Or, why it was so important to keep top marginal income tax rates constant for millionaires.
Figure 1 depicts the income shares accruing to the top 0.5 percent and top 0.1 percent of households (including realized capital gains). It is clear that their shares have declined going from 2007 to 2008; for the top 0.1%, their share has declined from 12.3% to 10.4% of total income.
Figure 1: Pretax income shares (including realized capital gains) accruing to top 0.5% of households (dark blue line) and to top 0.1% (dark red line). Source: updated version of Piketty and Saez (2007).
The income threshold for the top 0.5% is $558,726 in 2008 (the average income for households in the 0.5% to 0.1% range is $878,139). The income threshold for the top 0.1% is $1,695,136 in 2008. The framework currently under consideration in the Congress maintains the marginal tax rates applying to these income fractiles constant.
Corresponding graphs for top 5% and 1% income fractiles, either including or excluding realized capital gains, are displayed in this post.
Update, 8/2 9am Pacific: Readers AS and Buzzcut conjecture that rising income inequality is being driven almost solely by capital gains, despite large amounts of evidence to the contrary. Reader acerimusdux asserts that the rise in inequality is not strongly linked to equity markets. Below I present the series analogous to those in Figure 1, excluding realized capital gains.
Figure 2: Pretax income shares (excluding realized capital gains) accruing to top 0.5% of households (dark blue line) and to top 0.1% (dark red line). Source: updated version of Piketty and Saez (2007).
The pattern shown in Figure 1 remain in Figure 2; in fact, if anything, the pattern is even stronger (the top 0.1% receives 13.8% here, versus 10.4% in the ex.-capital gains series).
Your point is?
Marginal tax rates have a trivial effect on the income/wealth gap compared to the effect of Fed easy money on asset-related industries like Wall Street, property development, and Big Oil. Meanwhile the poor get food and energy inflation.
How anyone can complain about income inequality and still support the Fed is beyond me.
Dear Professor Chinn,
Are the taxpayers in the top .1% and .05% the same folks over any extended period? Do you think that income averaging is appropriate? Some or many of these taxpayers may be in these lofty income brackets only once in a lifetime due to sales of a business or exercise of stock options.
To be fair, we should also look at the tax paid by those groups and the charitable contributions by those groups. I assume the point you are making is that income needs to be redistributed in some sort of utopian way. But that figure provides no clue as to the change in the net flows from rich to poor across time.
Anonymous and tj: From Aaronson and Mazumdar:
This paper was published Journal of Human Resources (2008).
It’s interesting that real GDP growth exceeded 5% 12 times from 1950 to 1980 and only once since 1980. Combine that with the fact real GDP growth has been very sluggish since 2000 and its very clear that growing income inequality has slowed down economic growth.
You should discuss Ariely & Norton’s research. Here is the abstract from one short paper:
“Disagreements about the optimal level of wealth inequality underlie policy debates ranging from taxation to welfare. We attempt to insert the desires of “regular” Americans into these debates, by asking a nationally representative online panel to estimate the current distribution of wealth in the United States and to “build a better America” by constructing distributions with their ideal level of inequality. First, respondents dramatically underestimated the current level of wealth inequality. Second, respondents constructed ideal wealth distributions that were far more equitable than even their erroneously low estimates of the actual distribution. Most important from a policy perspective, we observed a surprising level of consensus: All demographic groups – even those not usually associated with wealth redistribution such as Republicans and the wealthy – desired a more equal distribution of wealth than the status quo.”
You can still take the online version yourself. By panel, they mean a random sample. It consisted of over 5k people from 47 states, same median household income as the US, same voting patterns in the 2004 election, etc.
They provided a definition of net worth for wealth. They asked what people thought was the actual distribution of wealth by quintile and what they thought was optimal. The findings are that people think wealth is much more evenly distributed than it is and the optimal distribution – chosen across the board, no matter one’s politics – is closer to Sweden’s than America’s. People estimated, for example, that the top 20% owned 59% of the wealth when they actually own 84%. People dramatically over-estimated the share owned by the bottom 20%.
The implication is that much of our public policy is shaped by misunderstanding basic facts. We think we’re more equal than we are. We think the poor have much more money than they have. We think the rich have much less. These two points alone explain a lot.
Joe- And not only the growing income inequality slowing growth, but the lower cap.gains and marginal tax rates on the rich are also a culprit. The huge productivity gains of the last 30 years have been funneled into CEO pockets and Wall Street gambling instead of going back to the workers that made it happen, like they were in the 1950s, ’60s and ’70s.
Numbers are not ideological or up for debate, folks.
IGE has been exploding since 2001. GOPonomics are designed to do this.
I think the numbers for 2008 are irrelevant. Of course the share of the top fractile fell in 2008. That was caused by a collapse of financial markets, above all equity markets. Since then equity markets have nearly doubled.
All of the effort of US authorities have gone into restoring financial markets which means that the efforts have massively increased inequality again.
Take it up one more decimal place and you can start naming names: the ten thousand wealthiest families in America. The donor class, who finance both political parties and are responsible for current trade and immigration policies, the existence of shell corporations, overseas tax havens, and the absence of a graduated expenditure tax. The ruling class.
Tj and the usual suspects…you do realize that the founding fathers wanted to create a society where inheriting wealth and privilege would be eradicated so that a landed/monied aristocracy would be avoided forever here? You so know this was an explicit point in the government they set up? So why would you want to return to this 16/17/18th century lifestyle now? Is this “good old days” syndrome for you?
If it were up to me, I’d tax estates so heavily that it would wipe out the ability to pass wealth on. This would certainly goose the economy don’t you think? I’d find every loophole, every foreign asset and make it a felony to conceal or defraud by using trust, partnerships, or whatever else. But hey, that’s just me. I don’t believe that the bulk of any wealth created should be passed on to some insipid child who expects it (my own included). And it is in full accord with the principles this country was founded on. You can pass on a couple of million…no one needs more than that to start with. The rest? Charity or forced charity. And there’s your tax, SS, and medicare problem solved.
