Arguing Taxes, Transfers, and Market Outcomes

May 22nd, 2014 at 12:20 am

Inequality analyst Scott Winship feels “systematically ignored” by “writers and researchers” including myself.  Since he’s a smart and interesting critic in this space, not to mention an old fellow traveler, allow me to correct that.

Scott is one of a number of analysts who criticize Thomas Piketty’s work for focusing largely on market incomes, thus leaving out the impact of taxes and transfer payments.  Include those sources, these critics assert, and both real income and inequality trends appear considerably more favorable than Piketty’s data show.

My analysis, with which Scott takes issue, is that this “transfer defense” as I call it, has merit, though less in terms of the growth of inequality (more on that below) and more in terms of real income growth for the middle class.  But my key point is that while analysts should look at all income sources, the market story Piketty tells remains true.  To the extent that middle-class families got ahead, it was through transfers and tax cuts more so than earnings.  As I read Scott’s own data, they further corroborate this insight.

Scott complains that my analysis failed to separate out elderly and non-elderly households.  In fact, I fully agree with the differences he notes, and noted them myself, stressing the role of Social Security and Medicare in particular on “aging boomer households.”  I devoted a precious paragraph (Scott gets more space than I do!) to the fact that “for the average elderly household that receives retirement benefits from the program, Social Security provides just under two-thirds of income.”

No question, the figure I posted looks different for different family types, with transfers obviously playing a lesser role—though still a larger one than many recognize, as I show below—for non-elderly households.  And no question, as I acknowledge, the changing composition (more of those “aging boomers”) means increasingly more transfers in the middle class.

That’s exactly my point.  The broad “middle class”—elderly, non-elderly, with kids, without—faces all the economic and fiscal pressures we’re currently debating, particularly in the age of Piketty, including stagnant earnings, attacks on social insurance, inequality channeling growth away from the middle, and the increasing dependence, particularly but not exclusively among the elderly, on tax cuts and increased transfers to lift wage-starved incomes (in fact, boomers are not just aging, they’re also working longer).

Scott’s own data neither assuage these concerns nor contradict these points.  He suggests that if we look at non-elderly households we’ll see the “strong gains in earnings” that I missed.  Except that his table shows real wages and salaries of this family type grew all of 5%, from 1979-2010.  That’s 0.2% per year and it is not “strong” growth.  Add in the value of employer-provided health care (which I argue these CBO data may overestimate) and other employer benefits and you’re up to 0.4% per year.  Drill down further to working-age families with kids and you get 0.4% per year in real wages/salaries; 0.7% including health care, etc. (14% and 23% over 31 years).

In what world is that strong earnings growth?  The economy’s productivity was up 89% over those years, or 2.1% per year, ten times the Scott’s allegedly strong gains in wages for middle-class, working-age households.  Moreover, as EPI’s Josh Bivens shows in the income chapter of State of Working America, the earnings gains these families achieved derived not primarily from higher hourly wages or benefits, but from more family members working more hours per week and more weeks per year.

Sticking with non-elderly households, Scott shows that wage gains explained 13% of the after-tax income growth they achieved over these years, while transfers and taxes accounted for 54%.  Of course that’s less than the 91% that I get by looking across the broad middle class, but the fact remains that more than half of the income gains from non-elderly households derived from higher transfers and lower taxes.  Only 13% came from earnings.

The CBO data show that these working-age families relied on wages for 70-80% of their income in these years, yet wages provided just 13% of the overall gains, even accounting for the extra hours and weeks worked.  In fact, for every family type he examines, taxes and transfers explain a larger share of their gains over these years than do earnings (e.g., for families with children, real earnings growth explains 30% of the gains; taxes and transfers explain 35%).  Again, how does this support Scott’s contention that market-based outcomes are working out fine for the middle class?

In fact, I suspect such numbers will lead objective readers towards the same conclusion of my Upshot piece: “…the extent of wage stagnation and its corollary, the increased role of transfer income and tax cuts in raising middle-income living standards, [is alarming]. Instead of hacking away at the safety net, the data reveal the need to preserve it while increasing the quantity and quality of employment opportunities and the real growth rate of earnings for the majority of the work force.”

Final point.  I’m not sure if Scott holds this position, but many who ply “the transfer defense” seem to believe that if Piketty had included taxes and transfers his conclusions regarding increased inequality would be altered.  As I wrote, “…while the progressive taxes and transfers that don’t show up in Mr. Piketty’s data reduce the level of inequality at any point in time, they don’t have that much impact on its growth. The share of comprehensive income going to the top 1 percent grew 6 percentage points before taxes and transfers from 1979 to 2010, and 5.4 points after taxes and transfers. (If one stops at 2007, before the recession, the same comparison yields an increase of 9.8 points before tax and 9.3 after).”

I’d invite Scott to weigh in on that point.  I definitely agree with him that it’s important to include these income sources in inequality and living standards analyses, though for reasons I stress in my piece, I place a lot of weight on Piketty-style market data too—as market inequality rises, you simply cannot ignore market outcomes unless you want to ratchet up the redistribution function every year to offset it.  I also find it awfully dissonant to hear some conservatives (not Scott, I don’t think) proffer the transfer defense on Monday, only to argue that we can’t afford social insurance on Tuesday.

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4 comments in reply to "Arguing Taxes, Transfers, and Market Outcomes"

  1. Brett says:

    I also pointed out on twitter that the increase in household income might be coming from more hours worked rather than rising wages, since the break-down doesn’t say whether the non-elderly households are single, double, or more-earners. He said that he thinks that’s a reflection of the disappearance of labor rents that working-age men had during the Postwar Period, but that still leaves us with either stagnating or declining wages for men at least.

