Fair Incomes

by Dave Schuler on October 27, 2011

In the light of the “Occupy” protests going on around the country and around the world the CBO report of income trends has received considerable attention, at least in the media and in the political blogosphere. This chart of the growth in real after tax income from 1979 to 2007 is receiving particular notice. I’m rather surprised that I’ve seen so little commentary about what jumped out at me from the chart: real incomes have grown in all sectors over the last thirty years. I would have thought that real income in the lowest quintile would actually have shrunk.

I also wonder what the chart would look like if it accounted for total real compensation rather than real income (or the CBO’s rather peculiar definition of compensation).

Felix Salmon remarks:

And yet — I’m still in the (upper quintile of the) 99%, and if you boil things down to just their income and wealth numbers, the 1% is as far away from me as I am from a struggling working family with an onerous mortgage and a highly uncertain employment outlook. And there’s no need for them to shower themselves with that kind of money. From me on out, it’s pure avarice. Which is human, and natural, and probably even helps in terms of economic growth. But given the amount of misery and poverty in America, it’s simply unconscionable that I and the people earning vastly more than me — including all of the 1% — are getting such an enormous share of the income and wealth so desperately needed elsewhere.

All of which is to say that my taxes are too low. If my taxes went up and the money was used to reduce poverty and unemployment in America, my standard of living would still be glorious — and millions of lives would be improved. And as for the 1%, their taxes could double and they would still be fabulously well off. I’m not proposing that as a policy solution. But I am trying to put things in perspective here.

I wonder what his perspective would be if his taxes went up and, rather than using the money to reduce poverty or unemployment, the bulk of the money went to other people in the top income quintile or was handed over to key constituencies to ensure re-election for incumbents. That’s largely what happens when we increase spending on healthcare, education, firefighters and policemen, or bailing out banks and auto companies.

That’s my main gripe about fiscal policy these days. I see a lot of irresponsible, profligate, and unreliable stewardship. To my mind the solution for that is more responsible, less profligate, and more reliable stewardship rather than more funds to be irresponsible, profligate, and unreliable with. It may well be more funds are needed but it’s darned hard to trust the same scoundrels over and over again. New scoundrels aren’t much of a solution, either.

Meanwhile, I’m mulling over what a fair income is and how that can be accomplished. I think I’d agree that stacking the deck and using your wealth and power to accumulate more wealth and power is unfair. As I’ve written before I don’t think that particular sport is limited to the top 1% but is to a large degree why the top quintile is in the top quintile. Further, I think the more power and wealth is concentrated in a federal government that determines what a fair income is the worse that will become. Rent-seeking increases because it pays off.

I’m not sure I see any way outside of a Benedictine monastery with vows of poverty, chastity, silence, and obedience to accomplish real equality. That hasn’t caught on in 1500 years so it probably won’t catch on now. Are equality and fairness the same thing? I don’t think so.

{ 43 comments… read them below or add one }

sam October 27, 2011 at 8:41 am

“Are equality and fairness the same thing? I don’t think so.”

Nor do I. But the way to a solution of the general problem is to investigate what we understand as “fairness”.

Mark October 27, 2011 at 9:32 am

I do tax planning & consulting and most of my clients are in the top 0.1%. Surprisingly many of them agree with Felix Salmon that their taxes are too low. My response to them (and anyone else who feels that way) is rather than asking the gov’t to increase their tax burden, just give more directly to charities. http://www.charitynavigator.org

PD Shaw October 27, 2011 at 9:59 am

Just from a google of “Felix Salmon” and “poverty,” he doesn’t appear to have written much about the topic. I don’t doubt the sincerity of his concerns, but it suggests that the problem is a difficult one to analyze through the lens of economics.

PD Shaw October 27, 2011 at 10:13 am

Mark: That’s a nice link.

It shows who some of the people in the top 1% are. Retired vice presidents and deputy CEOs for the American Cancer Society make $1.5 million per year.

Steve Verdon October 27, 2011 at 10:13 am

All of which is to say that my taxes are too low. If my taxes went up and the money was used to reduce poverty and unemployment in America, my standard of living would still be glorious — and millions of lives would be improved. And as for the 1%, their taxes could double and they would still be fabulously well off.

How? This guy must be a freaking genius, make him God Emperor and we can all have a glorious life.

Asshat.

