Notes:BC1.EF.WSJ.How to Distort Income Inequality

2014/11/12 User:Jeff

This is a copy of an article in WSJ with possibly relevant information to the subject of income inequality.

How to Distort Income Inequality

The Piketty-Saez data ignore changes in tax law and fail to count noncash compensation and Social Security benefits.

By Phil Gramm And Michael Solon

Nov. 11, 2014 6:50 p.m. ET

What the hockey-stick portrayal of global temperatures did in bringing a sense of crisis to the issue of global warming is now being replicated in the controversy over income inequality, thanks to a now-famous study by Thomas Piketty and Emmanuel Saez, professors of economics at the Paris School of Economics and the University of California, Berkeley, respectively. Whether the issue is climate change or income inequality, however, problems with the underlying data significantly distort the debate.

The chosen starting point for the most-quoted part of the Piketty-Saez study is 1979. In that year the inflation rate was 13.3%, interest rates were 15.5% and the poverty rate was rising, but economic misery was distributed more equally than in any year since. That misery led to the election of Ronald Reagan, whose economic policies helped usher in 25 years of lower interest rates, lower inflation and high economic growth. But Messrs. Piketty and Saez tell us it was also a period where the rich got richer, the poor got poorer and only a relatively small number of Americans benefited from the economic booms of the Reagan and Clinton years.

If that dark picture doesn’t sound like the country you lived in, that’s because it isn’t. The Piketty-Saez study looked only at pretax cash market income. It did not take into account taxes. It left out noncash compensation such as employer-provided health insurance and pension contributions. It left out Social Security payments, Medicare and Medicaid benefits, and more than 100 other means-tested government programs. Realized capital gains were included, but not the first $500,000 from the sale of one’s home, which is tax-exempt. IRAs and 401(k)s were counted only when the money is taken out in retirement. Finally, the Piketty-Saez data are based on individual tax returns, which ignore, for any given household, the presence of multiple earners.

And now, thanks to a new study in the Southern Economic Journal, we know what the picture looks like when the missing data are filled in. Economists Philip Armour and Richard V. Burkhauser of Cornell University and Jeff Larrimore of Congress’s Joint Committee on Taxation expanded the Piketty-Saez income measure using census data to account for all public and private in-kind benefits, taxes, Social Security payments and household size.

The result is dramatic. The bottom quintile of Americans experienced a 31% increase in income from 1979 to 2007 instead of a 33% decline that is found using a Piketty-Saez market-income measure alone. The income of the second quintile, often referred to as the working class, rose by 32%, not 0.7%. The income of the middle quintile, America’s middle class, increased by 37%, not 2.2%.

By omitting Social Security, Medicare and Medicaid, the Piketty-Saez study renders most older Americans poor when in reality most have above-average incomes. The exclusion of benefits like employer-provided health insurance, retirement benefits (except when actually paid out in retirement) and capital gains on homes misses much of the income and wealth of middle- and upper-middle income families.

Messrs. Piketty and Saez also did not take into consideration the effect that tax policies have on how people report their incomes. This leads to major distortions. The bipartisan tax reform of 1986 lowered the highest personal tax rate to 28% from 50%, but the top corporate-tax rate was reduced only to 34%. There was, therefore, an incentive to restructure businesses from C-Corps to subchapter S corporations, limited-liability corporations, partnerships and proprietorships, where the same income would now be taxed only once at a lower, personal rate. As businesses restructured, what had been corporate income poured into personal income-tax receipts.

So Messrs. Piketty and Saez report a 44% increase in the income earned by the top 1% in 1987 and 1988—though this change reflected how income was taxed, not how income had grown. This change in the structure of American businesses alone accounts for roughly one-third of what they portray as the growth in the income share earned by the top 1% of earners over the entire 1979-2012 period.

An equally extraordinary distortion in the data used to measure inequality (the Gini Coefficient) has been discovered by Cornell’s Mr. Burkhauser. In 1992 the Census Bureau changed the Current Population Survey to collect more in-depth data on high-income individuals. This change in survey technique alone, causing a one-time upward shift in the measured income of high-income individuals, is the source of almost 30% of the total growth of inequality in the U.S. since 1979.

Simple statistical errors in the data account for roughly one third of what is now claimed to be a “frightening” increase in income inequality. But the weakness of the case for redistribution does not end there. America is the freest and most dynamic society in history, and freedom and equality of outcome have never coexisted anywhere at any time. Here the innovator, the first mover, the talented and the persistent win out—producing large income inequality. The prizes are unequal because in our system consumers reward people for the value they add. Some can and do add extraordinary value, others can’t or don’t.