  2. Smith says:

    Transfer defense has no merit. If there is to be any practical purpose to considering income distribution, taxes, social security, health benefits, food stamps and EITC can not possibly be included. The purpose is to determine the proper and fair distribution, which implies considering all and only the money available which could be given to some person rather than another. It’s a zero ( + 2.2% productivity growth) sum game.

    No one negotiates their after tax salary (except of course the 1% who insist on stock options and other tax avoidance schemes). The bargaining occurs over the income received. The business owner may complain their taxes are too high, but the alternative they forgo of selling their labor would involve the same process, bargaining over income paid.

    Critics of measuring before tax in order to consider the gains from tax cuts ignore the externalities of tax cuts, like deficits, crumbling infrastructure, inadequate funding of education, research and development, continuing output gap due to lack of fiscal stimulus. But ironically the variability in taxes point to the primacy of the before tax figure. Here’s the money rewarded for work, now in a separate process, politically negotiate with government how much and on what you want to spend.

    Health insurance benefits are not included because they are mandated, for obvious reasons, so you can’t bargain the benefit away, and it is unfortunate this is only technically true in the U.S. starting this year.

    Likewise Social Security is mandated, so the money can never enters into the sphere of negotiations over salary. The Bush and Republican efforts to change (destroy) it, would remove some aspects of those restrictions.

    Whither capital gains and dividends in this construct? It’s easily seen dividends come right out of the pocket of labor as profits are created and distributed to owners from the product (or services) of workers, less the income of those workers. Less visible are that these profits from labor generate the rising value of companies which are realized as capital gains. That still leaves capital gains for real estate and other property to consider.

    For example, if a piece of land appreciates and is then sold, how does that affect the money available to be distributed to labor? Unlike dividends and stock, the value didn’t arise out of profits created at the expense of higher wages for labor. Yet common sense says large sums rewarded for the sale of such property obviously affects inequality. Such capital gains are in their own category. They are not associated with a wage input. The affect on wages is indirect, as money consumed in the purchase of non-labor property is unavailable to labor. The analysis presupposes a previous accumulation of wealth on the part of a purchaser. The nature of the transactions and effect on wages warrant further study. But surly no one would confuse the discretionary expenditure for non labor input purchases with mandated government social security payments.

    Consideration of food stamps and EITC in measuring inequality, programs that represent the failure of the current market system of distribution to even minimally meet the needs of the populace is absurd. Erstwhile progressives woefully err in promoting expansion of programs that treat symptoms instead of cause. Greater need and use should be an embarrassment to everyone.

    Finally, a point made by Piketty, but I haven’t seen in commentary yet, is that we already have wealth taxes. Why this isn’t this more forcefully argued from the left? Instead the so called progressives concede defeat at the outset on this point and only reluctantly call for raising additional revenue from income. They miss the point that marginal rates need to be confiscatory to have their desired effect, and that they represent a restoration of a system we had and that worked better. Again, wealth taxes exist and always have, income tax is new and barely 100 years old. It’s in the six response that begins “I think one of the main lessons of the 20th century…”

    “In most developed countries the way we tax wealth right now is through property taxes. So for instance in the US or in most European countries you tax real estate property just in proportion to their value. So it’s not progressive and also because these property taxes were set up in the 19th century, they do not really take into account financial assets or financial liabilities. So I think it would be important to adapt them to the structure of wealth in the 21st century. And it will be adequate to transform these property taxes into progessive taxation of net wealth. So for instance, if you have a house worth $500,000 and you have a mortgage of $490,000 your net wealth is only $10,000. You are not rich in any way. So in the current property tax system you shouldn’t pay as much property tax as someone without a mortgage. And sometimes you even have people whose property value is below their mortgage and they keep paying the same property tax.”

    • Smith says:

      Regarding property taxes, there is some consideration of net worth because of the home mortgage interest deduction. In the scenario of a nearly $500,000 mortgage at 5% interest costing $25,000 and a $100,000 household income, which is two earners at $50,000 and puts you just into top 1/5 (top 20% of income) with roughly 1/3 marginal rate you get a savings of 25,000/3 = $8,333 being 100% mortgaged. Please note you’re still flushing $17,000 down the toilet each year, paying it to banks, unless it’s invested and earning above the 5%. With a graduated wealth tax that hits 1% at half a million, without consideration of net worth, there would be a $5,000 wealth tax vs. essentially $0 if net was the amount taxed. Why then is the wealth tax better or more progressive than property tax? Because it is accessed against all wealth, not just property (meaning the billions of stock, cash equivalents, other securities, and real property) owned by the 1%. Also, a national wealth tax doesn’t benefit only the local rich communities. Just as importantly, it is progressive instead of the flat and/or regressive nature of property taxes.

      Average is 1% of valuation according to this site:

    • Smith says:

      In a bow to Krugman’s complaint I would acknowledge my error using “affect” but would say it was committed not out of ignorance but a combination of carelessness and cognitive processing fatigue (on a cognitive neuroscientific level of language processing, the similar words may be accessed in a hierarchical decision tree, leading to these types of errors, especially writing before coffee)

      “The affect on wages is indirect…”

      Along the same lines these errata are duly noted
      “Why this isn’t this more forcefully argued…” with an extra “this”
      “…so the money can never enters into the sphere of negotiations…” should be “can never enter” or “never enters”

      Previous comment used “surly” instead of “surely” and the like…