Andy October 27, 2011 at 10:46 am

Another instance of the inappropriate linkage of tax policy and income distribution. Felix Salmon’s solution is the Roman solution – tax those who hold all the wealth then give the capite censi bread and games to keep them quiet and occupied.

Dave Schuler October 27, 2011 at 10:59 am

Yeah, that’s what struck me, too, Andy and Steve V. He’s assuming the most benign possible policy rather than the most likely policy. I think it’s an instance of the Wishful Thinking fallacy.

Icepick October 27, 2011 at 11:46 am

Meanwhile, I’m mulling over what a fair income is and how that can be accomplished.

Is there any actual evidence that tax policy can change income distributions? I find it highly unlikely, short of taxes that are beyond onerous and all the way to draconian for those at the top, and things like that never work out well.

Icepick October 27, 2011 at 11:48 am

Should read:

Is there any actual evidence that tax policy can change income distributions so as to make them less weighted toward the very top of the income/wealth ladder?

jan October 27, 2011 at 11:51 am

Dave, a well written thread, and the same to comments that followed.

It may well be more funds are needed but it’s darned hard to trust the same scoundrels over and over again. New scoundrels aren’t much of a solution, either.

This is the conundrum of all conundrums — giving more dollars to do what? There are no guarantees or adequate enough oversight to follow these dollars and see that they are appropriated into areas which count, reduce poverty, help grow the economy etc.

I saw that same growth chart yesterday and was surprised by the growth in all sectors as well.

As for people in that outrageous 1%, it continues to be their money. However, those with a greater social consciousness, such as Buffett, Gates and empathetic Hollywood types, could achieve a feel-good status by contributing more of their profits elsewhere, whether it’s voluntarily paying higher taxes, starting scholarship funds — the possibilities and opportunities to help others are infinite. All it takes is a certain selflessness, to render a kind act, not necessarily noted by the public — that is called demonstrating the ‘courage’ of your own convictions.

Drew October 27, 2011 at 1:09 pm

I think several of my observations have been well covered:

1. Who says if we taxed away income it wouldn’t go to those most capable of repatriating it through the state?

2. Who decided we are now a Kingdom? I don’t think rappers should make $50MM a year. Others don’t think CEO’s should make $50MM a year. Should consumers and shareholders decide? Or a King?

3. “Yes, I agree, I’m undertaxed.” What a total bullshit throwaway line. Talk is cheap (and that includes the current darling Mr. Buffet) writing a check to the Treasury Dept. is a finite number and act.

What always seems to be missed in these arguments is that increased income taxation (to have a material effect on the nation’s finances) inevitably dips down – way down – into the income scale, and has an effect on GDP and employment. Our firm has a saying, but since I’m feeling in polite company today I’ll keep it less spicey: “do that, and you are shooting your foot off.”

PD Shaw October 27, 2011 at 1:39 pm

I skimmed the report over lunch, one of the interesting issues was how it accounted for household differences — specifically, the difference between a household with one income and several children and a household with two incomes.

The figures here are adjusted household income, which means that household income was divided by the square root of the number in the household. For instance, if the household has $80,000 income, it would be adjusted:

one person = $80,000 (Fifth Quintile)
two people = $56,569 (Fourth Quintile)
three people = $46,188 (Fourth Quintile)
four people = $40,000 (Third Quintile)
five people = $35,7778 (Third Quintile)

I’m not sure what I make of this, at the very least it suggests that one can work oneself down the scale by breeding in the CBO’s view. OTOH, I’m not sure the adjustments accurately reflect the true benefit of a second income-earner, even if the spouse is providing non-renumerated support for the household.

CBO asks and then ducks the question, has the increased participation rate of women in the workforce during this period increased inquality?

Steve Verdon October 27, 2011 at 3:13 pm

Yeah, that’s what struck me, too, Andy and Steve V. He’s assuming the most benign possible policy rather than the most likely policy. I think it’s an instance of the Wishful Thinking fallacy.

Well it isn’t just that Dave, although I share your skepticism on this point too. The only sure fire solution is to do what Andy suggests, tax those who have wealth and give it to those who don’t. Problem with that is it really messes up incentives. When looking at income inequality if you go for perfect equality guess what happens to work effort….buh bye. Why work when I know I’m going to get the same income no matter what I do?

