Responding To Readers' Questions With A Closer Look At The CBO Study On Income Inequality

Monday, November 07, 2011 13:18
Responding To Readers' Questions With A Closer Look At The CBO Study On Income Inequality

The Congressional Budget Office just released a study in which it concludes: “As a result of that uneven income growth, the distribution of after-tax household income in the United States was substantially more unequal in 2007 than in 1979: …” Here’s the sensational first slide presented in CBO’s 63 page document.




Shares of after-tax income going to the highest 1 percent of the population more than doubled over the 1979-2007 period, while shares going to each of the lowest quintile to fourth quintile declined, as you see in this chart.




While I trust that CBO has done the arithmetic correctly, it’s the way in which they set up the study that bothers me. In fact, I think their conclusion is extremely misleading. A cynic might say it represents a clear manipulation of the study’s beginning and end points in order 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 – and 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 cap-gains figures for either 1979 or 2007, but they do say this: “In the later years (of the 1979-2007 comparison period) an increase in the share of total income from highly concentrated sources, in this case capital gains, accounted for about four-fifths of the total increase in concentration.”


While CBO does not break out what portion of after-tax income was comprised of after-tax capital gains in their “share of after-tax income” slide, above, the following chart showing pre-tax realized capital gains as a percent of total personal income (pre-tax) gives us an indication of how much more significant capital gains were in 2007 compared to 1979, the endpoints of CBO’s study.




The increase in the top 1%’s share from 7.7% to 17.1% provides the basis for the dramatic 278% income growth in slide 1, which sort of reminds me of the “hockey stick” chart of climate debate fame. Had the study’s endpoints both been years of “normal” realized capital gains, the step up in share from 7.7% vs. 17.1% would be substantially reduced. Another key contributing factor to the top 1%’s increase in share was the Tax Reform Act of 1986, following which many C corporations converted to S corporations, whose income is substantially picked up in the top quintile.[1] So this contributor to the reported increase in share is really a measurement change rather than a change in substance.


CBO’s calculated Gini index over the period reflects a modest increase in income inequality with a noticeable pickup from the recession trough in 2002 through 2007. Cap-gains and business income were the key contributors to that rise. Had the endpoint of CBO’s study been post- the last recession it stands to reason that an up-to-date Gini index would reflect a decline from 2007 in business income and realized cap-gains.

[1] CBO’s “concentration index” for business income increased from 0.74 in 1979 to 0.92 in 2007.







Finally, as for “millionaires and billionaires” paying their fair share of taxes, the CBO’s study actually shows a steady decline from 1979 through 2007 in total federal taxes paid as a percentage of household income by the lowest bracket all the way up through the 80th percentile. On this measure the system has gotten 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.






Using CBO’s “hockey stick” slide to beat the drum on rising income inequality – and using that as an argument for higher taxes on millionaires and billionaires – may be expedient for politicians but the picture it portrays is grossly misleading.


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Comments (3)

Interesting take on the tax burden. Let's extend the argument, if the top 1% get 99% of the income and pay 100% of the taxes then our tax system is really progressive! Of course we'd then have only nobles and peasants, but why should the peasants complain since they wouldn't have to pay taxes?

If you review inflation adjusted tax tables going back to 1913, clearly tax rates are less progressive now than anytime post WW2, except maybe 1988-1990.

You discuss realized capital gains, but what about unrealized (or stepped up basis)- in other words increases in wealth that don't show up in income figures? That is a big number for the top 1% since 1979. And an insignificant number for most of the rest, particularly the lowest 60-80%.

It is also misleading to shift the argument from percentages of households to dollars of households. In fact, your point is probably another way to see the growing inequality- if the quintile income changes are correct, then if there are fewer in the middle and more at the top, then that means there are also more at the bottom.

Oh, in case you missed it, you might want to reconsider leaning on the hockey stick
bramsay , November 08, 2011
Right, regarding the distributon of wealth. Here's what CBO said in their October study: "Household wealth is much more unequally distributed than household income or household consumption. The distribution of wealth appears to have become more unequal from 1983 to 1989 but to have remained relatively unchanged from 1989 through 2007.”
My point on the shift in income distribution, page 60 of the powerpoint presentation, is that as a percent of total households the number in the lowest income brackets has remained steady (has not increased) even as the number in the highest brackets has increased. The loss came from the middle brackets. The result of this shift has been a gradual increase in the Gini index of income inequality, but the reason for the increase looks like good news to me, not bad. A flattening of the distribution, yes, but not at the expense of the lowest income brackets.
fritzmeyer , November 09, 2011
Another interesting way to view it. So if the economy has real growth of 100%, and 100% of that growth goes to the top 20%, and 0% goes to the bottom 80%, that's a good thing for the top 20%, and at least the bottom 80% didn't lose ground, so why should anyone complain?

Isn't that just another way of seeing the inequality, with the majority getting less of the overall growth of the economy over the last 30 years?

The imbalance is also ultimately a net negative for the top. Bill Gross put it well in his October letter- "Long-term profits cannot ultimately grow unless they are partnered with near equal benefits for labor."

Take a look at the 1940's through the 1970's. Economic growth was much stronger, and labor income growth (which is concentrated in the lower 80% as you point out) was much higher. So labor received a greater share of the growth of the economy over those decades than since the 80's.

That provides insight into part of our current problem since we don't now have a shortage of supply- we have a shortage of demand. Demand which can't increase to match supply because income growth is stagnant for the majority, who are also the ones who spend more of their income.
bramsay , November 09, 2011

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