In the early 1990’s the income share for the top 1% was near its historical average. Are you prepared to argue that Clinton’s top tax rate increase was “unfair”?
Menzie, forget it. Obama is the wrong one to challenge income inequality. He is a GS spokesman, and the gov has been hijacked by the rich clique.
The only solution would be a revolution, which will never come, as the public in this country is just plain stupid. Switch on some TV channel.
Btw ref. your post a few days ago “Bonds of August “, did not I tell you that “Obama will save as all, and the show script has been written by D. Axelrod”?
joe,
There you go with correlation=causation.
Alternative theory: weak GDP growth causes the Fed to ease monetary policy (which we know it does), which causes increased income disparity (which we know it does).
Nixon closed the gold window in 1971, and you’ll find a persistent trend of rising inequality since then, and it is of course worst in the post-2000 Greenspan-Bernanke DebasementFest.
I honestly fail to see why some on the left are so concerned about how much money those at the top of the income distribution earn. Why not focus instead on why poor people are poor? And please, blaming that on the rich is a non-starter. People make bad choices in life. They get pregnant before they finish school and have a career started. They use drugs. They get tattoos and body piercings all over themselves and then wonder why no one will hire them for an entry-level job. They do not take school seriously. They have parents who never should have bred in the first place. I really, honestly and truly feel for the poor people and hope they can lift themselves out of poverty. But throwing more money at the problem, and taking it from the “rich”, is not the solution.
These graphs are great as far as they go. But mixing realized capital gains with income taxes kind of muddles things, doesn’t it?
I am sure that the top 0.1% has more realized capital gains than even the top 0.5%, or especially the top 1%. It is not real clear to me HOW to “increase taxes on millionaires” without getting into issues of double taxation, investment strategies, etc.
Also, keep in mind that Menzie is talking about households. I have done some simple regressions on the household income data, and they look exactly like you would expect them to: increasing income correlates with increased hours worked, increased education, and increased number of income earners per household.
Here is my analysis:
http://bluecountyredstate.blogspot.com/2011/06/what-does-it-take-to-not-be-poor-in.html
OK, it is not quite Menzie quality in the regression department. When it comes to regression, I subscribe to the KISS philosophy.
This post and most of the comments are ‘short’ a couple of inches. Penis envy is real on the left.
“It’s interesting that real GDP growth exceeded 5% 12 times from 1950 to 1980 and only once since 1980. Combine that with the fact real GDP growth has been very sluggish since 2000 and its very clear that growing income inequality has slowed down economic growth.”
It is not “clear”. In that timeframe, you have the rise of economic competitors like China and India (and others!). It could be that low skilled American workers are seeing more global competition than high skilled workers, and economies of scale are increasing, adding yet more income to the highly skilled.
You can argue that we need more government spending on education to generate more highly skilled Americans, but we may be up against human resource limits in that area. Not everyone is college material, after all.
Buzzcut–why work when you can vote Democrat?
Buzzcut-
I think the last paragraph of your blog post is particularly insightful: some people do not understand the long-term ramifications of short-term decisions. Using drugs instead of studying for classes might be more fun in the short run, but the long-term consequences of not staying in school are dire. Buying fancy $5,000 rims for the 10-year-old car might elevate one’s status among peers in the short run, but it would be much better to save that money for real emergencies. The list goes on and on.
“There you go on about class again.” http://bit.ly/oxBZyW @ 1:20
Someone called shortie is accusing others of penis envy?
Dear Professor Chinn,
Thanks for your response to anonymous, it should read AS, I forgot to enter id. I have a couple more questions on income or wealth “inequality”. First, do you have any sources on longer term family wealth? I seem to recall reading a source saying that most of the families around the period of the US Civil War, who were in the top wealth ranks, were no longer in the higher ranks by about the 1950s. Second, from what I see in this post, the wealth distribution seems to be similar to Pareto’s law, so would not seem to be unusual. Third, looking at Piketty/Saez, it seems like it is just the 0.1% or .0.005% of the income distribution share that has “run away” from the rest of us. I am concerned that tax policy aimed at these taxpayers will actually land on the merely successful, making it ever more difficult to change a taxpayer’s income or wealth status due to increased taxes.
“Third, looking at Piketty/Saez, it seems like it is just the 0.1% or .0.005% of the income distribution share that has “run away” from the rest of us. I am concerned that tax policy aimed at these taxpayers will actually land on the merely successful, making it ever more difficult to change a taxpayer’s income or wealth status due to increased taxes.”
If that is the case, and if most of that increase in inequality is actually due to realized capital gains, I really question how income taxes have any bearing on inequality.
Thus, is Menzie really arguing for an increase in capital gains taxes?
Or is he really arguing for a wealth tax?
How would a wealth tax even work? And would guys like Buffet just use tax strategies like buying massive amounts of life insurance (a business he has bought into) to avoid a wealth tax?
And would these tax avoidance strategies hurt growth more than inequality?
Lots of questions that can’t be answered by simplistic graphs of household income “fractals”.
Menzie,
I am considering a non-profit organization called “Easing Rich Democrat Guilt.” It will be a central clearing house allowing those Democrats who feel guilty about being rich to ease their guilt. Even though it goes against Democrat standard operating procedure the organization will be voluntary rather than a compulsory – once it is nationalized it will become compulsory.
You can be my first client. The median wage in the US is $46,326. Please send me the difference between what you made last year and this median wage and I will see that it is deposited in the Treasury account at the FED.
Won’t it be great that you will no longer have that nagging in your stomach keeping you awake at night because you have so much money?
