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“Nothing from Nothing leaves Nothing” Billy Preston

July 31, 2014

With somewhat better economic times allegedly finally upon us (albeit temporary in my view), the issue of increasing income inequality in the US has begun to receive some attention again. The main figure that is brought up in support of the notion is that “median” incomes in the US adjusted for inflation have barely budged since 2000 and have actually declined during the Obama years but incomes for the top 1% and top quintile are increasing. A recent book  by Thomas Piketty, a French economist purports to show that the top 1% is getting much wealthier lately at the expense of the bottom 80% particularly since the 1970s and 1980s.

Of course, there are many problems with these statistics and the Pikettty study in general that make them much less meaningful than often supposed. ( or as Disraeli said “There are three kinds of lies: lies, damned lies, and statistics”). For example, the basic data on US incomes presumes that people are “static” and remain in the same quintile throughout their careers when this is generally not the case. So how meaningful is it to compare quintiles over time when the normal movement is to move up the quintiles thru the first 20-30 years of ones career?

Alan Reynolds of the Cato Institute in a recent op-ed (“Why Piketty’s Wealth Data are Worthless” July 10th in the WSJ) points out that the Piketty data are indeed worthless. Because he uses income data solely from individual tax returns and compares these over the 1960 to today period, Piketty falls into the trap of comparing apples and oranges. For example, after the changes in the tax laws during the 1980s with the top personal income tax rate dropping from 70% to 28% and eventually settling at 39.6 % rate today, there was a massive shift in small and even moderate size businesses to S corporations which resulted in income shift from the corporate tax rolls to personal income tax filings. This means that the observed greater “concentration” in wealth in the top rate 1% category between 1970 and the post-1986 period (and specifically in the top 0.1% in the recent Zucman-Suez follow-on presentation early this year that Piketty now cites as his “evidence”), was largely a function of more corporate income being reported on the personal income tax rolls. And there are other flaws with the use of ONLY personal income tax data due to changes in tax laws over time. The 1981 and 1986 tax reforms resulted in (1) reporting of municipal bond income (for the first time) which is predominantly from the top 1% earners (2) exclusion of capital gains on most middle-income earners primary home sales and (3) an explosion of unreported and tax deferred earnings which were no longer part of taxable income largely to the benefit of those below the top 1% with balances growing from $875 billion in 1984 to $12.4 trillion by 2012. And there are many other flaws that are discussed in the aforementioned article.

What can be gleaned from all this? Unfortunately, not much. U.S. wealth may be coming more or even less concentrated but the data makes it difficult to tell. (And I am hard pressed to believe that U.S. wealth is more concentrated than most other countries including developing countries such as India where there are many millionaires but also 40% of the population living in truly abject poverty on little more than $1 a day in income).  I believe in the end, fretting about “income inequality” is misplaced. We will always have income inequality to some degree, because the US is still largely based on the free market system which generally rewards people who produce more or who are willing to take risks to succeed or choose fields of work where others are not willing or able to do (i.e. the laws of supply and demand). Are there inequities? Sure, but who decides how much and whether and how to correct for these? If worker A is willing to do unpleasant or even more dangerous work or work much harder than worker B and he earns substantially more than worker B, should some of worker A’s wage be redistributed to worker B thru the tax code? And how much income inequality is acceptable?

I believe that our collective concern should NOT be that Bill Gates or other of the very wealthy few makes many, many times more $ than I do or for that matter many, many, many times more $ than a fast food worker.The real problem is that we aren’t doing a good enough job rewarding and making sure people on the bottom rung, the low-income workers, are living a decent life and that their children have the opportunity to advance and live an even better life.

I believe there are several ideas that I have expressed in this blog previously which will help improve conditions for low-income workers. Two in particular are worth noting again:

(1) Massive Tax Reform – Not to be a broken record but the “Fair Tax” which would completely scrap the current abhorrent tax system is by far the best idea. (See several of my blog posts over the past two years including most recently “Let Me Go Crazy on You” or simply go to fairtax.org).  This massive tax reform would have two very positive effects for lower-income workers. For one, it would create literally trillions of $ in new growth for the US economy and millions of new jobs giving more opportunities for the working poor. Second, it would eliminate all taxes up to the poverty line of income for the working poor ( some $25,000 per year) versus the current system where there are social security/ medicare taxes of 7.65% Percent ( or almost $2000) plus some federal income taxes on those making more than $10000 to $25000 (depending on their number of dependents). Another good idea, though not nearly as extensive nor as beneficial as the “Fair Tax”, is to raise the amount of the federal personal exemption and increase the earned income credit. This idea has the advantage of actually having bipartisan support (‘both Paul Ryan’ and President Obama support it) and would be a good first albeit small step towards improving our tax system .

(2) Public School Education Reform – Our school system is not working by any objective measure. We are near last among developed countries in math and science skills and only in the middle of the pack in verbal skills. (And as many correctly argue, we probably don’t really know where we stand on verbal skills give the more subjective nature of the international comparisons). Not surprisingly, a child in an inner city or poorer school district has a far smaller chance of graduating or in gaining the skills needed to be employable than those educated in wealthier districts. While there is no simple fix for this problem, introducing school competition through a voucher system would be a good start. I have never heard a good rejoinder as to why this wouldn’t at least improve things. To be sure, this is not the only answer ( somehow reversing the deterioration of the inner city family would be the most important action towards improving children’s education prospects) . However, school choice and competition is a largely doable proposition with demonstrated success stories ( e.g. Charter schools).

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Unfortunately, there is considerable political resistance on the part of special interests such as the teachers unions, some state governments, federal and government workers unions, mortgage and realty companies, homeowners with large mortgages, some corporations and industries with significant special tax breaks to name just a few.  I still remain optimistic that as people are better informed and educated about these reforms that they will gain support and eventually we may get there. In the meantime, we are stuck with antiquated, broken and even politicized public school and  federal income tax systems. Let’s hope we get there soon, so we aren’t humming “Nothing from Nothing means Nothing” anymore.

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