The inequality debate | Thomas Piketty and Ryan Bourne IEA

The inequality debate: Thomas Piketty and Ryan Bourne, of the Institute of Economic Affairs.

One mistake Piketty makes: he uses a marginal tax rate of 80% in the US in the 1920s and 1930s on incomes over $1 million to justify higher taxes on incomes over $1 million today. This fails to consider inflation. Adjusted for the CPI, an income of $1m in 1920 equates to an income of $12m today.

High marginal tax rates in the 1920s in the US were introduced to pay back war debt from WWI. They had the opposite effect of that intended and reduced tax collections. Treasury secretary Andrew Mellon subsequently increased tax collections by reducing maximum tax rates, with the famous quip: “73% of nothing is nothing.”

Piketty Problems: Top 1% Shares of Income and Wealth Are Nothing Like 1917- 28 | Cato @ Liberty

From Alan Reynolds:

First of all, the Piketty and Saez estimates do not show top 1 percent income shares nearly as high as those of 1916 or 1928 once we use the same measure of total income for both prewar and postwar data.

Second, contrary to Summers, there is no data from Piketty, Saez or anyone else showing that the top 1 percent’s share of wealth “has risen sharply [if at all] over the last generation” – much less exhibited a “return to a pattern that prevailed before World War I.”

Dealing first with income, it is interesting that the first graph in Piketty’s book is about the top 10 percent – not the top 1 percent. Saez likewise writes that “the top decile income share in 2012 is equal to 50.4%, the highest ever since 1917 when the series start.” That is why President Obama said, “The top 10 percent no longer takes in one-third of our [sic] income – it now takes half.” A two-earner New York City family of six with a pretax income of only $110,000 would be in this top 10 percent, and they are certainly not taking “our” income. Regardless whether we examine the Top 10 percent or Top 1 percent, however, it is absolutely dishonest to compare the postwar estimates with prewar estimates.

The Piketty and Saez prewar estimates express top incomes as a share of Personal Income, after subtracting 20% to account for tax avoidance. Postwar estimates, by contrast, express top incomes as a share of only that fraction of income that happens to be reported on individual income tax returns – rather than being unreported, in tax-free savings or assets, or sheltered as retained corporate earnings.

Transfer payments are not counted as income in either series (as though federal cash and benefits were worthless); this distinction is inconsequential for the prewar figures but increasingly important lately. “Total income” as Piketty and Saez define it accounted for just 61.8 percent of personal income in 2012, down from 67 percent in 2000.

Read more at Piketty Problems: Top 1% Shares of Income and Wealth Are Nothing Like 1917- 28 | Cato @ Liberty.

The Inequality Puzzle | Lawrence H. Summers

Larry Summers exposes the flaw in Thomas Piketty’s Capital in the Twenty-First Century. Piketty argues that inequality is rising because the rate of return on capital is higher than the economy’s growth rate.

Does not the rising share of profits in national income in most industrial countries over the last several decades prove out Piketty’s argument? Only if one assumes that the only factors at work are the ones he emphasizes. Rather than attributing the rising share of profits to the inexorable process of wealth accumulation, most economists would attribute both it and rising inequality to the working out of various forces associated with globalization and technological change. For example, mechanization of what was previously manual work quite obviously will raise the share of income that comes in the form of profits. So does the greater ability to draw on low-cost foreign labor.

Correlation does not imply causation. The fact that two events occur together does not prove that one has caused the other.

Summers also addresses whether returns on capital are largely reinvested:

A brief look at the Forbes 400 list also provides only limited support for Piketty’s ideas that fortunes are patiently accumulated through reinvestment. When Forbes compared its list of the wealthiest Americans in 1982 and 2012, it found that less than one tenth of the 1982 list was still on the list in 2012, despite the fact that a significant majority of members of the 1982 list would have qualified for the 2012 list if they had accumulated wealth at a real rate of even 4 percent a year. They did not, given pressures to spend, donate, or misinvest their wealth. In a similar vein, the data also indicate, contra Piketty, that the share of the Forbes 400 who inherited their wealth is in sharp decline.

That income inequality is rising is undisputed, but the causes are not as simple as Piketty assumes. His proposal of a progressive tax on wealth is unlikely to see the light of day: the history of inheritance taxes is an indication of their ineffectiveness. But a shift away from income taxes towards land taxes and other flat rate, indirect taxes would provide a significant boost to the economy as illustrated by the following chart from the Henry Review.