Interestingly, it seems that high concentrations of wealth are not very strongly tied to the performance of equities markets. In the short term, there is an obvious relationship (due partly to capital gains, perhaps also to things like wall street bonuses): you can see where drops in 1929, 1987, and 1999 immediately reduced income share at the top.
In the long run though, income conentration was still very high in the 1930s after the market crash, it declined during the strong bull market of the 1940s and 1950s, and while equities markets have still not recovered to 1999 levels, income shares at the top have blown past that previous peak and reached new highs.
It may well be that the recent uptrend in concentration of income is due in part to financial market deregulation. Brad DeLong, in 1998:
link
“And this is the third thing to note about the turn of the century robber barons: even though the base of their fortunes was the railroad industry, they were for the most part more manipulators of finance than builders of new track. Fortune came from the ability to acquire ownership of a profitable railroad and then to capitalize those profits by selling securities to the public. Fortune came from profiting from a shift–either upward or downward–in investors’ perceptions of the railroad’s future profits. It was the tight integration of industry with finance that made the turn of the twentieth century fortunes possible.”
“The Depression’s financial market reforms act broke the links between board membership, investment banking, and commercial banking-based management of asset portfolios that had marked American finance before 1930. Investment bankers could no longer be commercial bankers. Depositors’ money could not be directly used to support the prices of newly-issued securities. Directorates could not be interlocked: that bankers could not be on the boards of directors of firms that were their clients.”
“More of the return of the super-rich is due to the blurring of the lines between financiers and corporate managers as the Depression-era order of American finance has fallen apart. It is once again possible to raise large sums of money and then direct them to suit one’s own interest, rather than turning them over to salaried managers interested in perpetuating organizations.”
There is a big difference between liberty and equality. I choose liberty.
AS and Buzzcut: See Figure 2, added.
Buzzcut: I think you mean “fractiles”, not “fractals”. The two are, in mathematical terms, completely different.
for the weathly, the marginal propensity to consume is much lower than averge. So i gotta ask/wonder, wouldn’t raising taxes on the richest 98% and spending it (infrastructure) actually be stimulative? blah, that is crazy talk!
Re: People make bad choices in life. They get pregnant before they finish school and have a career started. They use drugs. They get tattoos and body piercings all over themselves and then wonder why no one will hire them for an entry-level job.
my first thought was hmmm, why are we talking about Sarah Palin’s family here?
But, seriously, someone needs to get a life.
@ David Penwell : take a holiday in France, David.
Liberté, égalité, fraternité.
French for “Liberty, equality, fraternity (brotherhood)”, is the national motto of France, and is a typical example of a tripartite motto. It finds its origins in the French Revolution …
And humanity is a word, David, you might have never heard of …
There is a bit of sleight of hand going on in this post. If I accept the graph, arguendo, nothing follows from it. It shows the portion of taxable income earned by individuals at the top of the income range. Just data points, nothing else.
The graph is intended to elicit a response, however: those guys are really rich! And they are not taxed enough! Why should the proportion of tax paid go up with increasing income? Usually the arguments, go as follows, in increasing order of sophistication:
There’s more of us than you, we want the money, we’re taking it.
It’s just wrong that these people have so much money, so we are setting things right.
A higher income taxpayer has enough to cover necessities, we are just taking away the part he/she doesn’t need.
We set the rules, and because of the rules, income is arbritary and thus how much you keep is arbitrary. There is so much good we could do with the money you have, so we are taking it.
Income is not distributed – by and large it is produced in voluntary transactions between free individuals (except where the state is involved – then it’s stand and deliver). If people are free to contract with each other, some will be wealthier than others – some much wealthier. That’s not arbitrary, it’s reality mixed with human talents and desires. The desire to confiscate the fruits of my labors is a perversion. It’s just envy with a veneer of respectability.
Johannes –
I thought the national motto of France is “We surrender.”
Here is a timely article that addresses income inequality –
http://online.wsj.com/article/SB10001424053111904772304576468820582615858.html?mod=WSJ_business_LeftSecondHighlights
Even Jesus Christ said – “the poor you have with you always.”
Again, this is just a pseudo economic problem. It is at its heart, a sin problem.
Dear Professor Chinn,
Thank you for the response. I scanned the Aronson & Bhashkar article. I wonder if some of the income mobility is due to the change of the economy in the past decade or so compared to economy that the “working man” experienced after WWII? The USA it seems to me was the only economy left in tact after WWII. The working man could get a job at “good” pay at the steel mill, auto manufacturer or a variety of other manufacturing plants supplying the world. The pay from these jobs was perhaps much better than the parents of these workers experienced. Could the nature of the economies at different decades help explain the quote below?
Daniel Aaronson and Bhashkar Mazumder
Our preferred estimates of the IGE suggest that economic mobility was relatively low in
1940 but increased over the subsequent four decades. However, economic mobility fell sharply during the 1980s and failed to revert, perhaps even continued to decline, in the 1990s. (p.2)
David-
In the Church of Progressivism, inequality is a mortal sin and will prevent a country from getting to “Heaven”.
why is this news ?
old story, surely you can do better even on a slo day.
I mean, this same graph, or some version of it, has been already posted about a gazillion times by various people.
what would be of interest professor, should you actually decide to do some work, would be to tabulate all the legislation championed by democrats, like NAFTA, that depress wages for the workers; sure, NAFTA is great for tenured profs – they get cheap clothes and cheap gardeners and cheap vegetables, but if you are laid off from your factory job, being able to take your welfare check and go down to wal mart and buy super cheap clothes from mexico just isn’t quite good enough
“The pattern shown in Figure 1 remain in Figure 2; in fact, if anything, the pattern is even stronger (the top 0.1% receives 13.8% here, versus 10.4% in the ex.-capital gains series).”
