The Politics of Inequality

The editors of the Wall Street Journal are trying to sell the idea that the growth of inequality isn't as bad as reported and is mostly politics, not substance:

Incomes and Politics, Editorial, WSJ: One sure sign that the economy is doing well is when the left revives that old political warhorse, inequality. With GDP growth of nearly 4% for three years running and a jobless rate of 4.7%, it's their last economic resort in an election year. But when you look at the actual evidence, the inequality campaign also proves to be trumped up.

The Treasury Department will soon release the latest IRS data on who paid how much in taxes in America through 2004. We've had an early look at the numbers, and ... the Bush years compare very well by tax and income equality to the sainted Clinton era.

First, the new data show that the bottom 50% of Americans in income -- U.S. households with an income below the median of $44,389 -- 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, Americans with an income in the top 1% paid 36.9% of all federal income taxes in 2004, down slightly from 37.4% at what was the height of the dot-com boom in 2000. But 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.

Especially instructive is what has happened to tax shares since the tax rate on capital gains and dividends was cut to 15% in 2003. These investment tax cuts have corresponded with a huge spike in tax payments by the affluent. ... A reasonable conclusion is that much of this increase reflects tax payments on capital gains and dividends -- which have soared by an astounding 79% and 35%, respectively, since the rate cuts.

Democrats and their media pals dismiss all this by saying that the richest are paying more taxes because they're making out like bandits in the Bush years. Former Clinton economic adviser Gene Sperling grouses that the 1990s were "an era of shared prosperity," but that the Bush policies have produced "a disappointing decade on inequality."

The new IRS report contradicts that fairy tale too. Let's use the left's own definition of fairness and examine the actual new IRS evidence (see chart). During the Clinton Presidency, the share of total income earned by the richest 1% increased to a post-World War II high of 20.8% in 2000, from 13.8% in 1993. By contrast, in the first four years of the Bush Presidency, the income share of the top 1% fell slightly to 19.0% from 20.8%.

The decline in the share of total income earned was even more pronounced when we look at the income shares of the top 0.1%; they earned a greater share (18.9%) of total income by the end of the Clinton era than they did in 2004 (17.4%). Some of this can be explained by the 2001 recession and subsequent strong economic expansion. The rich got socked hardest when the stock market plunged, though the dramatic income and wealth gains in the last three years are again raising income shares of the middle and upper income groups. ...

Some of our readers may not recall all of the front-page articles and editorials assailing the inequality in the 1990s. That's because there weren't many... The inequality theme somehow only emerges when Republicans are in power, and this or that statistic can be trotted out to play to the stereotype that the GOP cares only about the rich, or Halliburton.

The truth is that there has been a modest widening of the income gap in recent decades, regardless of which party is in power. That gap seems due largely to growing returns on education and skills in the global economy. Americans without a high-school diploma are losing ground against those who have college degrees. But this argues not for higher taxes on the rich, who already pay the vast bulk of U.S. taxes. It argues for reforming K-12 education so even the weakest and poorest students can compete against the world.

In any event, it's a mistake to put much stock in these class-envy statistics on income shares, gini quotients, and wealth gaps that Washington and the media like to stress. There's nothing that policy makers can do about them in the short run, and a preoccupation with inequality will do actual harm if it leads to policies such as higher tax rates that reduce economic growth. We'd suggest readers ignore the inequality fad that is intended for election-year consumption and keep their eyes on what really matters -- the policies that promote growth and prosperity for all Americans.

Why does the Wall Street Journal get an early look at government data? Maybe that's standard, but I don't see why they should receive special treatment with government generated statistics.

I have to drive from L.A. to Eugene today with a stop in Sacramento, a long drive, so I don't have time to comment on this the way I would like. But I've learned the commenters here are more than up to the task so perhaps I can rely on you to give this the scrutiny it deserves?

But I can't resist a few notes before I hit the road. First, are we surprised that when real wages of middle and low income workers fall, taxes fall? Or when the wealthy receive more income, they pay more taxes?

Second, the graph confuses income and wealth. To me, that's always a sign of sloppiness and I tend to discount the entire article when it is evident that nobody took the time to check things over carefully. The article only discusses income inequality, not wealth gaps.

