case for most people. Figure 3 shows that the median worker has almost no income growth between 35 and 45, and only the top 2% actually experience earnings growth after 45.* I hope these depressing findings for the median worker might help your self-confidence. The average numbers shown in Figure 1 are not the appropriate ones to question your life. (Figures 2 and 3 might be...)

Figure 3: Earnings Growth by Decade of Life.

Some other interesting findings in these article are that the dispersion of income growth (i.e. how much income growth differs across individuals) has a U-shape, decreasing with age up to when people are 50 years old where it spikes up again. Top earners are the exception once again, since their income dispersion grows every year of their lives. 

How about the asymmetries? Is it more likely to be below or above the average increase in income? The data suggests that as people get older or richer, it is more likely to get negative shocks to income. And these seems to be due to there being more room to fall down (not less room to move up). The higher your income, the more you can lose (remember most people are not willing to pay to work, so you cannot have negative wages).

Finally, let me end with a happy note. Suppose you just saw your income go down. You might be worried that it will remain like this for a long time. The data suggests otherwise. If the decrease was very strong, it is most likely that the persistence will be very short (unless you were a very high earner). In less than a year you should see your income recover most of its previous value.
(Very Small Print Note: this does not mean you should just lay down and wait for this fact to bring your salary back to normal. No complaints are accepted if incomes do not go up.)

* Remember that if a distribution is such that there are a few outliers with extremely high income growth, we will observe an average growth much higher than the one the median worker has. Hence, focusing on the median worker might be more illustrative in these cases. 

Based on an article by Guvenen, Karahan, Ozkan and Song.