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Posted at 5:40 PM ET, 01/ 4/2011

Understanding inequality, Part II

By Ezra Klein

In response to this post, Brookings's Gary Burtless wrote in with some helpful comments on inequality and median incomes that I want to quote at length. Standard disclaimer: I've made light edits for space and clarity.

I asked what made inequality jump so sharply in 1987. Probably the tax-reform bill, Burtless says, which convinced a lot of wealthy people to stop sheltering their incomes in corporate vehicles. What you're seeing in 1987, in other words, isn't new inequality, but numbers that more accurately reflect existing inequality:

Most public finance economists who have investigated this anomaly in the Piketty-Saez inequality trend attribute it to the Tax Reform Act of 1986 (TRA86). The law sharply cut the top marginal tax rate in the personal income tax, both absolutely and, what is more important, relative to the corporate income tax rate.

Before 1986 individuals with sizeable stakes in a company had a strong incentive to shelter their income inside a corporation because the corporate tax rate was lower than the top personal income tax rate. On the margin, the income earned by a corporation was taxed at, say, 35%, but if the exact same income were directly received by a wealthy private individual it could be taxed (at a minimum) at, say, a 50% rate. The difference between the two rates made it advantageous to earn the profits inside the corporation and then to take the money out of the corporation in an advantageous year by selling stock in the company (paying only the capital gains tax rate on the income, a tax rate that was just one-half the rate on ordinary profits or dividend income). By lowering the top personal income tax rate to below or near the corporate tax rate,TRA86 changed the rich business owner’s best tax strategy. Now it was more advantageous to receive the income directly, report it on one’s personal tax return, and pay a modest rate on the resulting income flow.

As for stagnation among median incomes, Burtless says to watch compensation, which includes benefits, rather than just income:

I tracked down BLS data on the "Median usual weekly earnings - in constant (1982-84) dollars." It shows approximately the same result that you mention: Full-time American workers had $334 of real weekly earnings in 2000 and $342 in the most recent 2010 quarter available. On the other hand, when I go to the BLS productivity Webpage to obtain information about AVERAGE real compensation per hour, I obtain the following variable and results: "Average real compensation per hour" has increased 11.3% since 2000. The difference between the growth of the median real weekly and average real hourly compensation is due to four factors: #1. Real compensation / hour has increased faster than the real hourly wage. This makes sense. Employers’ cost for providing health benefits to their workers (which is in compensation but not hourly wages) has increased faster than wage costs: Compensation has grown faster than money wages. #2. The average number of weekly work hours has slipped, meaning that weekly earnings have increased more slowly than hourly earnings. #3. The worker in the exact middle of the earnings distribution may have done worse than the average worker. This is also easy to believe. If workers in the top 25% of the earnings distribution saw their wages climb 2% a year and everyone else saw their earnings rise just 0.1% a year, the average weekly wage would grow faster than the median weekly wage (which, in my example only rose 0.1% a year). Notice that explanations #1 and #3 are closely connected to one another, although they are distinct. It costs an employer roughly $5,000 a year to pay for health insurance premiums for a single worker and $10,000 or so to insure a worker with dependents. It costs just about the same to insure a worker paid $39,000 a year (approximately the median full-time wage) as it does to insure a worker who is paid $100,000 year. This means that a rapid increase in the cost of paying health insurance premiums will have a bigger percentage effect on the compensation of a worker paid the median wage than on the compensation of a worker paid two or three times the median wage. What I am saying is this: The rapid growth of employer health costs adds more (in percentage terms) to the cost of compensating a worker paid the median wage than it adds to the cost of compensating a worker paid an above-average wage. If employers give high-wage and median-wage exactly the same percentage increase hourly compensation, they would have to give the median-wage worker a smaller increase in hourly wage. Anyway, my guess is that explanations #1, #2, and #3 in some combination all contributed to the fact that median weekly earnings hardly grew at all after 2000, even though productivity increased fairly robustly over that period. #4. Finally, the “labor share” (that is, the part of the total output price that is captured by laborers as opposed to business owners) also fell fairly substantially over the period. According to BLS, the “index” showing labor’s share fell from 105.82 in 2000 to 95.36 in the most recent quarter. Business owners are simply capturing a larger fraction of the revenue being earned from private-sector businesses; workers are capturing less of it. The main reason for this, I think, is that workers are now and have been for the past decade in a very weak bargaining position. (At the moment, 10% unemployment tends to put a check on workers’ wage demands, I think.) Now is a nice time to be a business owner. For your average worker, not so much. The bottom line is this: Median consumption (including consumption of health care) has increased more smartly than median cash and near-cash income. Not surprisingly, the increased overall consumption of health care has absorbed more of the total (cash, near-cash, and non-cash) income growth obtained by the poor and middle class than it has the income growth of the very affluent.