Third, the main point here is that inequality was also rising during the Clinton years, but it was largely ignored. However, in a recent post "What Were Economists Saying About Income Inequality in 1997?" which came before I knew the WSJ would make this claim, I didn't have any trouble finding articles about inequality. The difference is that it is the conservatives such as the Hoover Institution doing the talking, not the liberal think tanks the editors of the WSJ want us to focus on:

Rich Man, Poor Man, Hoover Digest 1997 No. 4, Interview by Peter Robinson: The difference between the income of the rich and poor in the United States is growing--and growing dramatically. In talking recently with Hoover fellow Peter Robinson, two experts, Arrow and Judd, agreed about the reasons but disgreed about whether anything should--or could--be done.

ROBINSON Consider two sets of statistics. In 1968, the average income for the richest one-fifth of American households came to about $74,000, while the average income for the poorest one-fifth came to less than one tenth of that amount, or about $7,000. That's the first set of statistics.

Here's the second. By 1994, the average income for the richest one fifth of American households had grown to $106,000, while the average income for the poorest one-fifth had barely risen at all, remaining at about $7,000.

Ken Arrow, do you accept the implication? That the rich in America are getting richer, while the poor are barely holding their own?

ARROW I do.

ROBINSON Ken Judd? Do you believe that the rich are pulling away while the poor are just treading water?

JUDD The evidence is pretty clear.

And I've argued, as has Krugman and others that the following diagnosis is wrong:

That gap seems due largely to growing returns on education and skills in the global economy. Americans without a high-school diploma are losing ground against those who have college degrees. But this argues not for higher taxes on the rich, who already pay the vast bulk of U.S. taxes. It argues for reforming K-12 education so even the weakest and poorest students can compete against the world.

On the progressivity of taxes, see the debate between DeLong and Mankiw. I'd also question this assertion about income gaps given the change in income inequality brought about by tax cuts for the wealthy:

There's nothing that policy makers can do about them in the short run

More precisely, there's nothing that can be done that the editors agree with. Finally, Greg Mankiw says, in a recent email:

There is no question that there has been a big increase in income inequality over this period.

But the editors say:

But when you look at the actual evidence, the inequality campaign also proves to be trumped up.

It's all yours, I'm hitting the road.

Update: Since the editors would probably admit that Paul Krugman is left of center, I listed a few things he wrote on globalization during the 1990s:

For Richer 1992
Ignorance and inequality 1992
The Rich, the Right, and the Facts 1992
What the Public Doesn't Know Can't Hurt Us 1995
The Spiral of Inequality 1996

There are also examples from the right critical of both Krugman and Clinton (Carter too) on the inequality issue.

Comments

[Lee A. Arnold]

For motion pictures of the distribution of income and wage taxes, see the first part of "Social Security" at (copy & paste:)

http://www.youtube.com/watch?v=Tts2uTWt6e8

and Chapter 2 of "Tax Cuts" at (copy and paste:)

http://youtube.com/watch?v=SA1f2MefsMM

If you have already seen these little financial flow-chart movies, please notify your Democratic Congressional candidate about them! There are just two months left until the election!

YouTube videos are FREE. They can be seen, emailed to others, and embedded to other websites.

Hit every issue! Take back Congress!

[save the rustbelt]

As a quick comment, just about everyone I know did better in the 90s, excepting a few folks (spine surgeon, etc.) who have been in the top 1% most of their careers regardless of the economy.

Those who own the government make the most money. Record bonuses on Wall Street this year boys!

Going to the county fair with the rest of the middle-class riff-raff - no wealthy people there!

[Zephyr]

If I take the time to plant seeds and nurture them as they grow to be fruit trees, and I fill my yard this way, someday I will have an abundance of fruit. Am I not entitled to this fruit?

If my neighbors never bother to make this investment they will have no fruit. When they look across the fence they will see a “rich” neighbor who sits in the shade of his trees eating fruit while they have no shade and no fruit.

They will not see my early investment as the cause of my abundance. Nor will they understand that their own lack of planning and investment is the cause of their shortage.

Some will say that I have hoarded all the fruit. However, I have increased the total supply of fruit.

I will trade some of my fruit to my neighbors for things they can do for me. They will complain about the income distribution. However, had I not made the early effort/investment in the fruit trees, my neighbor would have no fruit.