Marginal welfare loss from a small increase in selected Australian taxes

Marginal welfare loss is the loss in consumer welfare per dollar of revenue raised for a small increase in each tax (the extent of compensation required to restore consumer satisfaction reflects the distorting effect of the tax on the economy). A decrease in the level of tax, on the other hand, would be likely to produce a similar-sized benefit. So a trade off between taxes at the top of the scale and those at the bottom would be expected to deliver a substantial net benefit.

Read more at Lawrence H. Summers for Democracy Journal: The Inequality Puzzle.

The Inequality Puzzle | Lawrence H. Summers

Larry Summers exposes the flaw in Thomas Piketty’s Capital in the Twenty-First Century. Piketty argues that inequality is rising because the rate of return on capital is higher than the economy’s growth rate.

Does not the rising share of profits in national income in most industrial countries over the last several decades prove out Piketty’s argument? Only if one assumes that the only factors at work are the ones he emphasizes. Rather than attributing the rising share of profits to the inexorable process of wealth accumulation, most economists would attribute both it and rising inequality to the working out of various forces associated with globalization and technological change. For example, mechanization of what was previously manual work quite obviously will raise the share of income that comes in the form of profits. So does the greater ability to draw on low-cost foreign labor.

Correlation does not imply causation. The fact that two events occur together does not prove that one has caused the other.

Summers also addresses whether returns on capital are largely reinvested:

A brief look at the Forbes 400 list also provides only limited support for Piketty’s ideas that fortunes are patiently accumulated through reinvestment. When Forbes compared its list of the wealthiest Americans in 1982 and 2012, it found that less than one tenth of the 1982 list was still on the list in 2012, despite the fact that a significant majority of members of the 1982 list would have qualified for the 2012 list if they had accumulated wealth at a real rate of even 4 percent a year. They did not, given pressures to spend, donate, or misinvest their wealth. In a similar vein, the data also indicate, contra Piketty, that the share of the Forbes 400 who inherited their wealth is in sharp decline.

That income inequality is rising is undisputed, but the causes are not as simple as Piketty assumes. His proposal of a progressive tax on wealth is unlikely to see the light of day: the history of inheritance taxes is an indication of their ineffectiveness. But a shift away from income taxes towards land taxes and other flat rate, indirect taxes would provide a significant boost to the economy as illustrated by the following chart from the Henry Review.

Marginal welfare loss from a small increase in selected Australian taxes

Marginal welfare loss is the loss in consumer welfare per dollar of revenue raised for a small increase in each tax (the extent of compensation required to restore consumer satisfaction reflects the distorting effect of the tax on the economy). A decrease in the level of tax, on the other hand, would be likely to produce a similar-sized benefit. So a trade off between taxes at the top of the scale and those at the bottom would be expected to deliver a substantial net benefit.

Read more at Lawrence H. Summers for Democracy Journal: The Inequality Puzzle.

Income inequality: A big whopper

Hats off to John Mauldin for publishing retired economics professor (North Carolina State University) Dr. John Seater’s rebuttal of the Cynamon and Fazzari article on Income Inequality from last week’s newsletter:

A big whopper, for example, is their assertion that a shift in income from the poor to the rich will reduce total spending. Complete nonsense. What it may do is shift the composition of spending away from consumption a little toward investment. The permanent income/life cycle theory of consumption, developed independently by Modigliani and Friedman in the 1950s questions even that conclusion.

Second, John says most academics accept the view that inequality hinders growth. I don’t know how he knows that. I certainly don’t know that to be true. I am an academic economist, and I am unaware of any such consensus. I also know for sure that few and probably no economists who actually study economic growth (which happens to be my own current field of research) believe such a thing.

Read more at
Income Inequality and Social Mobility | John Mauldin
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Silence of the Left | John Goodman

John Goodman points out that while the left are extremely vocal on the issue of income inequality, they are largely silent on the issue of reforming the public education system to create equal opportunity for all students.

Here is the uncomfortable reality:

1.Our system of public education is one of the most regressive features of American society.

2.There is almost nothing we could do that would be more impactful in reducing inequality of educational opportunity and inequality overall than to do what Sweden has done: give every child a voucher and let them select a school of choice.