The average realized capital gains for the top 0.01% is $10M per year (out of $27M total). That is not insignificant, especially considering that capital gains is an almost nothing for even the top 10%.
But I take your point, in that that same top 0.01% has $17 million in non-capital gains income! I wonder what the folks in those 15,000 homes do for a living? CEOs and trial lawyers?
Menzie,
Are you following Krugman’s career path, parlaying a modest amount of insight into international economics into a much larger portfolio of clueless leftist propoganda?
A.West: I leave it for the readers to decide. Now, what is your objective? Are you aiming for an anarcho-libertarian utopia, given your statement “These [federal, state, local] taxes are basically legalized cannibalism.” Sounds like a pleasant world, as long as you’re on top of the heap.
Johannes: “Liberty, equality, fraternity (brotherhood)”, is the national motto of France…
Hmmmm, I thought the French motto was: “We surrender!”
David Penwell @ 10:47 AM–sorry, I read right past your post.
Sorry, Anon 11:23 was me.
Sorry, I am not familiar with the term “fractile”. “Fractal”, yes, “fractile”… not so much.
For those that have a little time, downloading the excel file that generated the graph is a good use of time. Figure 11, showing CEO income, is pretty enlightening, although it wasn’t obvious to me if these 100 CEO households were the driver of the income growth of the top 0.01%, seeing as how there are 15,000 of them.
It seems to me that what is important is jobs and economic growth. If we had this income distribution with strong economic and job growth, I don’t think this post would be very interesting.
But we don’t have job and income growth or economic growth. Is it because gains are accruing to the top 0.01%? And is THAT because of tax policy?
I’ve never understood what the link between inequality and economic growth was. Maybe that is another post for Menzie.
Could it be that income inequality and poor economic growth are actually results of globalization? It could very well be that these top 0.01% are folks who capture the gains due to massive economies of scale due to globalization (like, for example, Steve Jobs). And it could be that the low skilled are being hurt because they have to compete with the third world masses.
Perhaps I am reading too much into this post, and all Menzie is saying is that, if we need to raise revenue, you need to go where the money is, and that is the top 0.01%. But even raising their tax rate to 100% only captures $400 billion, and that doesn’t count supply side effects!
The thing with liberty and equality is, they usually go together. A concentration of wealth generally leads also to a concentration of power, which comes at the expense of individual liberty.
Buzzcut When it comes to regression, I subscribe to the KISS philosophy.
You sound like a patriotic guy, so here’s your chance to potentially contribute to the education of our young cadets at West Point. Next term my boss wants me to do a guest lecture thing on some econometrics stuff…specifically GARCH modeling. But after seeing your Excel analysis I thought that it might have excellent pedagogical value for the cadets in showing them how not to do econometrics. Rarely have I seen virtually every undergraduate mistake in the book all conveniently wrapped up in one example. Autocorrelation, heteroskedasticity, multicollinearity across regressors, intercept bias, and best off all applying linear regression when the appropriate technique is maximum likelihood. Note to Buzzcut: you might want to familiarize yourself with something called a Tobit model when you’re dealing with truncated data. In fact, there’s an affordable software package called LIMDEP that specializes in limited dependent models, censored data, truncated
data, Poisson regressions, etc. At work I use it all the time for those kinds of problems.
http://www.limdep.com/features/capabilities/
As to those lazy bums in Lake County Indiana who refuse to work as hard as someone with an “advanced” degree, well at least the damage they cause to society is limited to their welfare checks. From society’s perspective the misuse and propagation of bad statistical models is a far more serious offense. Do you moonlight for Heritage Foundation?
Rich Berger Income is not distributed – by and large it is produced in voluntary transactions between free individuals (except where the state is involved – then it’s stand and deliver). If people are free to contract with each other, some will be wealthier than others – some much wealthier.
We’re not just alking about income, we’re talking about extreme income. There’s a difference. You can certainly make an excellent case that there should be unequal distribution of income just as there is an unequal distribution of talent and effort. Up to a point income differentials can increase economic efficiency and enhance welfare overall. But for folks at the extreme right tail income does not reflect their marginal product. Extreme income only comes about through rent-seeking schemes. Dick Cheney and Donald Rumsfeld didn’t earn those huge salaries because their business acumen was thousands of times sharper than the next cleverist businessman. They got those salaries because they were in a position to capture rents. Investment bankers are smart guys, but they are not tens of thousands of times smarter than the next smartest guy. We now know that most of their contribution to GDP was a chimera. In the long run an economy that is rent based rather than productivity based is a dead economy, and that’s because rent-seeking requires restricting economic output rather than the expanding output. Look at the super rich. They got that way through copyright protections, patent right protections, inheritance laws, etc. When “owning” the rights to something pays more than “doing” something, then the economy’s prospects look dim. The reason we worry about extreme income inequality is because it’s a symptom of an unhealthy economy. Extremely high incomes should be heavily taxed in order to discourage rent-seeking over productive labor.
Menzie –
Why not consider giving us your view of the future in terms of fiscal policy?
For instance:
– govt spending as pct of GDP
– cyclical components (UI, food stamps, welfare, Medicaid, etc.)
– structural components: major drivers, components (SS, Medicare, etc., and the major challenges and obligations as you see them).
– revenue as a pct of GDP
– cyclical components (or lack thereof)
– major revenue sources (burden by sector; for individuals, burden by quintile, or something like that)
– evolution of the deficit
I have not seen a presentation in (simple) numbers of the egalitarian vision of the future. Why is that good? Why should we support it? I don’t think left-leaning Democrats have really made the case, and I think it’s hurt them.
In any event, I would certainly welcome a vision of the future, as you would like to see it.
Is the economy tanking? Sure looks that way.
Nice that you go back before WWII – too many analysts these days seem to think the economy was born post-WWII.
