Rising Inequality in the United States

Gabriel Zucman and Emmanuel Saez released a paper today tracking rising inequality in the United States (slides here). Unfortunately, the inequality-related development that sucked up most of the day's coverage was an Institute on Global Markets poll of prominent economists on the topic of "Piketty and Inequality." More on that in a moment.

Zucman and Saez is a far more detailed empirical investigation of wealth inequality in the US than appears in Capital in the 21st Century. It documents several facts:

1. The wealth distribution has become significantly more skewed, with the top 0.1% owning in excess of 20% of total wealth. That number was between 5 and 10% in the 1970s.

2. Wealth concentration is due to several phenomena:

• High labor incomes. Saez and Zucman document that a much larger share of labor income is accruing to households in the top 0.1% of the wealth distribution than was true in the 1960s. 
• High savings rates by the wealthy. The authors provide further support for the declining asset position of the bottom 90% of the wealth distribution, including savings rates that dipped into negative territory for the entire boom of the 2000s. At the same time, the savings rate for the top 1% was around 40%.
• Returns on wealth that increase in the stock of wealth. Saez and Zucman link individual capital income data with total wealth in each of nine asset classes from what's known as the Flow of Funds data. That enables them to determine a rate of return for each asset class. Because fractiles of the wealth distribution differ by their exposure to different asset classes, the authors are able to say that on average, the wealthier you are, the higher the return you enjoy on your wealth.

Crucially, all of this additional data Saez and Zucman bring to bear on the case of the United States confirms the analysis and predictions in Capital in the 21st Century. My paper responding to the book's critics divided the so-called capital channel for rising inequality into two arguments: that the overall wealth-to-income ratio in the economy would rise, and along with it capital's share of income, and that within the wealth distribution, savings rates and rates of returns would become increasingly stratified by household wealth.

Piketty spends a great deal of time analyzing the supposed anomaly of the US, where inequality has skyrocketed due to measured labor, not capital, income. His explanation for the "Rise of the Supermanager" is that executives have been increasingly able to ensure that the surplus earned by the firms they run accrues to themselves, and perhaps their shareholders, but certainly not to their employees. What Saez and Zucman tell us is that, to a surprising extent, these supermanagers are the same people as the very wealthy, and to the extent that today's wealth inequality is due to yesterday's labor market inequality, now and in the future, inequality will be driven by the very different wealth dynamics of different parts of the wealth distribution.

A few further points about Saez and Zucman: it absolutely puts the lie to supposed flaws in Piketty's reasoning. The rise of the wealth-to-income ratio is thanks to a housing bubble? Here's their Figure 2:


 The return on capital adjusts down as capital is accumulated, ensuring a constant factor share?


 The saving rate of the representative household will decline to zero as the economy-wide growth rate declines?

It's abundantly clear that in a world where the top 0.1% controls 20% of the wealth, a model of capital formation premised on the assumed behavior of a consumption-smoothing representative agent is a hopeless anachronism.

 So if the facts are so friendly to Piketty, what's up with that IGM poll? It asked thirty or so economists whether the rise of wealth inequality in the US to date is due to the empirical inequality r > g, what Piketty calls the Third Law of Capitalism. Emmanuel Saez said it wasn't. So did nearly everyone else. So is it Piketty against the world, or at least the economics world? No, or rather, not exactly. Piketty himself doesn't argue that r > g explains the dynamics of wealth in the US to date. What he argues is a less detailed version of the story Saez and Zucman tell in their paper. And in that story, what dominates the future is accumulated, inherited wealth and r > g, with inequality of savings rates and rates of return on wealth layered on top.

Some of the respondents to the poll understand both Piketty's argument and the facts, and could only disagree with the cartoonish version of Piketty's argument contained in the poll question. But many didn't, and predictably, the headline result that "no one agrees with Piketty" was picked up as a sort of death blow to the faddish theory du jour from some radical Parisian dilettante and the mindless t-shirt-wearing throngs who worship him. Many poll respondents offered up their own empirically-vacant, faddish theories: that biographies of the super-wealthy show they didn't get it all from Daddy, that fancifully-named-residual "technology" explains rising inequality, even that wealth inequality hasn't increased (!!). Caroline Hoxby decried Piketty's "negligible empirics," a subject she knows intimately.

So what to make of the dichotomy between a brilliant new working paper that brings tons of additional empirical insight to bear on the question of why inequality has risen so much in the US and a poll of economists that reveals, at best, ignorance of the facts, and at worst, an ideologically-motivated, dangerously groupthinking desire to close this debate as soon as possible? Simply that rising inequality and its causes poses a challenge to the economics profession at the deepest level, a challenge that isn't simply going to go away when all the t-shirts are sold out.

