David R. Henderson  

Emmanuel Saez's Medal

Richard Epstein on Happiness, ... Mark and Me on Macro...

Berkeley economist Emmanual Saez has won the 2009 John Bates Clark Medal, awarded bi-annually by the American Economic Association since 1947 to "that American economist under the age of forty who is judged to have made the most significant contribution to economic thought and knowledge."

Past recipients have included Paul Samuelson, Milton Friedman, Bob Solow, James Tobin, Ken Arrow, Gary Becker, Paul Krugman, and Larry Summers.

Some of the work highlighted in the award announcement was Saez's and Thomas Piketty's estimates, using IRS data, of the percent of income going to the top 1%. They show that between 1980 and 2004, there was a doubling of income going to the top 1% of taxpayers. However, in a January 2007 Policy Analysis, "Has U.S. Income Inequality Really Increased?", economist Alan Reynolds has poked a number of holes in their data and, especially, in the way many people, including Piketty and Saez, have interpreted their data. The most damning critique leveled by Reynolds, in my opinion, is that they don't take adequate account of a major change in the tax system in the Tax Reform Act of 1986. This Act dropped the top marginal tax rate on individual income from 50% to 28%, thus bringing the rate below the tax rate on corporate income. Shortly, after, thousands of corporations shifted from C corporations to S corporations so that their owners could pay the lower personal tax rates. The result: a major increase in apparent individual income at the top of the income distribution without necessarily a shift in the underlying reality. Reynolds writes up his results in a Cato analysis. Mark Thoma highlights Piketty's and Saez's response. On Thoma's site, scroll down to Reynolds's response. It's worth quoting, and not mainly because it refers to a joint Wall Street Journal article by Alan and me:

For Mark: Piketty and Saez did not claim I misquoted them or that my calculation was wrong, so no correction is needed. Actually, their figures show the top 1% received 9.7% of pretax personal income in 2004, so my Dec 14 estimate was too generous. On the CBO's estimate of top 1% income see my piece with David Henderson in February 6 Wall Street Journal.

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CATEGORIES: Income Distribution

COMMENTS (10 to date)
Mark Thoma writes:

Just to be clear, here are a few quotes from the Pikettly/Saez response. It explains why his calculations are wrong (where wrong includes the many conceptual errors that he makes, the serious misunderstandings of the work, and using the wrong, or minimally less accurate data in the analysis):

"we want to outline why his critiques do not invalidate our findings and contain serious misunderstandings on our academic work."

"The ... Census Bureau estimates are based on survey data which are not suitable to study high incomes. In contrast, tax return data provide a very accurate picture... Our key contribution was precisely to use those tax data to construct better inequality estimates."

"Alan Reynolds points out that transfers have increased since 1980 but taxes on high incomes have decreased substantially. Actually, we have estimated that the average Federal tax burden... The decrease in taxes at the top outweighs the increase in transfers at the bottom. Therefore, the top 1% disposable income share has most likely more than doubled since 1980."

"In contrast to what Alan Reynolds suggests, there is a debate among economists on whether reported incomes respond to tax rates. ... Even the small point on 401(k)s is conceptually mistaken".

"In sum, our work has shown the top 1% income share has increased dramatically in recent decades... [C]onservatives like Alan Reynolds ... prefer to dismiss the facts about growing income inequality rather than face the debate on income tax progressivity at a time of growing economic disparity."

The big point that Reynold's was trying to make - and that Krugman, Saez and others have thoroughly debunked - is that there has not been any increase in inequality. It's all a statistical illusion. But, of course, it's not.

When you (D. Henderson) quote titles like ""Has U.S. Income Inequality Really Increased?," with "really" emphasized and without qualification, and when you give Reynolds your support, it implies you believe this too. Do you? Was Reynold's right? Or has there been an increase in inequality?

That's the big question, the rest is all fog put up by Reynolds and others to try to obscure the change in inequality. Reynolds was just plain wrong. Inequality went up, way up, and as I said, the rest is just a (relatively poor) attempt to obscure that fact.