Is income taken from tax returns? One effect of tax reform (lowering the top marginal rate) was a dramatic increase in reported income in the higher brackets. Clearly, that was an artifact of tax reporting (and tax planning). Looking at the marginal rates in your earlier post (cited above), there would seem to be a negative correlation between the top marginal rates and income shares of the top groups.
Steven K – Well said. Can the Keynesians just give us a tax rate and per cent of GDP they want the government have, numbers that makes them happy, and then just go away? ( I have a guess that it is more a control question than a numbers question for them. Government spending is just a way to control.) Also, no one has ever been able to explain to me that if Keynesian policies work, why would a country ever have a recession? One down quarter of GDP, kick in the spending, and away we go.
2slugbait – Are not all career academics collecting rents? The poor students are forces to take the class. They have no say in the cost of the class they are forced to take. In general, can career academics make as much money at their next best option? (I know some can, but not many).
BTW – What is a 2slugbait anyway?
Slugs:I commend you for at least trying to defend why an egalitarian distribution would be better, but I’m afraid many of your points just don’t hold water. A couple of quick points:
a) Besides the anecdotal evidence of a couple of “bad rich guys” do you have any evidence that all (or at least most) high earners are rent seekers? You’d have to be pretty certain that all are rent seekers to use that justification, because the tax code isn’t able to discern that on its own.
b) Just because the income-to-talent ratio is not proportional is not an indicator of rent-seeking. In some situations, which may very well include investment banking, there is big difference between being the very best and almost the best.
c) I would hardly call copyright and patent holders rent-seekers. Patents certainly add value and we don’t want to discourage their development.
d) Same with inheritors, they can’t be by definition because they don’t earn any rent.
Finally, if you believe that rent-seeking is such a problem in the economy why do think its preferable to discourage the behavior indirectly through tax rates? Why not directly address the issues through the institutions that created them?
David Penwell Some academics might be rent collectors, but if they are, then they are mighty bad at maximizing incomes. And our hosts JDH and Menzie freely give away a lot of their pearls.
Your comment to Steven K. seems bizarre and not well informed. Keynesian economics doesn’t have anything to do with wanting to control the economy unless you think keeping aggregate demand in line with potential GDP is somehow controlling the economy. Keynesian economics is all about the tendency for modern capitalist economies to suffer bouts of too much desired saving relative to investment demand…”I” doesn’t always equal “S”. As a result aggregate demand falls and sometimes we end up in a low output equilibrium. It doesn’t have a damn thing to do with “a control question.” As to why the economy sometimes falls into recession, well, economists are not yet God. And politicians (particularly Tea Party politicians) do bear a striking resemblance to Beelzebub.
I’d be interested in seeing the difference between the 0.5% and the 0.1% plotted on either graph. Looks pretty flat to me.
(This implies that non-rent seeking but highly compensated activity continues to generate comparable income to historical levels.)
The movements in consumer sentiment for high income households were really interesting in the recession. See Richard Curtin’s analysis of the Michigan survey. Normally, sentiment is much higher among high income households relative to low income households. During the financial crisis in 2008, sentiment plummeted among high income households…which makes a lot sense given the massive negative wealth shocks and the high concentration of wealth. All of the recovery that we had seen since early 2009 was high income household feeling better. Low income households actually felt worse. You can see this in the tabs on the Michigan survey site. The last point that ties it back a bit more to your post is to remember that high income households have a disproportionate effect on aggregate spending. Income concentration is far, far less than wealth concentration in the US, but there is enough income inequality to have consumption inequality.
Jeff First, I didn’t make an argument for an egalitarian income distribution. As I said before, up to a point there is a good case to be made for unequal distribution of income. As to your question, yes, there is evidence that the lion’s share of of extreme income types (and I’m only talking here about those at the extreme right tail) are rent seekers. For example, the percent of income that comes from capital gains rather than ordinary earned income.
You should ask yourself the following question: Suppose the top 0.1% of income earners suddenly lost their jobs or just retired. And suppose they were replaced with someone whose name was randomly picked from a list of people who met the basic job requirements in terms of education, experience, etc. Now suppose that replacement worker received an income that was only in the top 1% rather than top 0.1%. Would the economy suffer a loss in GDP equal to the income differential? In almost all cases the answer would be no. In fact, GDP is likely to increase. These super rich are simply not carrying their weight.
Sometimes it may be more important to simply attack the ill directly, and figure out later whether you were efficient as well.
We have serious unemployment. The private economy has killed something like 16 million jobs, and almost three years later is still incapable of creating domestic jobs. What to do?
The government should hire directly, and infrastructure projects seem to be the most effective way to employ people. I don’t know if this will reduce income inequality. I don’t know if marginal tax rates need to be lowered or raised (I suspect a ‘use it or lose it’ tax policy would work better right now) but I do know this would create jobs by the millions.
I don’t care if this is a ‘chicken or egg’ situation, all I know is I don’t care what it is because the effective job is to create jobs and I know we can do that. Waiting around for another wave of liquidation is not the effective response.
2slugbaits – I agree, Econbrowser is a must read. Along with The Oil Drum, Greg Mankiw, Tyler Cowen and a few others. These guys could get a job anywhere. However, they are the exception that proves the rule.
I learn a lot from your comments, I just seem to disagree with a lot of them. But that does not mean I do not find them informative.
I just cannot get anyone to answer a simple question, if Keynesian policies work, why would a country ever have a recession? I just ask for a simple answer. If Keynesian policies are attempting to control the business cycle, was not that idea trashed in the 60’s and 70’s? Business cycle, sunspot cycle, good luck trying to control either. Set the level of government spending, tax economic activity once, and then just leave it alone. Business will adjust and make more people better off than any alternative. How can a President, Congress, or Super committee, outguess 350 million people each making their own decisions that are their own best interest?