[Lee A. Arnold]

Moral of the story: If you question the distribution of income, you must not like to plant fruit trees.

[Lord]

The inequality theme somehow only emerges when Republicans are in power

It at least gains preeminance. The reason is simple. Republicans are bad for the economy. When the rising tide lifts all boats, those in dingies don't object, but when the waves swamp all but the largest, the time for change has come.

[spencer]

So the well off were able to realize significant capital loses when the stock market was down to reduce their taxable income. that is all this data demonstrates.

[Tom Marney]

Zephyr, you sound like Chaucey Gardiner.

Everybody knows that investing for the future is a Good Thing. What we don't discuss, though, is whether there is such a thing as an optimum ratio of investment to consumption and what that ratio might be under current circumstances.

China is saving and investing fifty percent of its GNP and is experiencing a period of progress that's probably unprecendented in the history of the human race. The US, OTOH, is saving and investing far less, yet we can barely find anything worth investing in. Companies are using their record profits for stock buybacks and offshoring, and individuals are borrowing money to build a glut of McMansions, which makes our economy stronger-- how? When the current bubble economy tanks-- as bubble economies always do-- what will we have to take its place? And if we should be investing more, what, exactly, should we be investing in?

I think it's obvious that the level of capital formation in the US is excessive given the lack of real opportunities for productive investment. OTOH, I'm not so sure that increasing the share of wealth garnered by the middle class and poor is such a red hot idea in a nation with a negative household savings rate and a trade deficit of 7% of GDP. I don't know what we need to do, but then again, I'm just a lowly construction worker. It's above my pay grade. What bothers me is that I've seen very little indication that anyone else knows what to do, either.

One thing I am sure of, though, is that securing the economic future of the US will require more attention to truth and a great deal less truthiness.

[save the rustbelt]

Zephyr:

Sounds like the fable fo the Little Red Hen, one of my favorite childrens' stories.

However, it is really hard to fit pension underfunding and the manipulation of GAAP pension accounting under the fable of the the Little Red Hen.

And spinning IPOs doesn't fit very well either.

And the Little Red Hen didn't have to compete with K Street lobbyists, or age and gender discrimination, or backdating stock options, or offshore tax evasion schemes, or ..........

Children's fables teach character lessons to children, but don't work very well for adults.

[Zephyr]

One must not confuse stolen wealth with earned wealth. Clearly, both exist. But each should be treated differently.

Those who have earned their wealth deserve to keep it. Those who have stolen it should be treated like the thieves they are.

Taking wealth from those who have earned it is no better than stealing it from others.

[Greg Byshenk]

I fear we may be seeing a case of careful data selection, rather than anything really meaningful.

I am not an economist, and cannot quickly lay my hands on the data, but from memory (I welcome correction if I am wrong) in the USA, income inequality gradually declined from about 1945 until 1970, was more or less steady in the 1970s, increased in the 1980s, held steady or declined slightly in the 1990s, and then began to increase again after 2000.

Which would mean that there was (comparatively) little discussion of income inequality in the 1990s -- because it was not increasing. Indeed, in the reference cited, it was required to go back to 1968 (which was perhaps the high-water mark for income equality) in order to make a comparison reflecting unfavorably on the 1990s (which followed the increase in income inequality in the 1980s).

Or, stated differently, income inequality for any period after 1968 will suffer by comparison with 1968, because since then, the periods of decline have never been sufficient to offset the periods of increase. That said, there is (quite reasonably) less reason for concern about income inequality during those periods when it is decreasing.

[spencer]

Zephr -- your fable is supported by economic theory.
But the problem is that it is not supported by the data.

In the early 1950s SOLE PROPRIETORS, PARTNERSHIPS & HOUSEHOLDS accounted for some 25% of total capital spending. By the 1970s it had fallen to around 15%
and so far this cycle it is barely 10%.

Moreover over the last quarter century while we have implemented many policies to encourage savings, personal savings has collapsed.

In other words, you have a beautiful theory that has not worked.

So rather then continuing to pontificate about your beautiful theory maybe we ought to be talking about why it failed and what we should be doing differently.

