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Saturday, September 02, 2006

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.

    Posted by on Saturday, September 2, 2006 at 10:31 AM in Economics, Income Distribution, Politics | Permalink  TrackBack (0)  Comments (23)

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