The Income Inequality Myth
Posted on January 30, 2012
A smart guy emailed me over the weekend with a very provocative assertion: All of this income inequality stuff is over-blown political rhetoric.
He makes a compelling case. Instead of paraphrasing it, I am going to let the smart guy speak for himself:
It seems to me the whole premise of the Obama/Hill Dem position is that a dramatic income inequality trend has ensued.
They are wagering all the chips of the election on that premise and their preferred policy.
What if the premise is wrong?
What if shares of income have been relatively constant or have not changed dramatically from 1979-2006?
What if taking the edges off of market forces, which their policies, by definition, must do, actually reduces the economic pie that Americans basically share pretty constantly (as they move between cohorts over their lifetime)?
An income re-distribution policy carries the burden of dampening growth. That's the trade-off between equity and efficiency that most policy makers agree exists.
Isn't it then true that the President and his party, all in reliance on the false premise, if they were to gain full political control, would send Americans into a future of a lower standard of living?
This is why the premise of dramatic income inequality is the key to the whole debate.
It feeds the political line that the middle class is set up to a future of gloom and doom.
(Though when Democrats think of middle-class they focus on the non-income tax paying 47%).
The data is there to question their premise.
If you take the period CBO focused on 1979-2006, you find several key data points that the other side have either intentionally buried it or are ignorant of:
1. The statistics used by the President, Dems, and repeated without much review by the Fourth Estate, are tax return driven.
2. Republicans have been unaware of this data or unwilling to take on the conventional wisdom that surround the premise of runaway income inequality.
2. If 1979 is used as the bench mark, then the data base, gross income, per the tax return, has risen dramatically for higher income taxpayers.
3. Reasons: The Tax Reform Act of 1986 (TRA) broadened the tax base, mainly among the top 5%; that legislation alone accounts for 40% of the rise in the share of income for the top 5%.
4. For the top tenth of the top 1 percent, TRA 1986 base broadening raised their top share by 80%.
5. I don't know for sure, but will confirm, but my sense is that the change in the treatment of capital gains, which we all know dramatically accrue to the highest income taxpayers, fueled much of this upward change. In TRA 1986, capital gains were treated like ordinary income (subject to a top rate of 28% and away went the above the line deduction). When we dropped the rate in 1997 and 2003, we sent the capital gain income to a separate rate schedule.
6. Transfer payments, which have risen dramatically from 1979 to 2006 (primarily because of the aging of the population and Medicaid expansion for older and younger lower income folks), as we all know, basically aren't reported on tax returns. The exceptions are the taxable Social Security payments, but as we know that part of the tax base is the higher income elderly. In the income inequality report, thanks to Steve Robinson, CBO does pick this up part of the picture up, but it is displayed in the last big table and chart in the report. My first tax law professor articulated a few fun rules about the Internal Revenue Code. One of them was the "read on" rule. Those who didn't read on were likely to miss an overlapping rule or exception. In the policy debates in Washington, some folks fail to follow that rule. Hence, all the lead stories in the major media focused on CBO's first table and chart which, of course, heavily relied on tax return data.
7. Still another major factor which twists the income inequality case to the Democrats, if a 1979 to 2006 comparison is made, is the change in composition of households. This twist has been corrected in Finance Committee hearings by witnesses, like Scott Hodge. They've been able to show that demographic changes, like fewer two earner joint filer households, have made those households look richer simply because we are a more atomized society.
8. When you remove the distortions from the tax return data, you get income distributions that look a lot more like Census data. That's not to say that there still isn't some growth in inequality. There is, but is dramatically lower. What's more, the growth in income, per Census data, has been significantly outstripped by the rise in that group's share of the tax burden (as a percentage of GDP). During the Carter years, Census data showed the top 5% earning 16.8% of income, accounting for 20.9% of the tax base, paying 3.2% of GDP in taxes which meant 38% of the burden. During the Obama Presidency, the top 5% are earning 21.5% of income per the Census (about a 28% increase since the Carter years), accounting for 31.5% of the tax base (about a 51% increase since the Carter years), paying 3.8% of GDP in taxes (down by the way from 4.6% during Bush 43) which meant 59% of the burden.
Republicans, especially the party standard-bearer, will need to speak this statistical economic truth-to-power of the conventional wisdom. It seems to me it will be necessary to have the policy discussion with the appropriate premise. If we debate the policy on the other side's questionable premise, we will be fighting on their turf.