DW writes:

David, you're always such a downer!

Babinich writes:

Mr. Thoma,

Want a way to help even the playing field? Go to a flat tax, cut corporate taxes, cut or better yet eliminate capital gains.

Cut out confiscatory taxes like those imposed by Social Security.

Let the individual decide where their money goes.

David R. Henderson writes:

Dear Mark,
Thanks for your note. As you can see, I directed Econlog readers to your site so they could see the debate and make their own judgment. I highlighted Alan Reynolds's response to you in the comments section because otherwise they might get stuck in a debate about religion further down the thread and miss the fact that he had responded.
Now to your points.
First, I think income inequality probably has increased. I also think that Piketty and Saez substantially overstated the increase and one of the main reasons is that so much income that used to be called corporate income (taxed to C corporations) is now, with the Tax Reform Act of 1986, taxed as individual income.
Second, I haven't found Alan Reynolds saying that there has not been any increase in inequality. He might believe that. But I've never heard or seen him say it. I agree with you that one might think he's saying that based on the title of his paper. The only reason I quoted the title the way I did, with italics, is that that is the title, with italics.

Jacob Oost writes:

Not really knowing enough of the technicalities of this to follow the debate, I will say this: income inequality is a red herring. The free market has worked so well, and done so much to debunk Keynesian, socialist, communist, etc. ideas of macroeconomic engineering and big government, that those people now need some rationale for bringing back big government. Some use "global warming," others use income inequality. The very phrase conjures up images of poverty, but in fact it is totally, 100% irrelevant what percentage of the national pie I make. What matters is my standard of living. Is it going up, or is it going down? Do goods and services typically take up a larger or smaller fraction of the average person's income?

Big screen tvs, air conditioning, cars, luxuries from laptop computers to cell phones, video cameras, quality of housing, etc., have all skyrocketed in my lifetime, thanks largely to the workings of the market. Where the rubber meets the road, when you get down to the nitty gritty, the market blows away big-government policies, every time.

But some people need a rationale, a reason to cling to their debunked beliefs and to sell their debunked beliefs to others. They need to invent a problem which only they can solve. Enter income inequality.

Even if a low-income person in the US, somebody on the bottom of the income rungs, now gets a smaller percentage of the national pie, that pie has grown so large, and its purchasing power has increased so much, that it more than counteracts the growth in income inequality.

Charlie writes:

"Most of the scenarios described by Alan Reynolds, such as a shift from corporate income to individual income or from qualified stock-options to non-qualified stock options, would imply that high incomes used to receive capital gains instead of ordinary income. For example, a closely held C-corporation which does not distribute its profits increases in value and those accumulated profits would appear as realized capital gains on the owner individual tax return when the business is sold. Yet, our top 1% income share series including realized capital gains has also doubled from 10.0% in 1980 to 19.8% in 2004."

This seems to be a pretty damning response. If the argument you find compelling is right, shouldn't income share including capital gains stay the same?

Vadim writes:

I'm surprised that no one has mentioned that the 1986 tax reform eliminated many forms of abusive tax shelters that no doubt resulted in a vast understatement of income at the top end.

For instance, prior to IRC 465, people could claim tax losses in excess of they could lose economically. There was a huge industry of tax shelters that whose sole business was to generate huge tax losses that investors could use to offset against their real income.

Alan Reynolds writes:

What I have always said is that there has been no broad increase in the inequality of disposable income since 1987 (which is precisely when the Piketty-Saez tax-based data begin to create the opposite impression). The Piketty-Saez estimates contain no information about disposable income because they exclude all taxes and all transfer payments.

