More Debate on Whether Income Disparity is Growing

Last week, the Wall Street Journal featured the second opinion piece in two months by Alan Reynolds, a senior research fellow at Cato Institute, disputing the widely-held and reported belief that income inequality in America has increased.

We’ve discussed his December WSJ article, “The Top 1%….of What?,” which critiqued of the work of Thomas Piketty of École Normale Supérieure in Paris and Emmanuel Saez of the University of California at Berkeley, whose studies on income distribution are generally considered the most thorough in this field, and are the source of the widely cited factoid that the income share of the top 1% (of tax filers) has increased from 8% in 1980 to 16% in 2004.

Reynolds pointed out a grab-bag of shortcomings in the IRS data that Piketty and Saez used. Some of these gaps might be amenable to analysis and adjustment; others weren’t. But all the failings he cited were to prove that the great unwashed had sources of income that didn’t show up in tax returns. The problem is that there are also income sources for high earners that are similarly not reported (the generous expense accounts of top executives and private business owners; offshore accounts; low interest rate loans to corporate executives; deferred compensation). While it’s useful to say what’s wrong with the Piketty-Saez work, it’s misleading to consider only adjustments that lower the concentration of earnings at the top (in fairness, he did mention municipal bond income, but it would be an egregious oversight to omit that).

In the latest chapter, Reynolds had two articles published last week, the first with David Henderson in the Wall Street Journal, “Can the CBO Spell IRA?,” and a piece, “Income Distribution Heresies” in the website Cato Unbound, which in turn is a summary of his Cato report, “Has U.S. Income Inequality Really Increased?.” I had a lot of quibbles with his argument in the Journal article (for example, he cited several sources that indicated that income and wealth concentration had not increased, but they used markedly shorter time frames than the Piketty and Saez data, which went back to 1980. Not exactly apples to apples).

But the WSJ article, and the Cato Unbound piece both got pretty nitty gritty, and rather that offer a mere skeptical layman’s reading, I thought it would be better to wait for an expert to respond. And Mark Thoma, a professor of economics at the University of Oregon, did in a Cato Unbound so-called reaction essay, “Yes, Virginia, Income Inequality is Still Rising,” which addresses both the Cato and WSJ articles. Thoma points out that in the Cato article, the two arguments that Reynolds makes don’t prove what Reynolds says they prove (in one, he appears to have misread or misrepresented the data; for the other, the data appears to be inconclusive). In the WSJ article, Reynolds and Henderson claimed that factoring in IRAs and 401(k)s would reduce income inequality. Thoma cites a study that says the reverse, that tax-deferred earnings were a bigger boon to the rich than to other income groups. He also comes perilously close for an academic in polite company to saying that Reynold’s work is intellectually dishonest.

Is Alan Reynolds correct that widening inequality is a myth, or is he standing against a tide of increasingly persuasive evidence to the contrary?

If we were to find, as Reynolds contends, that differences in income and wealth are not as wide as we thought, that would be welcome news. Finding that lower-income individuals are better off than initially reported is preferable to finding they have lower income and wealth levels than we knew about. Unfortunately, a closer look at the evidence does not support Reynolds’ contention that data and measurement problems have produced a misleading picture of inequality in recent decades.

Before looking at some of the specific measurement issues Reynolds identifies, it’s useful to step back and take a broad overview of the research on inequality. There is considerable evidence on the inequality issue, much more than is discussed in Reynolds’ lead essay — it would be impossible to review it all here….

Let’s turn next to some of the more specific data issues. In his essay, Reynolds cites two issues repeatedly, the census top-coding issue and the fact that Gini coefficients do not show a rise in inequality.

Let’s take the Gini coefficient issue first. In a paper “Currents and Undercurrents: Changes in the Distribution of Wealth, 1989–2004″[pdf] from January 2006, a paper Reynolds mentions but does not give a full account of, Arthur B. Kennickell, the Senior Economist and Project Director of the Survey of Consumer Finances (i.e. someone who fully understands the data issues), says:

The Gini coefficient shows significant increases in the concentration of wealth in 2004 relative to 1989, 1992, and 1995; but the estimates from the 1998 and 2001 surveys are not significantly different from that from the 2004 survey. On the other hand, estimates of the total amount of wealth held by different subgroups of the wealth distribution show that the share of the least wealthy 50 percent of families fell significantly from … 1992–2001 … to about 2.5 percent of total family wealth in 2004…. Graphical analysis indicates that over the 1989–2004 period, there were statistically significant gains across the wealth distribution and that the level of gains was largest by far for the top few percent of the distribution.

