Income Inequality Follow-Up

I want to follow up on the most recent inequality post. Recall that the WSJ editorial page says that:

[N]ew data show that the bottom 50% of Americans in income ... paid a smaller share of total income taxes in 2004 (3.3%) than in Bill Clinton's last year in office (3.9%). That 3.3% is the lowest share of total income taxes paid by the bottom half of earners in at least 30 years, and probably ever. ...

By contrast, ... the top 5% and 10% of earners saw an increase in their tax share over that same period, with the top 5%'s share rising to 57.1% in 2004 from 56.5% in 2000. If this isn't the definition of a highly "progressive," aka redistributionist, tax code, we don't know what is.

Though I don't agree with defining progressivity according to share of taxes paid or by percent of income, I'd rather see it defined according to marginal tax rates, here's an example of how taxes can become more progressive according to the progressivity definitions used by the WSJ editors, and by others:

Suppose that the tax rate is 10% on the first 100 in income, and 30% after that.

Let person A have an income of 125. Taxes are 17.50.
Let person B have an income of 225. Taxes are 47.50.

Then the average tax paid as a percentage of income is 17.50/125 = 14% for person A. Similarly, person B's average tax rate is 47.50/225 = 21%. The shares of total taxes paid are 27% and 73% (e.g. 47.50/(17.50+47.50) = 73%)

Now move 50 from A to B, i.e. move 50 up the income ladder. This could be from government policy that redistributes income, productivity changes, or other reasons.

Person A now has an income of 75 and a tax burden of 10%. a smaller amount than before, and person B has an income of 275 and a burden of 23%, a larger amount than before. The shares of taxes paid have increased from 73% to 89% for person B, and have fallen from 27% to 11% for person A. Thus, taxes have become more progressive in the sense that average tax burdens have tilted upward, and in the sense that the share of taxes paid has increased for higher income people and decreased for lower income people.

Nobody should be surprised that the share of taxes paid by a particular group goes up when their share of income goes up. Nor should we be surprised that if a group's share of income falls to historic lows, the share of taxes will fall to historic lows as well. Share of taxes paid is a poor metric for assessing progressivity for this reason.

What is important, and where the debate should be focused, is why the shift in income shares has taken place, i.e. what is causing the more unequal distribution of income. Is it due to productivity or some other factor? If it's due to changing market power relationships, allocative inefficiencies, or government policies that transfer income upward, the fact that the higher income people now pay a larger share of total taxes may be of little consolation. Do conservatives really want to argue that increased progressivity is a good thing if it arises from redistributing income up the income ladder? Obviously not, and neither would liberals. So before we begin pointing to changes in the shares of taxes paid as evidence of increased fairness, we should be certain we know why the changes have occurred.

Currently, we don't know for certain, or even nearly so, and this is the subject of debate. The split is between those who think growing inequality is due to productivity changes, skill-based technological change in particular, and those who believe it arises from other factors such as changes in public policy (e.g. taxes, union busting) and globalization.

I believe that public policy plays a large role, but even if it is skill-based to some notable degree, public policy can still be a factor. For example, are we certain that the opportunity to acquire the skills needed to realize the skill-based premium are fair and equitable, i.e. that everyone has an equal chance to compete in the global economy? If the opportunity to acquire skills is not equal, has public policy (and doing nothing is a policy) played a role? If so, the role of public policy in bringing about inequality may be understated because econometric investigations designed to determine the source of income inequality will have trouble distinguishing the role of public policy in the skill acquisition process.

Comments

[save the rustbelt]

According to George Will this morning, the fact that 25000 people applied for 325 Wal-Mart jobs near Chicago is a sign of our great economic health.

Huh?

What am I missing here?

[Jacques]

"Do conservatives really want to argue that increased progressivity is a good thing if it arises from redistributing income up the income ladder?"

No. Conservatives believe increased regressivity is a good thing even if it is a result of a more unequal distribution of income. Never mind progressivity. The fact that the writers leave out the reason why the share of taxes paid by the rich has gone up to argue their case, in and of itself gives that away. The editorial page of the WSJ is just a propaganda venue.

In a way, I'm surprised that you, AB, don't know this by now. I do believe that it is a productive enterprise to debunk the WSJ. But let's not get confused about their motives.

[Bruce Wilder]

"The split is between those who think growing inequality is due to productivity changes, skill-based technological change in particular, and those who believe it arises from other factors such as changes in public policy (e.g. taxes, union busting) and globalization."

Here's something that puzzles me. Looking at the data (Piketty and Saez, for example), the two highlights are a stagnation in the growth of median wages, and, at the very top, hollywoodization (i.e. a huge growth in "star" compensation, particularly among CEOs) plus a growth in income from financial wealth (i.e. an increased claim by "capital" on the national income).

