Don't Believe It, Matt! Income Inequality Did Rise! A Lot!

Matthew Yglesias falls into a trap. He makes the mistake of crediting an empirical claim--in this case Alan Reynolds's claim--on the editorial page of the Wall Street Journal. The claim is that there is:

http://online.wsj.com/article/SB116607104815649971.html?mod=googlenews_wsj no clear trend toward increased inequality after 1988 in the distribution of disposable income, consumption, wages or wealth. The incessantly repeated claim that income inequality has widened dramatically over the past 20 years is founded entirely on [Piketty and Saez's] seriously flawed and greatly misunderstood estimates of the top 1%'s alleged share of something-or-other. The politically correct yet factually incorrect claim that the top 1% earns 16% of personal income appears to fill a psychological rather than logical need. Some economists seem ready and willing to supply whatever is demanded. And there is an endless political demand for those able to fabricate problems for which higher taxes are, of course, the preferred solution. In Washington higher taxes are always the solution; only the problems change.

Matthew writes:

Matthew Yglesias / proudly eponymous since 2002: Alan Reynolds' argument that we've been mis-measuring inequality by using flawed tax return data.... [T]his seems like an important project and I'll be eager to read the lengthier, non-op-ed form of his argument along with, one hopes, commentary on it from people better-equipped than I to evaluate the work...

Matthew thus forgets the two rules of reading the editorial page of the Wall Street Journal:

1. When you feel tempted to credit a surprising empirical claim found on the editorial page of the Wall Street Journal, your first step should be to lie down until that feeling goes away.
2. When you are tempted to believe that something on the editorial page of the Wall Street Journal brings new information to the party and sheds new light on the facts, don't.

One thing you can't learn from Reynolds's op-ed is that, back in their original paper that they wrote six years ago and published in 2003 http://elsa.berkeley.edu/~saez/pikettyqje.pdf, Thomas Piketty and Emmanuel Saez thoughtfully considered many of the claims made by Alan Reynolds. Here is some of what they wrote back then:

[W]e build new homogeneous series on top shares of pretax income and wages in the United States... based primarily on tax returns data published annually by the Internal Revenue Service... as well as on the large micro-files of tax returns released by the IRS since 1960.... We argue that both the downturn and the upturn of top wage shares seem too sudden to be accounted for by technical change alone. Our series suggest that other factors, such as changes in labor market institutions, fiscal policy, or more generally social norms regarding pay inequality may have played important roles in the determination of the wage structure. Although our proposed interpretation for the observed trends seems plausible to us, we stress that we cannot prove that progressive taxation and social norms have indeed played the role we attribute to them. In our view, the primary contribution of this paper is to provide new series on income and wage inequality.

One additional motivation for constructing long series is to be able to separate the trends in inequality that are the consequence of real economic change from those that are due to fiscal manipulation. The issue of fiscal manipulation has recently received much attention. Studies analyzing the effects of the Tax Reform Act of 1986 (TRA86) have emphasized that a large part of the response observable in tax returns was due to income shifting between the corporate sector and the individual sector [Slemrod 1996; Gordon and Slemrod 2000]. We do not deny that fiscal manipulation can have substantial short-run effects, but we argue that most long-run inequality trends are the consequence of real economic change, and that a short-run perspective might lead to attribute improperly some of these trends to fiscal manipulation....

[...]

[T]he evidence suggests that the twentieth century decline in inequality took place in a very specific and brief time interval. Such an abrupt decline cannot easily be reconciled with a Kuznets-type process. The smooth increase in inequality in the last three decades is more consistent with slow underlying changes in the demand and supply of factors, even though it should be noted that a significant part of the gain is concentrated in 1987 and 1988 just after the Tax Reform Act of 1986 which sharply cut the top marginal income tax rates (we will return to this issue)....

[...]

Our long-term series place the TRA86 episode in a longer term perspective. Feenberg and Poterba [1993, 2000], looking at the top 0.5 percent income shares series ending in 1992 (respectively, 1995), argued that the surge after TRA86 appeared permanent. However, completing the series up to 1998 shows that the significant increase in the top marginal tax rate, from 31 to 39.6 percent, enacted in 1993 on did not prevent top shares from increasing sharply. From that perspective, looking at Figures II and III, the average increase in top shares from 1985 to 1994 is not significantly higher than the increase from 1994 to 1998 or from 1978 to 1984. As a result, it is possible to argue that TRA86 produced no permanent surge in top income shares, but only a transitory blip. The analysis of top wage shares in Section IV will reinforce this interpretation. In any case, the pattern of top income shares cannot be explained fully by the pattern of top income tax rates....

