Is the rise in inequality exaggerated?

Pat MurphyThe rise in economic inequality is one of the most potent 21st century memes. You could even call it pervasive.

It dominates the debate in the Democratic presidential contest and has a material echo in our current federal election. The rich – particularly the notorious one per cent – must be made to “pay their fair share.”

Of course, income distribution isn’t a new issue. It was, however, turbocharged by the 2003 work of economists Thomas Piketty and Emmanuel Saez. Subsequently refined and updated with the help of another economist, Gabriel Zucman, their conclusions paint a picture of starkly rising American inequality.

This analysis has been immensely influential. Further, its narrative thrust has been picked-up and domestically adapted by social and political actors in many countries. So while this column’s discussion relates to the U.S., it has more general relevance.

Piketty et al haven’t had things entirely their own way. Some critics, such as economists Gerald Auten and David Splinter, have challenged their thesis.

Indeed, it’d be fair to say that Auten and Splinter register significant disagreement. To quote their recent paper: “Our results suggest that top income shares are lower than other tax-based estimates, and since the early 1960s, increasing government transfers and tax progressivity resulted in little change in after-tax top income shares.”

The latest update from Piketty et al posits that, between 1979 and 2014, the top one percent’s after-tax share increased by 6.5 percentage points. Auten and Splinter peg the number at 1.4 points. That’s quite a difference.

From the perspective of well-being, after-tax income (including transfer payments) is the most relevant yardstick as it captures the full range of economic resources available to families and individuals. And its importance is compounded when assessing trends over long periods of time.

If you focus only on market income – defined as what people earn – you’ll miss the growth in transfer payments over the last half-century. In the U.S., transfer payments more than tripled as a percentage of national income between 1960 and 2015. And proportionally speaking, transfers are much more important to lower income groups, so excluding them exaggerates the inequality picture.

Taxes have a similar impact. Political rhetoric notwithstanding, the overall impact of taxation is progressive.

To get a rough sense of dimension, consider the Congressional Budget Office study that looked at market income, transfers and federal taxes in 2013. For market income only, the ratio between the top quintile (fifth) and the bottom quintile was 16:1. But when transfers and federal taxes were factored in, it shrank to 8:1.

Evaluating long-term trends also requires knowledge of technical changes in things like tax law. Otherwise, analysis is susceptible to spurious conclusions.

For instance, there was a major change in U.S. tax law in 1986, slashing marginal rates but simultaneously broadening the base by closing loopholes. Consequently, previously sheltered income began to show up on individual tax returns, which at first glance looked like suddenly surging inequality. In reality, though, it was more like shuffling money around.

Yes, marginal tax rates were much higher prior to the reform – the nominal rate topped out at 91 percent in the early 1960s. But thanks to shelters, almost nobody had actually paid at that level.

Changing marriage rates pose another complication.

Since 1960, there’s been a substantial decline in marriage, some of which can be attributed to a rise in cohabitation. However, the top one percent has been largely immune from this shift.

This behavioural difference creates a challenge for analysis based on “tax units,” a concept that includes married couples filing a joint return but excludes cohabiting couples.

“Tax units” at the top are thus more likely to include two incomes, notwithstanding the fact that the cohabiting couples lower down – who are counted as separate “tax units” – also have two incomes at their disposal. The related inequality increase is an illusion.

Auten and Splinter have attempted to correct for these – and other – problems. And recent iterations of Piketty et al have moved beyond their initial focus on pre-tax market income. But it’s still a complicated business and major interpretive differences remain.

What, then, is a person to do when confronted with conflicting arguments?

If you’re a partisan, you’ll choose the answer you like – confirmation bias and all that.

But if you’re actually looking for the truth, you’ll ask questions about definitions and such.

Have fun!

Troy Media columnist Pat Murphy casts a history buff’s eye at the goings-on in our world. Never cynical – well, perhaps just a little bit.

© Troy Media


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