Congressional Budget Office Study On Income Inequality Is Misleading

Monday, October 31, 2011 14:11
Congressional Budget Office Study On Income Inequality Is Misleading

Tags: client communications | economy | U.S. economy

A study released last week by the Congressional Budget Office says government policy has become less redistributive since the late 1970s and doing less to reduce the concentration of income. The study is expected to figure prominently in election year arguments for higher taxes on millionaires and billionaires but the picture it portrays is grossly misleading.

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While I trust that CBO has done the arithmetic correctly, the way CBO set up the study makes its conclusion extremely misleading.
Cynics might say the beginning and end points of the study were manipulated to achieve a desired outcome.
Why? Because the study’s start-year, 1979, followed a flat decade for stocks whereas the study’s end-year, 2007, followed a more than doubling in the S&P 500 from 2002 to 2007.
Capital gains included in the 2007 after-tax income figure probably represent most of the increase in the top 1%’s share-of-income from 7.7% to 17.1% between 1979 and 2007. (I say “probably” because CBO doesn’t provide the actual capital gain figures for 1979 or 2007.)
Had the study’s beginning and end points both been years of “normal” realized capital gains, the step-up in share from 7.7% vs. 17.1% would be largely eliminated.  
Interestingly, the U.S. Census Bureau also just released an updated study5 of income distribution. Income distribution (in constant dollars) in 2010 has both flattened and shifted to the right compared to 20 and 40 years ago. Arithmetically, this means that the gap between median and mean incomes has widened, which class warriors point to as evidence of greater income inequality.
The data suggest, however, that today there are many fewer households in the $35K-$75K brackets because there are far more households in the brackets from $100K and higher. This is a good thing! It’s a rising tide lifting most boats!
Finally, as for “millionaires and billionaires” paying their fair share of taxes: The CBO study shows a steady decline from 1979 through 2007 in total federal taxes paid as a percentage of household income by taxpayers in the lowest bracket up through those in the 80thpercentile.
Based on this measure, the tax system has grow more progressive, not less. The top 1%’s taxes as a percentage of income significantly rises and falls with business income and capital gains tied to moves in the economy and stock market.
For advisors interested in posting content on their website or blog about the misleading conclusions in the CBO study, Advisor Products is releasing a video presentation about my view of the study, along with a script and slides.


Comments (3)

Why is it inappropriate to include capital gains in the survey? Most of the wealthiest individuals receive a large portion of their income in the form of capital gains, and it is only the wealthy who have the means to have after-tax portfolios significant enough to generate signficant gains?
How is it that capital gains 'probably' represent most of the gain in paragraph 2, but the gains would definitively be 'largely eliminated' in the next paragraph?
I would hope that a large number in $35-$75k bracket would move into the $100k plus bracket over almost 30 years. It would need to just to keep up with inflation!
You insinuate that they are data mining, but for some reason people have a 10 year holding period in the 1970s but a 6 year holding period in the 2000s. In fact the S&P 500 gained 99.58% from 1975 through 1979, and 82.86% from 2003 through 2007, both reasonable 5 year holding periods.
You flat out state that the tax system has grow[n] more progressive, not less without a any evidence. One part you leave out is that the reduction of capital gain and dividend tax rates is 'probably' represents most of the increase, rather than an increase capital gains and dividends themselves.
There is probably some skewing of the numbers, since the top 0.1% likely get most of their income from capital gains and/or qualified dividends, but to try and make the case that income inequality has increased over the last 30 years is naive at best, and flat-out fabrication at worst.
robertv215 , November 01, 2011
Fritz, you've just blown your credibility

bramsay , November 04, 2011
A4A put up the full text of my article on this topic today and with regard to your questions, above, I hope you will read it. Yes, capital gains must be included in any measure of income. My comments are focused on what's behind the 278% surge in the chart on page 1, and why the big jump from 7.7% to 17.1% in the chart on page 2. A big part of the answer is illustrated in the chart on chart 3, the outsized realized cap-gains of 2007 compared to 1979, the study's two endpoints. I think CBO's sensational chart, page 1, gives a substantially distorted picture because cap gains are realized in such a lumpy fashion over time. The Gini index, chart on page 4, illustrates that income inequality has risen. So, no, I'm not a "denier" as discussed in the NY Magazine article. However, the chart on page 5 illustrates the important "why" behind the Gini's measure of rising income inequality. My point is that the measured shift in income ditribution in this chart looks like a good thing, not a bad thing. So, it strikes me that if you dig into the most recent actual data on this topic it really does produce a perspective that's different from some commonly-held assumptions, to paraphrase the NY Magazine writer.
fritzmeyer , November 07, 2011

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