3.Yet on the left there is almost uniform resistance to this idea or any other idea that challenges the power of the teachers unions.

He tells how newly-elected New York City Mayor Bill De Blasio is opposing expansion of some of the city’s best charter schools:

Among the 870 Success Academy seats blocked was a modest 194-student expansion for Success Academy students in Harlem to move into a new middle school. That triggered days of searing press coverage pointing out that those 194 students, all low-income minorities, were coming from a school, Success Academy 4, that killed it on the new state test scores, with 80 percent of the students passing the math test, and 59 percent the English test. The co-located middle school (P.S. 149) the mayor is protecting ….. 5 percent of students passed the math test, and 11 percent the English test.

Read more at Silence of the Left – John C. Goodman.

Hat tip to John Mauldin.

Income inequality: Ask the wrong question, get the wrong answer

John Mauldin writes

That income inequality stifles growth is not simply the idea of two economists in St. Louis. It is a widely held view that pervades almost the entire academic economics establishment. Nobel prize-winning economist Joseph Stiglitz has been pushing such an idea for some time (along with Paul Krugman, et al.); and a recent IMF paper suggests that slow growth is a direct result of income inequality, simply dismissing any so-called “right-wing” ideas that call into question the authors’ logic or methodology.

The suggestion that income inequality stifles growth is a fraud, designed to promote a socialist agenda of redistributing wealth to the poor. We are currently experiencing slow growth because of the GFC, not because of rising income inequality.

The real question that needs to be answered is: which system best promotes growth and improves the living standards of the broad population? Evidence of the last 100 years is difficult to dispute. Socialism has an abysmal track record in uplifting the poor, while capitalism has fueled a massive upliftment in living standards over more than a century. High rates of tax on top income earners kills growth and redistribution to the impoverished does little to improve their living standards, whereas low tax rates encourage growth and raise living standards.

To recover from the GFC we need to allow capitalism to flourish instead of impeding it at every turn.

Read more at The Problem with Keynesianism | John Mauldin.

Why governments need asset bubbles | The Economist [video]

Zanny Minton-Beddoes, economics editor of The Economist, explains why governments need asset bubbles to mask growing inequality between rich and poor.

Hat tip to Gregor Samsa

US: Poverty rates

From the US Department of Health & Human Services:

US Poverty Rates

I suspect that most US voters are concerned about poverty (don’t believe everything you are told during an election) but where they differ is on how to address the issue. The view from the left is to raise taxes on the rich in order to increase welfare benefits to the poor. The right believe the solution is to get the economy back on track. That would create more jobs and increase tax revenues — which could enable more welfare spending. It is important to avoid the trap of long-term welfare dependency, but the solution is always going to be a compromise between the two extremes.

If Republicans want to be taken seriously by Black and Hispanic voters they need to pay more than lip service to fighting poverty.

Income inequality: Cause of our predicament or a convenient scapegoat?

A reader reminded me of this 2011 Vanity Fair article, where Joseph Stiglitz argues that growing income inequality will harm future US economic growth.

“What matters, [some people] argue, is not how the pie is divided but the size of the pie. That argument is fundamentally wrong……..

First, growing inequality is the flip side of something else: shrinking opportunity. Whenever we diminish equality of opportunity, it means that we are not using some of our most valuable assets — our people — in the most productive way possible.

Second, many of the distortions that lead to inequality — such as those associated with monopoly power and preferential tax treatment for special interests — undermine the efficiency of the economy. This new inequality goes on to create new distortions, undermining efficiency even further. To give just one example, far too many of our most talented young people, seeing the astronomical rewards, have gone into finance rather than into fields that would lead to a more productive and healthy economy.

Third, and perhaps most important, a modern economy requires ‘collective action’ — it needs government to invest in infrastructure, education, and technology……. America has long suffered from an under-investment in infrastructure (look at the condition of our highways and bridges, our railroads and airports), in basic research, and in education at all levels. Further cutbacks in these areas lie ahead. None of this should come as a surprise—it is simply what happens when a society’s wealth distribution becomes lopsided. The more divided a society becomes in terms of wealth, the more reluctant the wealthy become to spend money on common needs.”

There are obvious flaws in Stiglitz’ argument. First, he equates income inequality with unequal opportunity. These are two different concepts. Michael Jordan might earn more income than me, but this does not necessarily indicate unequal opportunity. Even with the same opportunity I am unlikely to ever succeed as a basketball player. Equal opportunity is important in maximizing economic growth but will not achieve equal outcomes.