[...]

From 1970 to 1984 the top 1 percent share increased steadily from 5 percent to 7.5 percent (Figure IX). From 1986 to 1988 the top shares of wage earners increased sharply, especially at the very top (for example, the top 1 percent share jumps from 7.5 percent to 9.5 percent). This sharp increase was documented by Feenberg and Poterba [1993] and is certainly attributable at least in part to fiscal manipulation following the large top marginal tax rate cuts of the Tax Reform Act of 1986 (see the discussion in Section III above). However, from 1988 to 1994, top wage shares stay on average constant, but increase very sharply from 1994 to 1998 (the top 1 percent wage share increases from 9 percent to 11 percent). While everybody acknowledges that tax reforms can have large short-term effects on reported incomes due to retiming, there is a controversial debate on whether changing tax rates can have permanent effects on the level of reported incomes. Looking at long-time series up to 1998 casts doubts on the supplyside interpretation that tax cuts can have lasting effects on reported wages.

Part of the recent increase in top wages is due to the development of stock options that are reported as wages and salaries on tax returns when they are exercised. Stock options are compensation for labor services, but the fact that they are exercised in a lumpy way may introduce some upward bias in our annual shares at the very top (top 0.1 percent and above). To cast additional light on this issue and on the timing of the top wage surge, we look at CEO compensation from 1970 to 1999 using the annual surveys published by Forbes magazine since 1971. These dataprovide the levels and composition of compensation for CEOs in the 800 largest publicly traded U. S. corporations.... Consistent with the evolution of top wage shares, average CEO compensation has increased much faster than average wage since the early 1970s. Therefore, the increase in pay gap between top executives and the average worker cannot be attributed solely to the tax episodes of the 1980s....

[...]

Similarly, the huge increase in top wage shares since the 1970s cannot be the sole consequence of technical change. First, the increase is very large and concentrated among the highest income earners. The fractiles P90–95 and P95–99 experienced a much smaller increase than the very top shares since the 1970s. Second, such a large change in top wage shares has not taken place in most European countries which experienced the same technical change as the United States. For example, Piketty [2001a, 2001b] documents no change in top wage shares in the last decades in France. DiNardo, Fortin, and Lemieux [1996] argue that changes in institutions such as the minimum wage and unionization account for a large part of the increase in U. S.... Changing social norms regarding inequality and the acceptability of very high wages might partly explain the rise in U. S. top wage shares observed since the 1970s...

Comments

[bigTom]

One would expect a different effect from changes in the marginal tax rates on income versus wages. A decrease in marginal tax rates for upper income shares likely increase inputs to investments -and over time would be expected to lead to an increase in investment income. Of course changes in Capital gains, and/or dividend taxes would add an additional complicating effect, likely changing the focus of portfolios away from deferred income (cap gains) towards dividends.

[Alan Reynolds]

[If you wanted to have any credibility at all, you would have the "academic version" now. And you don't.]

Of course Saez has acknowledged some of the data problems I mentioned, which is why I quoted him (in context)in the piece. I deal with the international evidence at length in Chapter 5 of my textbook on "Income and Wealth," and how that evidence (including Canada) confirms rather than contradicts U.S. studies of taxable income elastiticty (including two with Saez as author or co-author). There will also be a longer yet still simplified version at cato.org., and an academic version later.

[anne]

http://www.nytimes.com/2006/01/29/national/29rich.html?ex=1296190800&en=784822e4b0735ee5&ei=5090&partner=rssuserland

Again, 1% of households controlled 57.5% on corporate stock in 2003 which alone should tell us all we need to know about how concentrated wealth is and how concentrated income must be.

[anne]

http://www.nytimes.com/2006/01/29/national/29rich.html?ex=1296190800&en=784822e4b0735ee5&ei=5090&partner=rssuserland&emc=rss

January 29, 2006

Corporate Wealth Share Rises for Top-Income Americans
By DAVID CAY JOHNSTON

New government data indicate that the concentration of corporate wealth among the highest-income Americans grew significantly in 2003, as a trend that began in 1991 accelerated in the first year that President Bush and Congress cut taxes on capital.

In 2003 the top 1 percent of households owned 57.5 percent of corporate wealth, up from 53.4 percent the year before, according to a Congressional Budget Office analysis of the latest income tax data. The top group's share of corporate wealth has grown by half since 1991, when it was 38.7 percent.

In 2003, incomes in the top 1 percent of households ranged from $237,000 to several billion dollars.