I understand how declining unionization is one natural suggestion, given the stagnation of wages. I could come up with others, with the understanding that these phenomena are theoretically overdetermined so that various conceptual explanations are not necessarily mutually exclusive. For example, increased cost of fossil fuel energy, after 1973 might be a factor; energy use must be tied to labor productivity and conserving energy might have the effect of reducing the growth in the marginal productivity of labor. Women's liberation would be another factor; prior to roughly 1967, women mostly did not work outside the home, and those who did were segregated into a narrow range of service occupations -- secretary, teacher, nurse, etc. Increased labor force participation by women has resulted in rising compensation to women workers and slight declines for males workers -- supply and demand. The natural course of industrial development, including globalization, has resulted in the competing away of the rents on which some prominent industrial unions thrived, so the decline of unionization is partially result as well as political cause.

OK, so that's the median worker. But, the other half of the puzzle is the "star" CEO. It would seem that the norms on CEO compensation and tenure have broken down, and that corporate governance has broken down. I understand that part of the unionization suggestion is the idea that unions were effectively part of corporate governance, and a part that implicitly limited top management claims on compensation. But, what about shareholders? TIAA-CREF and other giant mutual funds, pension funds and trust houses also have an interest in reining in CEO compensation, for the obvious reason that it costs the stockholders, whose most organized representatives are these pensions, mutual funds etc., a lot of money. But, they are virtually powerless to do so, even though they are nominally very large shareholders in a great many Fortune 500 firms. Likewise, the discipline of the takeover threat seems to have been disappeared. And, the SEC watchdog appears to have been neutered. Since so much of the "action" in the income distribution is in skyrocketing CEO compensation, should some of these other countervailing forces on CEO compensation receive more attention? Why don't references appear more often in the short-form discussion of this issue; why are we so focused on unionization, front and center?

[James Killus]

I'm surprised that no one has noticed the first part of the shell game: the WSJ article only talks about income taxes.

Try doing the same analysis and include payroll and sales taxes. Then, if you like, add in the loss of means tested services that come with marginal increases in earnings at the lower income levels.

That gives a more accurate (dare I say honest?) picture of marginal taxation and government policy in this country, and it's pretty ugly.

[run75441]

If the issue is the upper 1% of the taxpayers are paying a higher percentage of taxes over the last 5 years even after the 2001/2003/2005 breaks, why is this such a mystery? Their income has increased over the last 5 years in comparison to the rest of the population of taxpayers.

Conversely, Poverty has increased significantly over the last 4 years for the overall population, finally stabilizing in 2005 at 12.6% (12.6% in 2004), and was 11.5% in 2000. Of course, there would be a decrease in income taxes paid at the lower end of the taxpayer population. Hell, more of them slipped into poverty and no longer have to pay income taxes.

WSJ can trumpet all they want too on this issue; but, the last 5 years of economic growth has focased on the 1% of the taxpayers at the expense of the other 99%.

[Tom Schofield]

Bruce Wilder asks a pertinent question about CEO compensation. In 2005, the average compensation for the CEO of an S&P 500 company was $11.4. The CEO of Valero Oil was paid more than $90 million for his work last year. Can these levels of compensation be in any way related to contributions made? Market forces seem to have no effect whatsoever on CEO compensation. Apparently, these folks simply cannot price themselves out of the market. Evidently there is no one in China or India who could assume the management of a S&P 500 company and do as good a job as the incumbent for an annual pay package of of a mere $6 million, $4 million, or $2 million. Nor are there any underlings within these companies who would be willing to assume the top job for such paltry compensation. Herbert Hooever was right, "...the only trouble with capitalism is capitalists. They're too damn greedy."

[Firozali A.Mulla MBA PhD]

Sir It is the inequality that spices up the wheels of the economy. If all had the Toyota or Land Cruiser and no bicycles, there would not be the envy. The ladies envious pull drive the men to invent invent and beat the other guys by more effluence and have more of everything just to show. MY DAUGHTER HAD THE HONYNMOON IN THE ARTCTIC. My dog has a central heating system. It is me me me always sir. Hence the difference and different step if the taxes. If all were equal we would have problems. It is the jealousy, the vengeances (KUWAIT WAR TO GO TO IRAQ) that drive s us and our ego. Pay more tax and say my dad paid $100,000 this year only. And my houseboy and the watchman paid 4500 per month. We are contributing to the Americana income. Sir this then goes to discover the Moon has the water!! Pluto is not the Planet, Earth is small, but we know not. We want to show off.
I thank you.

Firozali A.Mulla MBA PhD
P.O.Box 6044
Dar-Es-Salaam
Tanzania