Sunday, April 29, 2012

Increasing Income Inequality, the Great Moderation, and the Great Recession

You all know what the “Great Recession” is.

The “Great Moderation” is what people were calling the 25 years right before that … basically right until the recession started. The reason is that we’d had 3 strong expansions and 2 moderate recessions in the 1983 to 2007 period. Really, this was a period to rival any other in our macroeconomic history.

But, there the inequality problem. It’s an axiom of Democratic political belief that inequality has gotten worse over that period. This is true, but as shown in earlier posts, it’s true of all developed countries … including many that did not share America’s generally conservative policies in that period. And the progressive position has been that this is a problem that we need to do something about. That’s more of a political than an economic position, so I’ll just set it out there and leave it alone.

The problem here is that casual observation of life in America should suggest that the lives of the poor have gotten a lot better over the last generation. Think about it: most of you students are officially poor. And yet you have snowboards. And cars. And air conditioning. And x-boxes. I think I’ve made my point: there’s an inconsistency between what people say about the lifestyles of the poor and the reality on the ground.

Economically, a lot of research has been done on this, and the leaders in this field are Piketty and Saez. They are featured in a front page article in The New York Times on April 17 entitled “French Duo See (Well) Past Tax Rise for the Richest.”

“The United States is getting accustomed to a completely crazy level of inequality,” Mr. Piketty said, with a degree of wonder. “People say that reducing inequality is radical. I think that tolerating the level of inequality the United States tolerates is radical.”

As much as Mr. Piketty’s and Mr. Saez’s work has informed the national debate over earnings and fairness, their proposed corrective remains far outside the bounds of polite political conversation: much, much higher top marginal tax rates on the rich, up to 50 percent, or 70 percent or even 90 percent, from the current top rate of 35 percent.

Trust me on this … go to an HSS professor and ask them to name some current economics researchers, and Piketty and Saez will be the first ones off their lips.

… Mr. Obama’s election, brought the issue back to the fore. Peter R. Orszag, the former Obama budget director, has said the Piketty-Saez work “helped to point the way for the administration in its pledge to rebalance the tax code.”

The problem, for me as a macroeconomist, is that Piketty and Saez’s work is pretty good stuff. I can take some shots at it, but I have trouble denying that there’s not a kernel of truth in there.

The problem for the broader profession, including people who specialize in this stuff, is how do they get their numbers (which seem to be done correctly) when the evidence you obtain by just looking around seems to contradict it.

Now, there’s new and improved research. What Piketty and Saez did was create new and comprehensive data sets to establish their point. Now, Richard Burkhauser from Cornell has created a new data set that encompasses the Piketty and Saez data set. This is good because he should be able to match their results, and perhaps add new ones.

This he does.

It turns out that Piketty and Saez’s results depend on 4 features of the unit whose income they are measuring. First, they are measuring units that pay taxes: basically, households. Second, they are measuring income pre-tax. Third, they are measuring income pre-transfers. Fourth, they are not counting in-kind payments of health insurance.

Burkhauser’s data allows them to group data by those 4 measures. Or not.

And the not case is interesting. It turns out that all 4 of those measures serve to make inequality appear to be worse.

First, tax units. Households have gotten smaller over the last 40 years. A large part of this is the number of adults who live on their own: singles, divorced people, widows and widowers, and college students. Smaller households tend to have less income because they have less people in them. Is that inequality? I don’t think so; my gosh, I think it’s nice that so many people can live on their own rather than having to pool their resources.

Secondly, our tax system is progressive. To the extent that people live in smaller households, the taxes paid by those households go down faster than their income does … leaving more to spend.

Third, transfer payments work in much the same way. These are based on households, and it is possible to split a household that would not be on welfare into two households that would both qualify.

Fourth, obviously, the costs of healthcare have gone up. Most people receive this as a payment in-kind: you get it as part of your job, but you don’t actually see the cash in your paycheck. Again, bigger health costs (and benefits) means … raises your boss can’t afford to give you in cash.

So, what does Burkhauser conclude?

First, that his data supports Piketty and Saez, provided that he matches Piketty and Saez’s assumptions that we should look at pre-tax, pre-transfer, healthcare excluded incomes of tax units. For this data, there has been a 3% increase in income over the last 30 years. That’s stagnation.

Second, once Burkhauser accounts, with the same data, that people are choosing to live in smaller households (and can actually pull this off), that they live in a system with progressive taxes, an ample social safety net, and healthcare primarily provided as a benefit, that incomes are up 36% over the last 30 years. Note that this is not a huge increase. But, it isn’t stagnation. And, it is most directly comparable to per capita real GDP growth (of 1.5% per year, on average) than to aggregate real GDP growth (of 3.5% per year, on average).

The bottom line is that there’s new, strong, evidence that the Republican position that life has been improving for just about everyone over the last generation is not contradicted by the data.

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