Here are the Census Buereau’s Gini coefficients for their 14th broadest definition of income, which subtract direct taxes and add transfer payments and taxable capital gains (a dwindling share of total gains). The apparent jump in 1993 is a statistical illusion, caused by new survey methods that sampled a larger fraction of top incomes. For 2008-2009, my estimate is that the Gini for disposable income fell to 0.375 or less.



http://www.census.gov/hhes/www/income/histinc/rdi5.html http://pubdb3.census.gov/macro/032007/rdcall/1_001.htm

Income data from the Fed's Survey of Consumer Finances (which do not exclude taxes) likewise show no rise in the income share of the top 10% after 1987. For that data and more please see my graphs at the following sites:



The title "Did Income Inequality Really Increase?" was not my idea. It began as as a paper presented at the Western Economic Association called "The Misuse of Tax Data to Measure Income Inequality."

The key issue then and now is that high elasticity of reported income with respect to marginal tax rates distorts the Piketty-Saez and CBO data whenever absolute and relative tax rates are changed. Putting personal tax rates above corporate rates under Obama, for example, will clearly encourage more filing under the corporate tax.

Piketty and Saez have never responded to my book “Income and Wealth” which quotes them extensively in support of my conclusions on this issue, nor to my 1997 Wall Street Journal article:


If anyone had attempted to do a serious analysis of the many points I have raised about this misuse of tax data, then I would have gladly responded in kind.

Jaime L. Manzano writes:

Invidious comparisons between the rich and the poor are informative, but, economically and politically naive. At bottom, it seems that some academics and political pundits, bristle over the fundamentals of the market and succumb to the siren song of the alternative world - the regulated command economy.

A free enterprise market of production and ideas, while making the rich richer, also increase the well-being of the poor. The rich, however, tend to be more enterprising and manage their money better, so they get richer faster than the poor. As a result, the earnings gap increases. But there is more.

Since the rich earn more than the poor, their income grows faster than their ability to consume. As a result, they have no other choice but to save, and/or invest what is left. To over simplify, both the rich and the poor have the same size stomachs, so the volume of food they eat is about the same. Of course, the rich, like the kings of France in their halcyon days, might spend more to eat swallows tongues and the poor might spend less eating salted fish, but in both instances, the stomach does impose limits.

The same observation, albeit with less precision, can be made for other forms of consumption, like the size of ones house that can be used at any one time, or the number of cars that one can drive. Sure, one can build castles in Spain, or collect cars in garages, but at a certain point, another house or another car contributes little to a rich man's satisfaction. With each Versailles or Maserati, satisfaction, on the margin, diminishes. It is like sex. While, sex is great, it isn't that great.

So what the rich ultimately do, once additional consumption loses its appeal, is to succumb to the inevitable, namely, saving and investing. But even accumulating wealth has limits to contributing to happiness. Along the way, the rich begin to realize that what they have will be lost when they die, not a particularly happy prospect. So, with their ever-increasing wealth, they buy a piece of eternity - a pyramid, a cathedral, a university, a museum, a symphony, a research institute, a foundation. And what they can't find a use for, they leave in banks which then lend it out to clients who use the money to consume or invest. These clients pursue happiness just like others, both rich and poor, with the same results.

When you think about it, the enterprising rich might be golden geese laying eggs for the non-rich, those who can't earn and save enough to meet their appetites for consumption or the capital needed to expand their workplaces. Therein lies the magic of the market and free enterprise, the near cousin to the miracle of compound interest. Growth, savings, and investments pile up, one on top of the other, and man's appetites leads him to grasp for more, creating ever-increasing quantities of wealth.

fundamentalist writes:

I don't care about the level of inequality. I don't think it matters at all. I care about why the inequality happens. Does it happen because the wealthy have powerful connections in the government so that they can steal from the majority, as happens in most countries in the world? Or is it because they're better educated, have more experience, went into the right fields, etc. In other words, do they deserve it?

I suspect that a great deal of the increase can be attributed to inflation. Even low levels of price inflation transfers wealth from the poor to the wealthy because the first receivers of the new money tend to work in financial services and government. The pay of both groups exploded in the past 20 years, especially those in management positions. Meanwhile, the wages of the lowest paid never keep up with inflation.

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