Some inequality and taxation links

I’m planning on writing about taxes and inequality, since they are very much in the public debate.  Here are some interesting links I’ve stored over the past few years:

My priors:

  1. I’m not sure our inequality will lead to the social unrest some are predicting. I think they predict chaos as an ad hoc rationalization of burden-shifting in the tax code.  In terms of lifestyle and access to critical conveniences (like plumbing, food, etc.), inequality is waaaay down over the long haul.
  2. When we try to tax the very rich, we end up taxing the next tier down
  3. The tax system is highly progressive and has become somewhat more progressive over time. It already works hard to redistribute income.  The right way to measure progressivity is share of taxes over share of income. Here it is for the top 1% (remember this doesn’t adjust for the increase in reportable AGI after the 1986 tax reform): 
  4. It makes more sense to focus on the fairness of the system today. Comparisons to the past, like the inequality stats, are fraught with measurement differences, especially pre & post the 1986 tax reform
  5. The system is most “unfair” at two points: 1) at the very low end where entitlements phase out and 2) and possibly at the very high end where the 95-99.5% get hit with full income taxation on their high salaries/bonuses and the 0.5% can structure around the tax code.  Whether we should or can do anything about that is another matter.  There is also clearly unfairness between those who are employed and those who control a business. The latter have much more latitude to find deductions, shelter retirement savings and structure income around the tax code.  The result is that the top half of the 1% is where all the action is:

    Even the bottom half of the top percentile hasn’t grown, only the top 0.5%

  6. Unfortunately, the vast majority of the debate highlights this latter unfairness within the top 5-10% of the distribution, missing the boat entirely. Furthermore, such punditry is riddled with analytical traps, inconsistencies and outright pablum.
  7. I don’t think anyone should pay more than 25% of their income in taxes. Since I earn 95% of my income, I pay more like 45% (inclusive of state and RE, but not counting sales, tolls and other consumption taxes).  Forgive me if I don’t get all sentimental about paying more tax, or if I am cynical about it being used to actually reduce the deficit.  Surveys suggest that the vast majority of people think the highest fair tax rate is between 20-40% except, of course, that they themselves pay too much and clearly others are paying way less than this.
  8. When you own a tax-paying entity, the dividends are after taxes, thus it is double-taxation to tax most dividends.  A lower rate is appropriate here.
  9. However, taxing capital gains is not necessarily double-taxation.  This is mostly loophole and it would not be unfair to get rid of it.
  10. I think our tax system should be biased toward taxing consumption, not savings. Especially considering the savings drought ahead of us.
  11. I think more rich people would willingly pay more taxes if they thought it would create a permanent change for the better in the country’s fiscal situation, as opposed to providing more money to drunks.
  12. Our most pressing fiscal problem is entitlements that were not designed to handle our demographic future.  We can’t afford them. We can trim now or default later. The former is far preferable.
  13. A large portion of the change in measured income inequality comes from changes in household composition (double earners, for instance) and the increasing use of LLCs and S-Corps, which put business income onto personal tax returns.  This money showed up in corporate returns before.
  14. (more of a fact than a prior) Muni bond interest constitutes invisible tax income – it shows up as lower interest expense instead of higher revenues. Thus it is wrong to include muni income in the effective tax rate of wealthy people. That is after-tax income. However, the revenue is lost to the federal government and the savings accrue to state and local governments, so it functions as an intra-government transfer.
  15. The stagnation in median income overall reflects underlying trends – new entrants to the workforce, non-working people and the changes in double income couples. If you break them out, you get a very different picture:

Larry Summers offers an opinion I think is closest to the truth about the causes of inequality:

Why has the top 1 per cent of the population done so well relative to the rest? The answer probably lies substantially in changing technology and globalisation. When George Eastman revolutionised photography, he did very well and, because he needed a large number of Americans to carry out his vision, the city of Rochester had a thriving middle class for two generations. By contrast, when Steve Jobs revolutionised personal computing, he and the shareholders in Apple (who are spread all over the world) did very well but a much smaller benefit flowed to middle-class American workers both because production was outsourced and because the production of computers and software was not terribly labour intensive.

Brookings says something similar, once again properly getting the cause before the tax intended to fix it:

The evidence suggests that the causes of rising income inequality arise in large part because of changes in patterns of trade and globalization, technological advances, and other economy-wide factors. These economic changes have raised the incomes of high-skill workers and business and capital owners, but impaired or reduced the earnings of others—for reasons beyond their control.

I would say globalization and technology have played a major role in creating more of a “winner takes all” system in income.. The ability for major disrupters to dominate the margin in any type of good or service is vastly increased. But this has been a huge benefit to the middle class of the entire globe, providing dirt-cheap sanitation, food, energy, communications, travel, clothing, etc, both decreasing the percent of the global population making more than $1/day and making that $1 go further towards a safe and tolerable lifestyle.

For the record, here are total income and social insurance revenues as a percent of GDP since 1930

I find arguments like this, by Nick Kristof, to be of incredibly low quality, meandering, as they do, between sloppy non-causal linkages. Critics of the tax system on the left tend to implicitly state that our tax system has caused inequality or caused the shifted priorities in government’s spending, ignoring the inconvenient facts of growing government revenue (real, per capita) and even faster growth in real per capita spending.  Our income tax system is designed as a partial treatment of unequal income distribution, it is not the disease.  Income taxes are progressive and have gained in progressivity over time. Second, inequality as measured above is typically in pre-tax income. Last, this is like blaming the band-aid for the bleeding. Taxes redistribute some income, they do not address the unequal distribution of income in the first place. You cannot accumulate wealth simply by not paying taxes.

Of course income is not wealth, which is a whole ‘nother issue with the debate.  here’s a handy graph of wealth shares (Domhoff).

I’ll end this with the important observation from Tyler Cowen:

In terms of immediate political stability, there is less to the income inequality issue than meets the eye. Most analyses of income inequality neglect two major points. First, the inequality of personal well-being is sharply down over the past hundred years and perhaps over the past twenty years as well. Bill Gates is much, much richer than I am, yet it is not obvious that he is much happier if, indeed, he is happier at all. I have access to penicillin, air travel, good cheap food, the Internet and virtually all of the technical innovations that Gates does. Like the vast majority of Americans, I have access to some important new pharmaceuticals, such as statins to protect against heart disease. To be sure, Gates receives the very best care from the world’s top doctors, but our health outcomes are in the same ballpark. I don’t have a private jet or take luxury vacations, and—I think it is fair to say—my house is much smaller than his. I can’t meet with the world’s elite on demand. Still, by broad historical standards, what I share with Bill Gates is far more significant than what I don’t share with him.

Compare these circumstances to those of 1911, a century ago. Even in the wealthier countries, the average person had little formal education, worked six days a week or more, often at hard physical labor, never took vacations, and could not access most of the world’s culture. The living standards of Carnegie and Rockefeller towered above those of typical Americans, not just in terms of money but also in terms of comfort. Most people today may not articulate this truth to themselves in so many words, but they sense it keenly enough. So when average people read about or see income inequality, they don’t feel the moral outrage that radiates from the more passionate egalitarian quarters of society. Instead, they think their lives are pretty good and that they either earned through hard work or lucked into a healthy share of the American dream. (The persistently unemployed, of course, are a different matter, and I will return to them later.) It is pretty easy to convince a lot of Americans that unemployment and poverty are social problems because discrete examples of both are visible on the evening news, or maybe even in or at the periphery of one’s own life. It’s much harder to get those same people worked up about generalized measures of inequality.

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