Now the obvious answer is don’t go for perfect equality…well okay no how much? I’m not necessarily opposed to this, but there are so damn many people getting their incomes either directly or indirectly via the government you’ll probably never get anywhere. It is why we always end up with a horrifyingly complicated tax system that imposes significant efficiency losses on our economy. Tax attorneys, accountants, even the buttheads at Turbo Tax and the like, prefer it that way. The last thing the Turbo Tax people want is a simplified tax code. Not to mention the more direct benefits that accrue to politicians and their various supporters.

The guy is a complete twat. I can’t believe the ASA gave him an award, they should ask for it back after that commentary.

Ben Wolf October 27, 2011 at 3:22 pm

@Drew

“What always seems to be missed in these arguments is that increased income taxation (to have a material effect on the nation’s finances) inevitably dips down – way down – into the income scale, and has an effect on GDP and employment.”

You’re right: taxation does indeed create a certain level of unemployment, which negatively impacts GDP. As government must tax, however, the best and most permanent solution is to pass the Jobs Guarantee making government the Employer of Last Resort. If the economy tanks it automatically stabilizes employment, and when the economy recovers the program winds itself down.

Steve Verdon October 27, 2011 at 3:26 pm

Oh, and exactly how much income tax would be raised by doubling the tax on the rich? I’m going to guess it isn’t nearly anywhere near what most people think. According to the tax foundation the top 1%, in 2009, paid $318 billion. Even doubling that is not going to make much of a difference. And that kind of an increase might have a negative impact on economic growth. We aren’t talking a marginal or small change we are talking a doubling. That is a big change.

Steve Verdon October 27, 2011 at 3:29 pm

Ben,

I don’t think many people believe in perpetual motion machines nor are they going to buy that argument as the government acting as the employer of last resort.

Ben Wolf October 27, 2011 at 3:46 pm

@Steve Verdon

Could you be more specific in you objection? No one is making claims of perpetual motion.

PD Shaw October 27, 2011 at 3:52 pm

On taxes, the CBO found that the top 1% paid just under 30% of their income in taxes. That has to be put in the context of the broad definition of “income” being used, which includes income from capitol. Simply doubling the rates on the income tax return won’t make that 60%.

The other interesting thing is the CBO was uncertain whether federal taxes have become more or less progressive. In one measure, they have become slightly less progressive since 1979 and the early 1990s, under another measure it was mostly unchanged.

Andy October 27, 2011 at 4:21 pm

Ben,

So is that some kind of make-work program, digging ditches and the like?

Steve Verdon October 27, 2011 at 4:23 pm

My problem Ben is that aside from a few exceptions government doesn’t create much. When 5 million people become unemployed the government is not going to employ them doing something useful. Really, what you are talking about is giving people money for being unemployed. They will take longer looking for a job (depending on how much they are getting paid) and stimulus of this nature has generally been found wanting. Temporary economic stimulus doesn’t usually provide much of a long term bounce.

Ben Wolf October 27, 2011 at 4:24 pm

The real problem with the incomes of the 1% is that they tend to generate financial instability. There are a limited number of productive, healthy investments to go around, meaning our wealthy (who have a LOT of capital) are looking for something to do with it to generate returns better than the 1 – 2% they get from bonds. That “excess” capital creates perverse incentives to generate exotic, high-return and high-risk financial vehicles. Under less extreme conditions we could just let those people blow themselves up, but the vast quantities of capital hat goes into these things (derivatives are a $600 trillion market) that when things go wrong it blows up the whole financial system.

My personal preference is to outright ban by law any form of speculation not related to providing security to real economic activity, rather than to raise taxes on the wealthy.

Andy October 27, 2011 at 4:30 pm

PD Shaw,

Interesting figures especially considering we are a family of five with an income of a bit over $80k a year. I can certainly confirm that kids are very expensive, but that is partially offset by tax breaks – our effective federal income tax rate is usually around 3-4%.

OTOH, I’m not sure the adjustments accurately reflect the true benefit of a second income-earner, even if the spouse is providing non-renumerated support for the household.

We’ve done those calculations for us at least and the cost of a second full-time income earner is $25-30k a year. Most of that is child-care for three kids.

CBO asks and then ducks the question, has the increased participation rate of women in the workforce during this period increased inquality?

Megan McArdle wrote some posts on that topic I think.

