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Is the Breakaway Top One Percent a Problem?

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Is the Breakaway Top One Percent a Problem?

August 9, 2017

The policy community is buzzing over a New York Times column by David Leonhardt describing a recent economic inequality study by noted economists Thomas Piketty, Emmanuel Saez, and Gabriel Zucman.

The centerpiece of the study is a chart showing the average annual income gains between 1980 and 2014 at various percentiles on the income distribution. It shows that, while upper-income individuals have seen faster income gains than lower-income individuals, the yearly differential between income groups is roughly linear until incomes reach the top three percent and higher—at  which point the ultra-wealthy break away asymptotically.

This study overcomes many of the flaws of past income inequality studies, including prior work by the authors. The authors mostly control for demographic changes (reduced marriage, low-skilled immigration, and retiring baby boomers) that – rather than economic changes – explain much of the widening dispersion of family incomes. The data incorporate fringe benefits such as health insurance and employer retirement contributions, and include a measure accounting for federal, state, and local taxes and transfers. Finally, the authors are better able to capture income earned and taxes paid than traditional studies that use only IRS-based data, which suffers from inconsistent standards and definitions.

A significant shortcoming – which the authors concede – is the study’s failure to account for income mobility over this 1980 through 2014 period. So while a typical individual in the 45th income percentile would have seen 0.4 percent real annual income growth over this 34-year period, virtually no individuals actually stayed within this same percentile all 34 years. In reality, a study by three U.S. Treasury economists  showed that most families in lower income quintiles rise to higher quintiles within a decade.

Another problem is that many of the top one percent of earners in a given year are based on one-time capital gains sales (rather than permanent high incomes), which the authors address only in a roundabout way. U.S. Treasury data show that of the top 400 earners in tax years 1992 through 2014, 71 percent were among that select group for only one year.

Overall, lifetime incomes show much less inequality than random snapshots in time. IRS data show that three-quarters of the top one percent fall out within six years. And measurements that focus on consumption rather than income -- which take into account taxes, government benefits, and the lifetime smoothing of consumption -- show little change in inequality across the quintiles between 1960 and 2014.

All that said, Piketty, Saez, and Zucman make a useful contribution to the study of income inequality. The major policy question (assuming one accepts the data) is whether this pulling away of the top 0.5 to 3.0 percent is really a “problem” to be “solved.” After all, the economy is not a fixed pie whereby one person’s wealth creates another person’s poverty. Former Bush White House economist Keith Hennessey has described how a flower garden is the better metaphor for an economy. All flowers in a garden share the same common underlying climate, soil, and pests, yet will grow at different rates due to the individual aspects of each flower. Although some flowers enjoy natural advantages over others (some of which may not be fair), their faster growth does not come at the expense of slower-growing neighbors. Hennessey adds that:

“Policymakers should focus their energies on absolute growth rates rather than relative ones. It’s not a problem that some flowers are growing faster than normal, unless (a) that growth is indeed coming at the expense of other flowers, or (b) that more rapid growth is because the gardeners are neglecting [some flowers] to help [others] grow faster.”

Bill Gates, Steve Jobs, and other computer revolutionaries set in motion a process that created enormous global wealth, revolutionized the economy, enhanced communications, and improved countless lives. That they retained a small fraction of this wealth and thus increased income inequality does not undo any of these societal benefits.

The more common viewpoint is that income should be both celebrated and heavily taxed. Someone must pay the government’s bills, the argument goes, so why not the economy’s top beneficiaries? Moral questions aside, that argument can proceed only so far before colliding with budgetary and economic reality.

America already has the most progressive tax code of all OECD nations. The top one percent of taxpayers – which closely approximates the group pulling away from the rest – already pays 39 percent of all federal income taxes despite earning 15 percent of the income. Significantly taxing the super-rich would not finance much more government. According to IRS tax data, the entire universe of currently-untaxed annual income over the $1 million threshold is 3 percent of GDP. Many of these families are already paying combined (federal, state, and payroll) marginal tax rates above 50 percent. Additional taxes on these millionaires could realistically capture perhaps one more percent of GDP in revenue before the exorbitant tax rates stifle the economy and begin to reduce revenues.

Not enough taxpayers exist at those high incomes to solve the long-term budget deficit, much less finance new spending. Consequently, lawmakers who begin by calling for millionaire taxes often end up reaching much further down the income scale – where nearly three-fourths of income is earned outside of the richest five percent. Therefore, taxpayers hearing calls for “tax increases on the super-wealthy” should guard their own pocketbooks.

Brian Riedl is a senior fellow at the Manhattan Institute. Follow him on twitter @Brian_Riedl.

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