Maybe if we really wanted to incourage investments we should eliminate the corporate income tax and go ahead and tax income from dividends and capital gains at least as high as wage income, if not higher. Because the theory that giving them lower tax rates would lead to greater investments has completely failed according to the data.

[save the rustbelt]

"...Those who have earned their wealth deserve to keep it....."

It is not quite that simple.

Many earn great wealth partly on their own accord and partly because they have bought influence with the government.

Name me a plumber in this a country who can pick up a telephone and talk to anyone of significance in the federal government. I can barely get a call through to a junior staffer of my elected representatives. I have friends though who have the homenumbers of Senators because theyare wired through money and connections.

[Chris Mann]

>"The reason is simple. Republicans are bad for the economy."

Republicans aren't at all bad for the economy, crony capitalism is bad for the economy.

The problem is that the current republicans in power have engaged in more crony capitalism than any other party in history. The majority (comprised mostly of the lower end of the bell curve) of Americans were tricked into voting for crooks through the promise of a miniscule 'tax cut' and gross media manipulation. (Some lip service was also made of banning gay marriage to hoodwink the fundamentalists.) They are now busy through deficit spending raping and pillaging future economic growth to benefit of a few wealthy sponsors.

By the time the majority finds out what happened, those sponsors are going to have moved their capital to safer ground. Far too late to have them drawn and quartered.

[Robert]

Zephyr
What if the earth upon which the fruit trees were planted was in reality, highly variable. What if, the yields and and ability to propagate further trees and crops were a function or the earth? Then, even if EVERYONE invested precisely the same amount of effort in cultivation, there would still be lucky ones who through no fault of their own inhabited a fine piece of earth and reaped bumper crops, while others with a short-stick, derived - as a result of simply bad geographical luck - nothing.

But there is good news! The earth, could - of course - be improved and thus total fruit increased. Oh but this remediation might take capital resources and education beyond those presently available to any indiviudal, but not beyond the means of the society as a whole. Since a priori no one could know whether their terroir was fine or lame, the rational person would choose a a more inherently just form of relations where the lucky ones would structurally provide the means for the unlucky ones to have the opportunity to improve their lot. If perchance, ex-post, one was lucky, one would be relatively worse off than otherwise which would be the fair price for insuring that ex-ante, everyone has a more or less equivalent opportunity to succeed or fail. Note that this is not advocating forced equality as some critics would posit, but merely sketching the basics for insuring access to opportunity.

The only rational people who would oppose such a schema are those who, ex-ante already HAVE the knowledge of their relatively advantageous position and through whatever justifications for their selfishness they can parry, wish to defend it.

[Chris Mann]

."Maybe if we really wanted to incourage investments we should eliminate the corporate income tax and go ahead and tax income from dividends and capital gains at least as high as wage income, if not higher."

It's the best solution, but in the current climate it's also political suicide.

What I really fear is that the new democrat fetish with populism may lead to an INCREASE in corporate income tax in the next term. This will lead to even less capital investment.

[Tom Marney]

Chris,

So what?

[save the rustbelt]

"...What I really fear is that the new democrat fetish with populism may lead to an INCREASE in corporate income tax in the next term. This will lead to even less capital investment...."

Chris:

Not to worry. The ability of large corporations to avoid and evade the corporate income tax is amazing, especially when they have signficant overseas operations to use for transfer pricing schemes and income dumping on subsidiaries.

[Chris Mann]

>"Not to worry. The ability of large corporations to avoid and evade the corporate income tax is amazing"

I'm not worried about whether they will evade the corporate income tax, that much is a given. The question is whether they eventually move their operations and capital to Ireland, Iceland and Dubai.

[lonesome moderate]

From Greg Byshenk:

I fear we may be seeing a case of careful data selection, rather than anything really meaningful.

I am not an economist, and cannot quickly lay my hands on the data, but from memory (I welcome correction if I am wrong) in the USA, income inequality gradually declined from about 1945 until 1970, was more or less steady in the 1970s, increased in the 1980s, held steady or declined slightly in the 1990s, and then began to increase again after 2000.

I think it's more of a case of data without context than selective data. There certainly was an increase in income inequality in the final years of the Clinton administration, due to the high-tech/NASDAQ bubble. And then there was a decrease in the beginning years of the Bush Administration, due to the bursting of same bubble.