By Ezra Klein  | January 4, 2011; 5:40 PM ET
Categories:  Inequality  
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Comments

Which means that in this time of national crisis the available excess money is at the high end. As a(n) humane society, we simply should not tolerate 10% unemployment and absent health care. This article, then, makes a persuasive case that allowing tax cuts to persist for high earners is a mistake.
I just don't think it should be government policy to reward greed. Gates/Buffett et al appear to agree with this.

Posted by: joesolo | January 4, 2011 6:05 PM | Report abuse

Good follow up.

"I asked what made inequality jump so sharply in 1987. Probably the tax-reform bill, Burtless says, which convinced a lot of wealthy people to stop sheltering their incomes in corporate vehicles. What you're seeing in 1987, in other words, isn't new inequality, but numbers that more accurately reflect existing inequality"

And that's going from 50% marginal tax rates to 28% - not 90% or even 70%. I wonder how much of the Great Compression was optical and related to high marginal tax rates causing income to go unreported.

Posted by: justin84 | January 4, 2011 6:10 PM | Report abuse

It always come back to health care...

Posted by: bobsimmons | January 4, 2011 6:30 PM | Report abuse

I wonder what role may have been played by the downsizing mania in the late 80's and early 90's. I've never seen this mentioned in discussions of growing inequality, but the timing is right for this to have been a factor, and I think it may have played a role in that "weak bargaining position" mentioned here. I'm no expert, but my understanding is that historically businesses avoided downsizing because it was seen as a signal that the business was in trouble, and the stock value would decline. That all changed in the 80's, as downsizings then were seen as a sign that the business was becoming more efficient, with accompanying increases in stock value and executive compensation. Meanwhile, the downsized employees typically ended up in worse jobs, and the people who kept their jobs were likely intimidated into not pushing for improvements, for fear of also losing their jobs. Also, seeing downsizings at other companies probably intimidated other workers as well, even at companies that didn't downsize. Consequently, downsizings led to increased compensation at the top and decreases for everyone else. Obviously the decline of unionization was also a major factor here, but I'd like to see someone who knows more about this than I do talk about whether downsizing was an independent factor, or a reflection of other conditions (e.g., increases in health care costs increasing employer motivation to shed employees).

Posted by: beckya57 | January 4, 2011 9:13 PM | Report abuse

"The law sharply cut the top marginal tax rate in the personal income tax, both absolutely and, what is more important, relative to the corporate income tax rate."

I would love to see the U.S. adopt a single income tax rate for all income, no matter what the source with no deductions at all and turn any existing tax subsidies that are still desired into discretionary spending programs.

I.e. Personal income, corporate income, capital gains, dividends, carried interest, etc. would all be taxed at the same rate with no deductions and everyone would file as individuals. This would eliminate or at least drastically reduce the opportunities for tax arbitrage that are being described in the above post.

If we desire to subsidize children or farmers, or home ownership, or people making below a certain amount of income the government would mail you a check and the programs would be in direct competition with things like Head Start, clean energy subsidies, etc.

If we start a war overseas or enact a new health care entitlement, the government simply raises the one tax rate to pay for it and everyone's taxes go up.

Posted by: jnc4p | January 4, 2011 9:36 PM | Report abuse

I have a few small quibbles with the health care increasing compensation --

(1) those at the $39k end of the income range very frequently do not have health care (or retirement) as part of their compensation package... how is that reflected in the 11.3% increase? They are still just stuck with the flat cash wages, no growth.
(2) Even if spending on health insurance has increased, that does not mean that consumption of health care has increased -- that would be assuming a fairly perfect market which we all know does not exist in the health insurance market. I know I have been consuming less health care as my premiums and co-pays have gone up.