“But after seeing your Excel analysis I thought that it might have excellent pedagogical value for the cadets in showing them how not to do econometrics. Rarely have I seen virtually every undergraduate mistake in the book all conveniently wrapped up in one example.”
Sweeeeeet. Be sure to send me the Powerpoint, I thank you in advance.
Menzie,
I think it would be nice to see the 0.5-0.1 broken out separately from the top 0.1. I realize you may need cooperation from Saez to do such a thing.
What’s striking to me has that rising inequality appears to be almost exclusively the extraordinary gains by the top 0.1 percent. The share by 0.5-0.1–the difference between the two lines–looks stable in comparison to the sharp rise of the top 0.1.
mike: If you go to the second to most rightmost columns in Tables A1 and A3 in the Piketty/Saez spreadsheet, I think you will see your conjecture is not validated.
Slug: The percent of income that is from capital gains tells us nothing about the level of rent-seeking that took place.
And again your claim that GDP would not decrease or even increase is another unsubstantiated claim. If your going to make a convincing argument you have to do more than tell a story that fits your intuition.
@ David Penwell
Check the numbers, the economy actually performed better in the 1960s and 1970s than it did in the 1980s, or than it has over the last 15 years. In general, during the era where at least some attention was paid by policimakers to Keynesian thought, we had a period of about 65 years of generally mild recessions and strong economic growth. We are doing less well in recent years since Keynes has fallen out of favor in Washington.
I do think there was also a failure in the latter half of the 1970s, but that was an economy where proper Keynesian thinking should have dictated massive reductions in government spending. At that time, interest rates, inflation, and capacity utilization were all well above trend and heading towards record highs. Clearly, the shortfall was on the supply side, not the demand side.
On your question about the appropriate rate of taxes as a percent of GDP, understand first that the entire point of Keynesian policy is that this rate shouldn’t be fixed on an annual basis. The budget should be balanced (roughly) cyclically, not annually.
But, for a long term target, I would personally like a level of around 15% of potential GDP, which would require a significant reduction in the size of the federal government relative to the historic rates of federal taxation and spending (around 19% of GDP). This doesn’t make me any less Keynesian; I still favor a stong counter-cyclical fiscal policy response to recessions.
As for how to raise those taxes, there isn’t really going to be one “Keynesian” answer there, either. I would personally favor replacing all personal and corporate income and estate taxes with an annual tax of 0.75% (three quarters of a percent) on financial assets (which currently total about $150T in the US economy per the Fed). The thinking behind this is perhaps more “Georgist” than Keynesian (though Henry George favored taxing land, rather than financial assets).
As to why we haven’t achieved any Keynesian utopia, I think a good part of it is that it is often psychologically difficult to persuade people, including policimakers, that Keynesian policy is correct. Most people tend to want to think of the Federal budget as being similar to a household budget. When there are shortfalls, they think budgets should be cut. When there are surplusses, they want government largess. The key Keynesian insight is really that because government, unlike housholds, has the power to print money, it should do the exact opposite of what most people seem to expect.
Of course there is generally some cost to simply printing money, in the form of inflation. But the point is that inflation doesn’t actually occur until there is some constraint, in either labor markets, capital (capacity utilization), or resources (i.e., the three factors of production). When there is slack in all of these markets, printing money in order to spend it is practially free, it costs taxpayers nothing. And, once that slack is absorbed, modern central banks are pretty adept at soaking up any excess dollars before inflation becomes too great a problem.
In addition, with very low interest rates, also due to the degree of slack in the economy, borrowing in order to spend also costs taxpayers almost nothing. Indeed, interest rate costs on the Federal debt are currently near a 30 year low.
Thank you for saying this. Someone needed to
@ acerimusdux
Thank you taking the time to respond. I do like your target of 15% of GDP. It would be great to have the government at that per cent of GDP, no matter who was driving.
I believe a lot of inflation is occurring now. My wife tells me about every time she goes to grocery store. The problem is wages have been mostly stagnate over the past decade. I do not know, but my guess is, that is why people were playing so fast and loose with their house. They were using the increasing equity to live off of. Not wanting to tell the lies they told on the applications, they just wanted to feed their families.
In the ongoing battle between capital and labor, capital has been winning for the past two decades or so, and will probably continue to. Just too many people and too few jobs. I am in the IT field, and even that is tough. Job are usually contracting with little to no benefits. Back in the 60’s and 70’s, it was the other way around. Women jumped into the work force, two income households produced extra purchasing power and an improved lifestyle, or so they thought. (until the latch key kids started producing illegitimate offspring, drug addictions, and various assorted activities unsupervised teens can get into.) Now dual incomes are almost a requirement not a lifestyle improvement choice.
Through all of this so called “great recession” none of the throw money at it approaches have done any good. When I was a young teenager, and Ronald Reagan cut taxes, I could see the closed down factories opening back up. I did not need a bus tour to try and tell my about a summer of recovery. (That idea was about as dumb as the WIN button). You can feel 7% GDP growth, 1.3%, not so much. So, from what my life experience tells me, supply side works, Keynesianism does not, just that simple. Which side is has the best theory, I do not know, all I know is that in the 80’s the once unemployed, got a job.
David Penwell Although acerimusdux did a fine job of addressing your question, I can’t resist the temptation to pile on. Just because The General Theory has been around long enough to qualify for Social Security does not mean it is mainstream thought among politicians or voters. Today’s Republican thinks Keynes = Marx, and has probably not read either.