For every group below the top 1 percent, shares of corporate wealth have declined since 1991. These declines ranged from 12.7 percent for those on the 96th to 99th rungs on the income ladder to 57 percent for the poorest fifth of Americans, who made less than $16,300 and together owned 0.6 percent of corporate wealth in 2003, down from 1.4 percent in 1991....

[anne]

The tricks the tricksters use are using consumption as a supposed measure of inequality, which is all the current rage, or telling us how much more taxes are paid by the richest of the rich than others to show that there is inequality but it is fair inequality.

So we are told a "rich" person might spend $40,000 a year, while a poor person would spend $40,000 / 6.5 or $6154 a year, since the rich and the poor are supposed to spend the same portions of income.

The example of course is absurd, since a person who simply spends $500 dollars a month on rent, say, with utilities thrown in, would have $154 dollars to eat and clothe and travel for the year. So the poor actually must spend more income relatively simply to survive, but if the poor spend relatively more on consumption than the rich are the poor not really rich?

Trick away, trickers.

[anne]

http://www.nytimes.com/2006/12/12/opinion/12tue2.html?ex=1323579600&en=f5dd4ceb951b887a&ei=5090&partner=rssuserland&emc=rss

December 12, 2006

Consumption Gap

Conservative economists often argue that wage stagnation and income inequality are not as big a threat to Americans' standard of living as they've been made out to be. In their view, how much one buys — rather than how much one makes — is a better measure of economic well-being.

In a recent article in The National Review, researchers at the American Enterprise Institute asserted just that, saying that when you look at how much the middle class is consuming, they're "even doing better than the upper crust."

Why make a fuss over other grim economic statistics if everyone manages to keep buying things?

Here's why. The assertion — that the middle class has out-consumed the "upper crust" during the Bush years — is false, the result of rosy assumptions that turned out to be wrong.

Researchers at two other think tanks, the Center on Budget and Policy Priorities and the Economic Policy Institute, reworked the figures, including newly available spending data for 2005. There is no dispute among the various researchers over the new findings. Over all, consumption is growing. But the growth is unbalanced, consistent with the wide disparity in wages and income that has characterized the Bush years.

Consumer spending by low-income households is way down since 2001. Over the same period, spending by high-income Americans has been robust, supported, in part, by generous tax cuts. In 2005, the top 20 percent of households made 39 percent of all consumer expenditures, the highest share since the government started keeping track in 1984....

[anne]

Yes; there is wealth inequality and it is growing, and there is income inequality that is growing as wealth inequality grows. No; consumption patters do not show the poor are as well off as the rich only that they save less. No; the fact that the rich pay more in taxes than the poor does not in the least show that we are using taxes to make the rich less rich and poor richer and reversing the trend to inequality.

Inequality in wealth and income has been increasing for 25 years, but these last 6 years we have designed economic policy that will accentuate inequality. So, 1% of households control 57.5% of corporate stock while the maximum tax on dividends and capital gains is 15%. I would suggest the taxes the rich pay on corporate shares is not in any way designed to, say, increase equality.

[bigTom]

Anne, I agree with the gist of your agument. However the statement that the max tax on dividends and capital gains is 15% is misleading. The Alternate Minimum Tax, has a marginal rate of 21%, presumably those in the top 1% have enough income that the deduction isn't much of a factor.

[anne]

Tom,

Nice argument; actually though the point of the Alternative Minimum Tax is that the effect is only relevant for those who are upper middle class to moderately wealthy. Say $112,000 to $273,000 for a single tax filer, $150,000 to $382,000 for a couple. Above those levels tax structure is flat to gently regressive.

[howard]

i'm thrilled to see that alan reynolds has actually shown up here to spread more horse manure. people who make dishonest claims on the dishonest editorial pages of the wall street journal are the ones with psychological needs, and they aren't pretty, either.

sorry, alan: you're wrong and dishonest, and you've been found out.

[kharris]

The good news, regarding Matt Y, is that when he decided some time back that he knew enough to write about economics, he often did not. In the post cited here, he didn't presume to reach a conclusion about economics. He merely declared himself interested in seeing a fuller elaboration of Reynolds' claim, and a critique by those qualified to offer one. That's intellectual progress. In fact, a good bit has now been written. I believe three-card-monte was the key phrase in one such critique.

[Paul Botts]

Does anyone have an answer to these two logic questions about Piketty-Saez?

(a) Why exactly did they leave transfer payments out of their version of personal income? They note having done so but I can't find any explanation of why, including at Saez's blog.

(b) If the 1986 tax code changes caused a short-term distortion in the data, why wouldn't those distortions be persistent in the data for years since that period? Did subsequent tax-law changes reverse them, moving some high-end incomes back from individual to business tax returns?

Thanks in advance for illumination.