So... if the median income earner also does not get non-cash compensation and/or has access to health care reduced how is that "growth" through benefits?

Posted by: kcar1 | January 4, 2011 10:37 PM | Report abuse

I didn't have a chance to write in on this before, but I'll quickly add:

-- The winner-take-all, or superstar phenomena is a big part of the startling growth in income inequality, see:

http://www.prospect.org/cs/articles?article=talent_and_the_winnertakeall_society

-- And Republican/Right domination of the last generation has been huge, slashing taxes on the rich and government aid to the poor and middle class -- and no not just welfare by any stretch, for example the cost of a college education has skyrocketed due to slashing of government support, for example loan sharks are everywhere now allowed to legally suck people dry, for example...

There's a well developed literature on this, so you absolutely should consult an expert to avail yourself of all the man hours already spent thinking about this. I'd ask a good economist like Dean Baker for a reference to some of the top economists in this area, and then I'd interview them.

Posted by: RichardHSerlin | January 4, 2011 10:58 PM | Report abuse

Let me tell you one thing that the best health insurance plans has completely different set of meaning for different type of people. For those who are rich, the plan which can earn them more is best. However, those who are in the middle class have different ideas. They think that insurance plan is the best for which they will have to pay minimum premium. However, the poor person does not even know that what is health insurance? If you are one of them search online for "Wise Health Insurance" and get smart about insurance.

Posted by: anthonytuner | January 5, 2011 1:42 AM | Report abuse

I put my boots on and waded through the Brookings ejaculation. If I had a head for math, I'd make a comment... but since the post is way, way too complexicated for me, I'll refrain from saying anything of value.

Posted by: rmgregory | January 5, 2011 2:29 AM | Report abuse

Two interesting posts on income inequality... And, not one mention of the word 'trade'.

I really appreciate the interest in the topic, but the academic lefty types have to stop pretending that our goal of sacrificing the 'build stuff' industries hasn't played a major role in this mess.

Posted by: rat-raceparent | January 5, 2011 9:02 AM | Report abuse

Burtless is right, but it really points to a significant limitation of the Piketty-Saez findings -- they are based solely on recognized taxable income and ignore most of the wealth of the Forbes 400, which is unrealized (and untaxed) appreciation.

Take a simple example. In 2009, Larry Page received one dollar of compensation but his Google stock appreciated by $8.7 billion. Piketty-Saez records Larry Page as earning just one dollar.

The fact that Page's economic income consisted of unrealized appreciation didn't prevent him from borrowing against it, and spending it, as Larry Ellison was reported to have borrowed over $1 billion against his Oracle stock and spent it in 2000.

Effectively, these super wealthy individuals are subject to a zero rate of income tax. And increasing the rate of tax will do no good; even if the rate was 100%, Page and Ellison would still pay no tax.

If we're serious about reducing economic income inequality, then we should impose a mark-to-market tax on the publicly-traded securities of the 0.1% wealthiest and highest-income individuals.

For more on this, see http://www.cadwalader.com/assets/article/120505MillerTaxNotes.pdf

Posted by: DavidSMiller1 | January 5, 2011 9:05 AM | Report abuse

While you are looking at the compensation data take a look at compensation as a share of corporate expenses. From WW II to 1980 it experienced minor cyclical fluctuations around 67%. But since 1980 compensation as a share of business output -- or labors share of the pie -- has been on a significant downward slope with a couple of minor upticks before the 1990 and 2000 recessions. It is not down to 57% or some 10 percentage points less than the 1946-2000 average.

So even when you look at compensation to include the impact of health insurance labors share of the pit has fallen sharply over the last 30 years and is now at all time record lows.

P.S. you can not calculate this data directly from publically available data.
But Haver Analytics has gotten a special download to include it in their database.

If you want it I can send you the data.

Posted by: seerrees | January 5, 2011 5:34 PM | Report abuse

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