There are two obvious factors that need to be acknowledged when doing an honest (i.e. NOT Wall Street Journal) analysis of these kinds of numbers. First, income from a speculative bubble is not wealth that has been created, but rather wealth transferred to a bunch of wealthy people this year from other wealthy people a few years from now. Second, increasing inequality of wealth is generally (and, IMO, rightly) regarded as OK by the general public when it occurs in the context of a growing economy where everyone gets a slice of the pie. When it happens in the context of a growing economy where 80% of the population is getting nothing or less than nothing, however, then that's not OK.

[gordon]

Chris Mann says: "What I really fear is that the new democrat fetish with populism may lead to an INCREASE in corporate income tax in the next term. This will lead to even less capital investment."

Not to worry, Chris. The Govt. can invest the extra tax income on behalf of all the people.

[Zephyr]

The government is the poster child of waste. They will not invest efficiently or effectively. We would just get more pork barrel bridges to nowhere.

If you want more of something subsidize it.

If you want less of something tax it.

What do we subsidize, and what do we tax?

[run75441]

I like using the "Tax Policy Center" for collecting my data. It has been a useful tool for defusing some of the arguments put forth. Here is the web site: Current Law Distribution of Individual Income Tax and Payroll Tax by Cash Income Class 2004"

Lets start at the beginning of what the WSJ is using for data to define their population.

WSJ: "By contrast, Americans with an income in the top 1% paid 36.9% of all federal income taxes in 2004, down slightly from 37.4% at what was the height of the dot-com boom in 2000. But 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."

The 36.9% is probably correct as the tables do not define 1%; but instead, they define Income Classes. 6 tenths of 1% make $500,000 or more per year and pay 29% of all the "Income" taxes. So 36.9% sounds reasonable to me for 1% of the taxpayers.

What the WSJ attemptes to do is increase the amount of people at the top to inflate the amount of taxes paid in comparison to the rest of the population. They do this by adding those who make less than $500,000/year including those who make as little as $150,000/year. This bracket of people would typically not be included in the same bracket as those making greater than $500,000 when analyzing income inequity in comparison to the Clinton years as the 2001/2003 did not benefit them as greatly at the upper 1%. This is adding 10 million middle and upper middle bracket taxpayers to the ~800,000 upper bracket taxpayers making greater than $500,000/year. Smoke and mirrors in the numbers.

The WSJ neglects one other category of taxes, Payroll Taxes. Looking at the tables from The Tax Policy Center, and including these taxes in the total, an entirely different picture is painted. The 6 tenths of 1% of the taxpayers making greater than $500,000/year pay ~16.5% of all "Income and Payroll Taxes" (I am not going to guess what the 1% number is as the example is pretty clear as to what the WSJ is doing). WSJ categorizes their research to just Income Tax and ignores Payroll taxes which paints an entirely different picture of who pays how much in taxes.

One final factor before I end this long winded post. The WSJ makes a point of telling us the bottom 40% of the population is paying less in taxes. No kidding . . . of course this is true when poverty increased by 1.1% since 2001, which means fewer people in this category are paying taxes since they slipped in poverty and no longer have to pay taxes. They are using an aggregate number. In comparison during Clinton's tenure, more of the marginal work skill people went back to work (as evidenced by a higher BLS Participation Rate of 67.3%) and paid taxes as more jobs were available and labor was tight. The Bush Administration job creation record still has not reached the BLS Participation Rate level of 66.8% which was expereinced immediately after the 2001 Recession (another topic). He will be more than likely go down as the 2nd worst President for job creation with Hoover being #1.

[Betsy L. Angert]

Dear Mark . . .

I thought I might share a little not so funny humor. This is taken from a video clip presentation. It aired on Cable News Network, American Morning, yesterday, Labor Day.

ELAINE CHAO, LABOR SECRETARY: The majority of the 5.7 million new jobs created require higher skills, more education. So by definition they are better paying jobs. Our economy is evolving, it's transitioning to a knowledge-based economy. 


CHAO: As for the tax basis personal income has actually risen and it's very important to know that because of the president's tax cuts. The after tax, the disposable income, increased 9.2 percent since 2001.


May you live long, learn much, and feel fulfilled . . . Betsy
Betsy L. Angert Be-Think