One of the more interesting developments in the U.S. economy over the past few decades has been the dramatic rise in incomes at the very top of the scale. There’s all sorts of anecdotal evidence for this, from spectacular paydays of hedge fund managers to the sharp rise in entrance requirements for the Forbes 400 to the prices of Fifth Avenue apartments to the private-jet boom. But the most exhaustive empirical evidence for this income explosion at the top has come from the work of economists Thomas Piketty and Emanuel Saez, who have mined IRS data to deliver a previously unavailable picture of the sharply rising share of income going to the top 1%, the top 0.1%, and even the top 0.01% of taxpayers.
Whether this rise in income inequality is a good thing or a bad thing is a question I really don’t have a good answer for. But I do think we ought to be discussing it.
Certain elements among the right-wing economic chattering classes, though, have honed an interesting response to this rise in income inequality: They deny that it exists. My economic policy cover story of a while back, which cited Piketty and Saez, seems to be drawing these denialists out of the woodwork. Gary North is one, and now David Gitlitz joins in at National Review Online:
On income inequality, Fox accepts as fact the findings of economists Thomas Piketty and Emanuel Saez that “75% of all income gains from 2002 to ’06 went to the top 1% — households making more than $382,600 a year.” But as Piketty and Saez have acknowledged, these results are significantly skewed by the fact that their data only includes income reported on individual tax returns.
Following cuts in individual tax rates in 1986 (under Ronald Reagan) and 2003 (under George W. Bush), many of the businesses that had been reporting income under the corporate tax switched to the lower individual rate. In 1986, business income accounted for only 11 percent of the income reported by the top 1 percent of earners. By 2005 that share jumped to more than 29 percent. Clearly, much of the reported gain of the top 1 percent is accounted for in this bookkeeping shift.
Uh, no it’s not. That purported problem, raised by Alan Reynolds, was swatted down pretty convincingly by Piketty and Saez:
Most of the scenarios described by Alan Reynolds, such as a shift from corporate income to individual income or from qualified stock-options to non-qualified stock options, would imply that high incomes used to receive capital gains instead of ordinary income. For example, a closely held C-corporation which does not distribute its profits increases in value and those accumulated profits would appear as realized capital gains on the owner individual tax return when the business is sold. Yet, our top 1% income share series including realized capital gains has also doubled from 10.0% in 1980 to 19.8% in 2004.
A fair description of the current state of knowledge on the income distribution is that members of the economics establishment (from right-wingers to left) more or less unanimously accept the Piketty and Saez data as a more or less accurate representation of reality. There are big debates about what it all means, and why it’s happening, but the only major objections that I know of to the Piketty-Saez data itself have been those raised on the op-ed page of the Wall Street Journal by Reynolds, a senior fellow at the libertarian Cato Institute who doesn’t appear to have an advanced degree in economics or in anything else.
It’s a case where the scientific consensus says one thing, and this one guy says the opposite. I don’t have an advanced degree in anything either, and I like to think that on occasion the scientific consensus will turn out to be wrong and the lone outsider right. But I’m pretty sure this isn’t one of those cases.
Why not? First, there’s all that anecdotal evidence of vast new fortunes being created.
Second, Piketty and Saez have pretty convincing answers to all of Reynolds’ objections to their data.
Third, Piketty and Saez come across as data jockeys with no particular axe to grind, while Reynolds is an overt ideologue.
Finally, when Reynolds strays into an area that I actually know something about–the use of stock options in compensation–he is so clearly blowing smoke that it becomes difficult for me to trust anything else he says. Here he goes:
There are other serious problems with comparing income reported on tax returns before and after the 1986 Tax Reform. When the tax rate on top salaries came down after 1988, for example, corporate executives switched from accepting stock or incentive stock options taxed as capital gains (which are excluded from the basic Piketty-Saez estimates) to nonqualified stock options reported as W-2 salary income (which are included in the Piketty-Saez estimates).
My impression is that the switch began even earlier, after the first Reagan round of tax cuts. But as indicated in the Piketty-Saez quote above, they do keep track of capital gains income as well, and the trends in income distribution aren’t significantly different with and without capital gains included. What’s really misleading about this little passage from Reynolds, though, is that grants of stock and incentive stock options have always been limited in size–stock because companies have to take a charge against earnings when they give it out, and incentive options because of both legal limits and the fact that recipients have to put up money to buy the underlying stock and hold on to it for a while. There are no such limits on nonqualified option grants, which weren’t (until recently) charged against earnings and can be flipped immediately when exercised. So as companies moved away from stock grants and incentive stock options and toward nonqualified options in the 1980s and early 1990s, there was some amount of substitution and tax shifting going on. But the really important development was that these new option grants were orders of magnitude bigger than the old ones. The result was a huge increase in executive pay that showed up in corporate financial disclosures as well. It was not a quirk in the IRS data.
So here’s where all that leaves me. I’m going to keep “accept[ing] as fact the findings of economists Thomas Piketty and Emanuel Saez.” And anyone who says I shouldn’t do so, without raising some major objections beyond the feeble array already trotted out by Reynolds, goes down in my book as something of a joker.