Today’s Keynesian advocates an activist Fed to keep aggregate demand within normal bounds. And over the last couple of decades that approach worked very well. Fiscal policy is not usually the first tool pulled from the Keynesian workbench because it is prone to be badly timed, but when policymakers find themselves in a liquidity trap fiscal policy may be the only option left standing. And I think that’s the situation today. But as acerimusdux said, otherwise intelligent people have a hard time getting their heads around the idea of running big deficits when the economy is weak. It’s counterintuitive because people think in terms of household budgets when prudence requires a repairing of balance sheets during down times. But if everyone in the private sector tries to save and repair balance sheets, the result will be too much saving relative to investment demand and this will drive down aggregate demand. The only way to bring desired saving in line with investment demand is by lowering income. That’s a recession. Normally the Fed can adjust the interest rate to equilibrate desired savings with investment demand, but when you’re at zero bound this option is off the table. Fiscal policy is the only option left short of accepting a low output equilibrium. And why would anyone want that?
Also, recessions have different causes. During the 70s and 80s a lot of our recessions were aggregate demand responses to supply side shocks. Today’s recession is a financial recession, which is qualitatively different. A policy that is appropriate for one type of recession may not be appropriate for another.
Jeff I disagree. The percent of income from capital gains is a pretty good proxy for rent seeking behavior. Or if you don’t like that, then look at the contribution from GDP coming from finance and banking. Now I’m not against innovation in finance and banking that promotes growth, but if you look at the NIPA tables you will see that over the last 15 years a huge chunk of GDP growth has come from the financial sector even as hourly productivity in that sector has fallen. That’s a little hard to explain if you believe income gains at the very top (which is dominated by investment bankers) were due to productivity gains. What has the finance & banking sector really done to generate added value…and as Krugman likes to say, ATMs don’t count? Another example is the auto industry. For years top executive salaries went through the roof as corporate mismanagement set new records. Then the govt takes over GM and Chrysler, fires top management and replaces them with people making a lot less. Lo and behold, management improves and the auto industry is at least marginally profitable once again. Isn’t that more evidence that income gains at the very, very top reflected rent seeking opportunities more than marginal”value added?”
A side note from the general discussions of income concentrations is that I noticed something that convinces me that the revenue generating abilities of capital gains tax cuts have always been oversold.
We are often told that the narrowing of the differential between capital gains rates and other tax rates as part of the 1986 tax reform was detrimental to revenue collection since it discouraged the realization of capital gains by investors. The initial spike in capital gains realizations in 1986 and the subsequent fall off and lower overall level is supposed to be evidence of that.
However, in the data set here, we see an interesting behavioral response by high income earners, who collect an extremely disproportionate share of capital gains receipts. While the share of income earned by high income earners does not move much between 1985 and 1990, the share excluding capital gains surges, implying a shift in the compensation structure away from capital gains (i.e. stock-based compensation) and toward other sources.
As such, I suspect that a lot of the supposed revenue gain that occurs on the capital gains side is at the expense of tax receipts subject to the rates levied on earned income and other unearned income. I don’t doubt that there are temporary effects where individuals who had been waiting to realize gains will do so in the event of a capital gains rate reduction. This would generate a blip in revenues. However, I think the idea that a reduction in capital gains tax rates is additive to revenues as a whole is extremely questionable.
Menzie, do you happen to know if there is research that has looked at this behavioral response beyond just an examination of what happens to capital gains receipts in isolation? I’ve generally only seen the latter.
Slug: If you are going to say that capital gains are an indicator of rent-seeking, at the very minimum you have to come up with a convincing story as to why a rent-seeker is more likely to be paid in assets rather than ordinary income. Finding actual evidence would be the the next step. So far you’ve done neither.
Without going and verifying the numbers, I really don’t think productivity in the financial sector has decreased over 15 years. Perhaps you mean that it hasn’t keep pace with overall productivity gains? But regardless, there’s nothing mysterious about those numbers a priori. If you add more low-productivity workers than high-productivity workers you’ll drive the average productivity down. This can happen even if the high productivity workers are getting more productive.
Finally, according to this article, the new GM CEO is paid the same as Wagner was and gets a significant portion of his income from stock. Has your opinion of him suddenly changed?
Brian Quinn: Good question. Afraid I don’t know of any such studies; surely a public finance expert would know.
Jeff What makes it rent seeking is that they are making some increment above what it would take to get the same level of effort and same contribution to the economy. If a sports star makes $20M/yr but that same star or another star would be willing to play at the same skill level for $1M/yr, then the extra $19M is rent. The ability to extract rent is based upon one’s political or legal ability to withhold supplying that effort. In the case of high flying investment bankers they use networks & political relationships to extract rent (oftentimes from taxpayers). Investment bankers made money by churning transactions rather than adding value. And compensation packages were nominally called “capital gains” for reporting purposes, but anyone would recognize it as ordinary income. They just didn’t want to pay income tax so they called it something else.
As to the new GM President, I think you missed the point. Notice that the GM officers are now doing for nothing what they used to get paid a lot of money to do…that is, sit on the Board of Directors. Also, the compensation package in the article compares the new guy’s compensation (Akerson) to the previous CEO, who was Whitacre, not Wagoner. For his sterling efforts at the helm of GM, Wagoner received $15.7M in 2007 and $14.9M in 2008 despite GM losing $82B in the last three years of Wagoner’s stewardship. So the new guys do a better job for less money. And they don’t get all the perks that Wagoner got that were not taxable, such as $160,000 for use of personal aircraft, $270,000 for “personal security,” $11,500 for company vehicles, $12,000 for financial and estate planning, etc. It’s unclear if he received skybox seats at the Detroit Lions games, and if he did it wasn’t clear if that counted as an incentive or as punishment for bad behavior. I promise, I’m pretty sure that I could not do any worse than Wagoner did and I’d do it for one-tenth the salary.
Slug: Do you see that your definition of rent seeking is entirely inconsistent with all your other example of rent seeking? How is it that Wagner is a rent seeker, but Akerson-who was directly given the job by the government not? How is any sports star’s earning in any way tied to politics? If someone is getting paid 20M/yr and they would do it for less that’s not called extracting rent-that’s called producer surplus. If someone else would do the same job for less, the difference is not extracting rent either, not even by the very definition you just gave. And you have still yet to tell me why rent seekers are more likely to be paid in assets.