I suppose it would be possible to cherry-pick a few statements from the paper to make a case, but the Gini coefficient evidence is by no means the refutation of rising inequality that Reynolds would have us believe. The write-up to the paper makes this clear.

What about the Census top-coding issue, does Reynolds have a point there?….The technique he uses is rather technical and involves fitting and integrating a Pareto distribution for top incomes and calculating the top-coding effect, but it is clear that the top-coding issue remains important despite Reynolds’ objections.

Let me turn to another place where Reynolds has raised measurement issues regarding inequality data. Recently, in a Wall Street Journal commentary, Alan Reynolds and David Henderson say CBO data on income inequality, which are widely used in inequality research, are misleading because they fail to properly account for interest and dividends earned on deferred income IRA and 401(k) type accounts. According to the commentary, since tax-deferred earnings are not reported, the distribution of interest income from these assets is imputed from reported interest on other assets and this skews the measured distribution of income toward inequality.

Is this an issue? Yes. Should we correct for it if we can? Of course, more precise data are always best. Will correcting the data affect the overall picture? No. In fact, it may even work in the other direction (Gary Burtless makes the same point in his reply).

To look at this, I used the Survey of Consumer Finances data shown in Tables 1 and 5 in “Recent Changes in U.S. Family Finances: Evidence from the 2001 and 2004 Survey of Consumer Finances,” by Brian K. Bucks, Arthur B. Kennickell, and Kevin B. Moore of the Federal Reserve Board’s Division of Research and Statistics.

This report shows that the median value of retirement assets for the bottom 90% of the income distribution was approximately $13,000 in 2001 and $15,400 in 2004, while the median value of retirement assets of the top 10% was approximately $138,500 in 2001 and $182,700 in 2004 (all values are expressed in 2004 dollars). If we assume a 5% rate of return, then the median lower 90% household would have earned around $770 in interest income. Presumably the CBO allocates some interest income to the lower 90% group. After all, they do have financial assets and report interest income to the government. However, even if we assume that no interest income at all is allocated to the bottom 90%, this correction would only raise their incomes by around $770, not enough to matter, especially when compared to the rise in incomes in the top 10% from sources other than the potential mismeasurement of capital income. The basic point is that most Americans have so little capital income that exactly how you count it is not an important issue.

One final point on this. When you examine the distribution of financial assets in the Survey, you see that the distribution of retirement assets rises more steeply with income than do other categories of financial assets such as stocks and bonds. Thus, if interest income is distributed by the CBO according to the distribution of reported interest income, this works in the opposite direction from what Reynolds claims since too little rather than too much interest income will be allocated to upper-income taxpayers.

I chose these examples because they are indicative of Reynolds’ analysis generally. When we examine the points he makes, we find that they are either too inconsequential to change the inequality picture, that they are an incomplete presentation of the evidence, or rebutted by other work. As conservative economist Bruce Bartlett says:

Even accounting for the factors Reynolds cites, there are too many different sources all showing a rise in income inequality… No matter how you slice it, the distribution of income has become more unequal over the last 20 years or so….

Moving to a final issue, one that Gary Burtless raises as well, there are potential measurement issues that work in both directions –- some adjustments to income and wealth work against inequality and some work for it -– and a fair presentation of the evidence would note both sides. But that is not what we have. Only those adjustments that favor the proposition that rising inequality is a myth are presented favorably by Reynolds. For example, we didn’t hear about this:

There is evidence, however, that because of the way the G.D.P. is calculated, the actual shift [in inequality] is much more pronounced. “We know that income inequality is quite substantial,” said Harry J. Holzer, a labor economist at Georgetown University, “and this new evidence suggests that it is worse than we thought.”

The Bureau of Economic Analysis, which issues the G.D.P. reports each quarter, is on the case. So are two prominent economists at the Federal Reserve. … If these [adjustments] … were incorporated into G.D.P. …, labor’s share of national income would decline from a fairly steady 65 percent in the 1950’s, 60’s and 70’s to less than 60 percent today.

The issue is whether R&D should be counted as an investment or an expense. If it is counted as an investment, and there are good reasons to do so, the picture changes dramatically. This change alone would dwarf the kinds of adjustments Reynolds discusses.

As I said at the start, I would be very pleased to find out that growing inequality is not a problem. However, despite the attempts of Alan Reynolds and a few others to argue otherwise, the preponderance of evidence and of professional opinion clearly indicates that inequality has been rising since 1988, and that the trend toward widening inequality has been present for much longer than that. The question is what, if anything, to do about it. If we can get past the attempts to cloud the issue, perhaps we can proceed to more important discussions.