Distortions associated with monopoly power and unequal treatment of taxpayers both promote inefficiency. But we must be careful not to “put the cart before the horse.” Increasing taxes on the rich will not eliminate these distortions. We need to eliminate monopoly power and unequal treatment of taxpayers to promote greater economic efficiency — not greater income equality.

I have no argument against increased investment in infrastructure, education, and technology, but it is a stretch to blame under-investment in this area on the wealthy. There are a multitude of other interests, including defense and welfare, that have diverted funds away from investment in these areas. Economic growth benefits us all — the interests of the wealthy are generally aligned with those of their fellow citizens. In fact, as a group, top income earners benefit more from economic growth than any other group and are unlikely to act against their own self-interest.

No doubt there are interest groups who argue for lower taxes or favorable treatment of specific industries, just as there are interest groups that argue for increased welfare payments to retirees. What needs to be addressed — in the interests of greater economic efficiency and equity — is the amount of influence these interest groups exert over political decisions.

Economists often confuse arguments for greater efficiency with arguments for greater equity. Stiglitz tries to draw a line from greater equity to greater efficiency. Unfortunately most of the evidence points to the opposite. Societies, like the UK in the 1960s and 1970s and Sweden in the 1970s and 1980s, who focused on greater equity, ended up damaging economic efficiency and growth — harming the very people their policies were intended to help.

As Ross Gittins argues, we need to achieve both efficiency and equity. My suggestion is twofold. Start by designing a tax system based on efficiency, where we maximize economic output while minimizing costs of tax collection. This requires greater simplicity, removal of progressive tax rates, and elimination of favorable treatment for specific industries and/or voting blocs. Complexity increases costs as well as creating opportunities for tax avoidance.

When we have maximized tax revenues through increased output and efficient collection, we can then focus on equity when deciding how tax revenues are spent. Redressing the imbalances of income inequality is unachievable. Instead concentrate on ensuring equal opportunity for all. Long-run investment in education, additional support for disadvantaged students, increased spending on infrastructure, and on research will have payoffs in terms of economic efficiency. And an efficient economy will benefit everyone.

The “size of the pie” really does matter but how it is shared will also make a difference to future growth.

Stiglitz, Conard Debate Income Inequality

Some sweeping generalizations from Stiglitz and Conard denial that the Fed was architect of the 2007/2008 asset bubble but some interesting insights from both parties.

Edward Conard, a former managing director at Bain Capital LLC, and Nobel Prize-winning economist Joseph Stiglitz, talk about the U.S. economy and income inequality. They speak with Betty Liu on Bloomberg Television’s “In the Loop.”

The Anatomy of Global Economic Uncertainty – Mohamed A. El-Erian – Project Syndicate

Mohamed A. El-Erian, CEO of PIMCO, describes four key dynamics that will shape the future of the global economy:

  1. Many economies have built up excessive debt that is now causing market instability. They have three options for de-leveraging: default, like Greece; austerity, like the UK; or “financial repression” like the US — where “interest rates are forced down so that creditors, including those on modest fixed incomes, subsidize debtors”.
  2. Economic growth would reduce the ratio of debt to incomes: “Many countries, including Italy and Spain, must overcome structural barriers to competitiveness, growth, and job creation through multi-year reforms of labor markets, pensions, housing, and economic governance. Some, like the US, can combine structural reforms with short-term demand stimulus. A few, led by Germany, are reaping the benefits of years of steadfast (and underappreciated) reforms.”
  3. It is also important that the benefits of economic growth be shared across the entire community,  reducing income inequality and related social instability.
  4. Political systems in Western democracies, designed to support the status quo, are ill-equipped to deal with these “structural and secular changes”. Failure to adjust is the greatest risk.

“Those on the receiving end of these four dynamics – the vast majority of us – need not be paralyzed by uncertainty and anxiety. Instead, we can use this simple framework to monitor developments, learn from them, and adapt. Yes, there will still be volatility, unusual strains, and historically odd outcomes. But, remember, a global paradigm shift implies a significant change in opportunities, and not just risks.”

via The Anatomy of Global Economic Uncertainty – Mohamed A. El-Erian – Project Syndicate.