How exactly are we poorer because Bill Gates , Warren Buffett and the Walton family are so rich? Mr. Gates became rich by mainstreaming computer power into our lives and in the process made us better off. Mr. Buffett’s genius improves the efficiency of capital allocation and the whole economy benefits. Wal-Mart stretches our buying power and raises the living standards of millions of Americans, especially low-income earners. Rich people don’t “take” a large share of national income, they “bring” it. The beauty of our system is that everybody benefits from the value they bring.

Yes, income is 24% less equally distributed here than in the average of the other 34 member countries of the OECD. But OECD figures show that U.S. per capita GDP is 42% higher, household wealth is 210% higher and median disposable income is 42% higher. How many Americans would give up 42% of their income to see the rich get less?

Vast new fortunes were earned in the 25-year boom that began under Reagan and continued under Clinton. But the income of middle-class Americans rose significantly. These incomes have fallen during the Obama presidency, and not because the rich have gotten richer. They’ve fallen because bad federal policies have yielded the weakest recovery in the postwar history of America.

Yet even as the recovery continues to disappoint, the president increasingly turns to the politics of envy by demanding that the rich pay their “fair share.” The politics of envy may work here as it has worked so often in Latin America and Europe, but the economics of envy is failing in America as it has failed everywhere else.

Mr. Gramm, a former Republican senator from Texas, is a visiting scholar at the American Enterprise Institute. Mr. Solon was a budget adviser to Senate Republican Leader Mitch McConnell and is a partner of US Policy Metrics.

Some relevant reader comments:

Szabolcs Szentpetery 6 minutes ago Socialism and income redistribution failed in many countries. In Hungary it was introduced in 1947, they took our house, land and my father went to jail- he was in the Small Farmer Party. From then on everybody got the same paycheck and lived from paycheck to paycheck.Became a motto:" they pretend to pay us and we pretend to work".The economy died. As the government stole from everybody the morals went to hell. NEver really recovered. The leaders gotten rich, though. Socalism is a scheme for the leaders to become rich, everybody else suffers equally. The human lives lost in the transformation is staggering, 30-40 million in Russia and China equally.Recently 2 million in Cambodia...It is a social experiment that should not be repeated

Michael Hatem 10 minutes ago No one is talking about rising income. Of course people earn more today than in 1979. However their share of the total economic pie is much smaller. In 1980 the bottom 80% owned 50% of America's wealth today they own 20%. That is unsustainable and rationalizing it away does not help this country compete on the global stage. In 1980 we had the best educated popultion, the healthiest population, the best healthcare, lead the world in all form of technology and were the most egalitarian, none of that is true today. The cause of that decline is the very policies that Mr. Gramm is now championing.

JOSEPH MICHAEL 14 minutes ago In other words, high income people push the right-hand "tail" of the income distribution way further to the right. Eventually this push to the right drags the entire median to the right with it.

Jerome Abernathy 15 minutes ago Too bad the authors decided to play politics rather than address the real issues.

There are secular global trends that are changing the distribution of income and the types of jobs available in the U.S. It is those forces- not government policy, or how much Bill Gates is worth- that are at the root of "income inequality".

With globalization, manufacturing jobs have made their way to lower cost locales. The U.S. economy is increasingly split between highly skilled, highly compensated knowledge workers and low-skilled, low income service workers. Jobs in technology and specialized trades go unfilled, while unskilled workers have a hard time earning a living.

Real wages for those with more than undergraduate educations have grown substantially in the past three decades, while real wages for those with just a high school degree or some college have fallen.

The gap between the types of jobs available here and the distribution of educational attainment is the real challenge.

jack Canzonetta 7 minutes ago @Jerome Abernathy Playing politics, It was the left-wing Berkely tag team of Pikety-Saez. Look at the Berkely culture(past & present) and you will find cause to be suspect..

Steven Cook 1 minute ago

@Jerome Abernathy "It is those forces- not government policy... that are at the root of income inequality".

Government Policy has a direct impact on the cost of doing business. They set a policy that increases the cost of labor through various labor laws, set policies that increases the cost of energy through various environmental laws, set regulatory standards it mandates capital expenses and a numerous other actions that raise costs that drive business out of business or overseas to cheaper markets.

This decimates the manufacturing jobs that bridge the gap between no to low skill labor jobs and the management and technical jobs that pay more. Now, with our failing education system, the technical jobs are being lost.

Then, as a proverbial slap in the face of those who understand economics and the consequences of decades of Federal policies, the answer to the income inequality resultant of these policies, we are told we need MORE regulations, HIGHER labor costs, HIGHER energy costs.

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