2slugs, that is an excellent description of rent seeking there, I just think that you are delusional that you think that this is a Republican issue. Those investment bankers are all big contributors to Obama.
I don’t think that increasing taxes is the way to address it, either. Nor is financial regulation. We need to simply outlaw certain financial products, like CDOs and MBSs, stuff that nobody but a select few really understands. Without these financial products, I don’t think the investment bankers can make as much money as they do.
Regarding CEOs, again, do you think that Obama contributors like General Electric are somehow different? GM has been curbed because it is partially owned by the Feds, but I am sure that once the ownership ends, they will go back to their ways.
And if income taxes are raised, how do you make sure that other means aren’t used to compensate CEOs? For example, Warren Buffet sells the company an enormous life insurance policy on the CEO, and then the CEO “borrows” against the policy, to be paid back upon death.
What is really needed is stockholder activism. At the end of the day it is stockholders that are being hurt by excessive CEO salaries.
The BIG rent seeking activity in this country goes on in the halls of Congress … where big corporations and liberal organizations lobby for government largesse at taxpayer expense. A constitutional amendment that limits government outlays to a fixed percent of GDP would go a lot further in solving the problem……that would giving politicians more revenue to dangle before rent-seeking organizations.
For those asking why we “normal” Americans should be concerned with the amount of wealth held by the richest, it’s because that’s where the tax revenue is. It’s all well and good to hope for less government spending, but it ain’t gonna happen, at least in sufficient size to reduce the need for additional revenue. That’s the conclusion of Simpson-Bowles and I dare anybody to challenge it.
So, either the rich pay more or I do. Either the estate tax is raised or my children pay more in income tax. These are the choices. Unless you’re among the top 1%, you’re an idiot to think otherwise.
“For those asking why we “normal” Americans should be concerned with the amount of wealth held by the richest, it’s because that’s where the tax revenue is.”
Is that true? The top 0.01% of households has average income of $27M and there are 15,000 of them. Do the math. That’s only ~$400 billion.
There aren’t enough people in the top 1% to pay for all this spending.
For what it is worth, I am totally on board with Simpson-Bowles. We need to get rid of a lot of the income tax deductions: mortgage interest, state and local taxes, etc. This will be mildly progressive (only really effects people who itemize, which are higher end taxpayers).
I think anyone who takes Medicare should have their estate taxed right up to the amount they consumed in benefits.
Jeff Do you see that your definition of rent seeking is entirely inconsistent with all your other example of rent seeking?
No. The essence of rent seeking is the ability to extract a premium that is above marginal product. Oftentimes that is done through the manipulation of scarcity; e.g., sports skills, patents, copyrights, oil wells, Enron withholding electricity, etc. Sometimes rents are a natural result of inherent differences in productivity; e.g., agriculture prices are based on the value of the marginal field, so fertile soils return a rent premium to the farmer equal to the difference between the higher price set by the marginal field and the lower cost of the fertile field. And sometimes rents are due to people using connections and government power to grant exclusive rights; e.g., sports stadium deals, railroad right-of-ways, Cheney/Rumsfeld, or Thomas Ridge/Michael Chertoff’s security deals with DoD, etc. Investment bankers used government connections to backstop risk. Investment bankers also used government power to redefine ordinary income as a “capital gain” only for investment bankers and no one else. It’s easy to be merely rich without benefit of rent seeking schemes; it’s impossible to be super rich without rent seeking.
And you have still yet to tell me why rent seekers are more likely to be paid in assets.
I never said they were. In fact, my whole point about investment bankers is that they are getting the benefit of a lower capital gains tax rate without being paid in assets!
Go back and check your post at 2:45. I presume you meant that rent seekers and capital gains were positively correlated. Or are you now trying to argue that rent seekers, and only rent seekers, have the ability to mis-characterize ordinary income as capital gains?
Go back and check your post at 2:45. I presume you meant that rent seekers and capital gains were positively correlated. Or are you now trying to argue that rent seekers, and only rent seekers, have the ability to mis-characterize ordinary income as capital gains?
Is there any concern for the current status of savings? It used to mean deferred consumption. Now it means consumed by someone else. There is minimal global true savings(resources actually but aside). This may be a problem for future debt payments in an era of constrained resources. Where are the storehouses of grain from the fat years?
It’s a mathematical tautology that if income in an economy is growing, unless every participant grows his/her income at the exact same rate (which is of course impossible) that the top 10%,5%,1%,.5%,.1% will all capture of greater share of the overall wealth. It’s not mathematically possible for any other outcome.
Steve: You need to read more carefully, and then also learn some math. First, the graph pertains to income, which is a flow, rather than wealth, which is a stock.
Second, consider an economy with three people, one with zero income, one with income of 1 and one with income of 3. If the middle-income person has her income double, while those at the low and high end experience no change, then the top 1/3 sees her income share fall from 3/4 to 3/5, while the middle 1/3 sees her income share rise from 1/4 to 2/5. So, to say the least, other outcomes are possible, mathematically.
For what it’s worth, which is probably zippity do da, I think capital gains should be taxed at regular income levels, but there should be a credit of 4% or so on dividend income.
Why do I think this? Because it appears to me the capital gains tax rates have only resulted in dysfunctional equity markets that no longer allocate investment income, but instead have devolved into old style ‘bucket shops.’
If dividend income were elevated to a more important income position, this would suppress short term betting with longer term enterprise investment.
As for tax cuts, Lord, what more evidence do we need that cutting them from reasonable rates has resulted in threatening the nation’s peace and prosperity. Force hoarded money into consumption or investment by raising top marginal rates. Use it or lose it, buddy.