Tax Progressivity and Inequality

The other day, Vox published a column by political scientists Cathie Jo Martin and Alexander Hertel-Fernandez arguing that progressive, "soak-the-rich" tax systems don't address inequality. The evidence for that argument is that Sweden collects a larger portion of its tax revenue from the bottom and middle of the income distribution than does the US. Europe generally relies on the Value-Added Tax, as opposed to our heavier reliance on income taxes. Weirdly, this argument also cropped up in a New York Times Op/Ed by Ed Kleinbard that uses the same "soak-the-rich" locution.

The argument is not correct for multiple reasons. The two main problems appear in a response by Mike Konczal: first, looking at where tax revenue comes from isn't the right measure of progressivity, since that just captures income inequality. Second, there's good reason to believe that the regressification of the US tax system is precisely why inequality has grown so much. I'll add a few further points to Konczal's analysis.

Using the same OECD data Martin and Hertel-Fernandez report, Konczal regresses the income share of the top decile on "progressivity" as measured by the concentration of tax system revenue at the top. He finds they're tightly linked. The more unequally distributed is income, the more tax revenue will be drawn from the rich. But that doesn't mean that the rich are more burdened by taxes, the usual definition of progressivity.

To follow up, the OECD's measure of income is top-coded, so the top decile income share it reports is too low. I've reproduced Konczal's scatterplot and overlain one drawn from the World Top Incomes Database, which is not topcoded. Obviously all the points for the top decile's share are shifted vertically, with the increment proportional to tail inequality. One surprising thing, at least to me, is that the slope didn't get steeper as well. It does if you include capital gains, but there are only five countries that have that data in the WTID for 2005.
 

 Within each color, each point is a country. Non top-coded data come from WTID "Top 10% Income Share (2005)" without any adjustment for households in OECD data vs. tax units in WTID. Some countries are in the OECD but not the WTID. The US is the top-right-most point.

The OECD's top-coded measure of tax progressivity misses an outstanding aspect of the US tax system: that the effective tax rate is declining in income at the top of the distribution. In this country, the rich enjoy a variety of tax advantages. Those include a lower tax rate for capital gains,the famed "carried interest loophole" that lets hedge fund managers pay income taxes as though they are capital gains, and all manner of tax deductions that are more valuable if you have a higher income. That declining effective tax rate is why Warren Buffett's tax burden is lower than his secretary's.

Obviously, these facts makes the US tax system more regressive, but not as measured by the OECD.

Konczal also cites the great paper by Piketty, Saez, and Stantcheva (discussed at length in Capital in the 21st Century) arguing that the statutory decline in the top marginal tax rate is why the US has become so much more unequal in the past several decades. At the Center for Equitable Growth's annual conference last month, Saez argued that we already know how to reduce inequality at the top: progressive income taxes. He repeated that at an event at the University of Chicago this past week. In some ways, this is disappointing to those of us thinking up what to do about inequality, because of course we've known progressive taxation is effective since the publication of the Gotha Program in 1875 and the enactment of a permanent federal income tax in the US in the Progressive Era.

Finally, let's get back to the question of revenue, which is in fact where Martin and Hertel-Fernandez focus. The US income distribution post-tax-and-transfer has become more unequal since the late 1970s. But our spending programs have remained intact. They've become more expensive because of the in-kind nature of the government's healthcare commitments. They've also become more tilted toward the elderly of all income levels, as opposed to the poor, thanks to the aforementioned trend as well as the enactment of Medicare Part D. But it's fair to say that on the spending side, redistribution hasn't changed *that much.*

On the revenue side, however, we've become much less redistributive, thanks to regressification at the very top. I've plotted the post-tax income concentration over time against the statutory top marginal tax rate below.

The CBO's measure of post-tax income share of the top quintile is on the right axis, and the statutory top marginal income tax rate is on the left axis.

The time trend isn't dispositive, but it is highly suggestive. Post-tax income inequality has gone up as the tax rate has gone down. Piketty and Saez (2006) look at the declining progressivity of the US tax system in more detail and in a comparative context. Their entire body of research is what underlies Saez's argument that we need to get back to talking about tax progressivity.

Crucially, though, that's not because of revenue. Saez's argument, and Piketty's in Capital in the 21st Century, is that we should enact progressive taxes precisely because that would compress the pre-tax income distribution. It's not about increasing the government's revenue, but rather about creating a more egalitarian society. In theory that could be done through redistribution, but if Piketty, Saez, and Stantcheva are correct, the reason for high incomes in the first place is just bargaining power, and society doesn't lose anything by reducing them.

When President Obama committed himself not to raise taxes on households earning less than $250,000, some commenters decried the implication that we wouldn't be able to enact an ambitious liberal agenda without a larger tax base. First of all, thanks to tail inequality, the tax base above $250,000 is quite high if you get serious about loopholes and overseas tax havens, as the administration has to some extent. But more importantly, and contra Martin and Hertel-Fernandez, we don't need ambitious redistribution to deal with inequality.