Ben Wolf October 27, 2011 at 4:32 pm

@Steve

The system creates a certain level of unemployment; this is unavoidable. I tend to think that system should therefore take responsibility and provide work in order to correct the flaw. I’m not suggesting simply handing out money. There’s plenty of work those people can be put to in support of the private sector, which is exactly what government is for. Put the wage paid at slightly below the minimum wage and people will look for work in the private sector. Until that work exists, however, I see no reason they can’t build the infrastructure which allows the private sector to accrue wealth.

Unemployment at any level is by definition an economic and social drag.

Dave Schuler October 27, 2011 at 4:35 pm

My personal preference is to outright ban by law any form of speculation not related to providing security to real economic activity, rather than to raise taxes on the wealthy.

I’m not sure how you’re using the term “speculation” here. Are you using it colloquially or consistent with its technical usage in finance?

In either case how would you go about determining whether the speculation you would ban is “related to providing security to real economic activity”? It seems to me that would effectively be a ban on lending money at interest.

Dave Schuler October 27, 2011 at 4:39 pm

Put the wage paid at slightly below the minimum wage and people will look for work in the private sector. Until that work exists, however, I see no reason they can’t build the infrastructure which allows the private sector to accrue wealth.

I find these two sentences very confusing. Could you expand a little on what you’re saying here? It seems to me that cutting the minimum wage would itself create a certain number of new jobs.

Andy October 27, 2011 at 4:41 pm

Ben,

You need to check your figures. The top 1% don’t compare to institutional investors – US pension funds alone account for around $14 trillion.

Also, I’m not sure how derivatives can be a $600 trillion market when global GDP is a tenth that.

Until that work exists, however, I see no reason they can’t build the infrastructure which allows the private sector to accrue wealth.

Ah, so it is a make-work program. Not very practical for a variety of reasons, not to mention the administrative costs.

Steve Verdon October 27, 2011 at 4:41 pm

My beef with the income inequality is that when coupled with our type of government it creates corruption. Not blatant corruption, but more subtle corruption where government policy is crafted with the desires of the 1% more in mind than that of the remaining 99%. It is why, if we are to have government, I favor a government with explicit rules vs. discretion. Make it so that the 1% have a considerably harder time steering policy in their favor.

Of course, given how much incest there is between Wall Street and Washington and how cozy the relationships are between policy makers and the 1% the chances of getting “good” rules now are pretty slim.

I really see no way forward with our current system.

Dave Schuler October 27, 2011 at 4:43 pm

The real problem with the incomes of the 1% is that they tend to generate financial instability.

Could you please substantiate and/or document that? Please concentrate on the 15% of those in the top 1% of income earners who are physicians. How do they tend to generate financial instability?

Steve Verdon October 27, 2011 at 4:55 pm

Put the wage paid at slightly below the minimum wage and people will look for work in the private sector.

That wont go far. Soon you’ll have people talking about how a family of four (or whatever size) can’t live off of that. That is should be a wage that allows people to live in dignity, etc. And when you are robbing Peter to pay Paul you can always count on Paul’s support–i.e. these kinds of things have an annoying tendency to get passed.

I really don’t think “good” policy is generally attainable. Simplifying our tax code makes quite a bit of sense, IMO. A complex tax code is a drag on the economy. Having uniform unleaded gasoline blends vs. the patch work of boutique blends also makes quite a bit of sense. Why aren’t we doing these things? The last one in particular is a no-brainer. With a uniform standard for gasoline blends if any region suffered a natural disaster gasoline from other regions could move there and keep prices from spiking. Even for things like large refineries having unsuspected shut downs can have adverse price spikes. We should do it, but we haven’t and we wont.

Steve Verdon October 27, 2011 at 5:03 pm

Andy,

Yeah the derivatives market has a very, very large notional value. Probably between $650 trillion and $700 trillion.

Think of it this way, the notional value is like saying that saying that every lottery ticket is worth the full jackpot value. Multiply every lottery ticket by the full jackpot value and you’ll get a number that is orders of magnitude larger than the actual value of the jackpots.

So, could the derivatives market blow up and $675 trillion dollars disappear? No.

Steve Verdon October 27, 2011 at 5:06 pm

Until that work exists, however, I see no reason they can’t build the infrastructure which allows the private sector to accrue wealth.

We tried that already, and guess what it didn’t work.

Andy October 27, 2011 at 5:14 pm

Steve V,

Thanks for the derivitives explanation.

Why aren’t we doing these things?

The short answer is federalism.

Dave Schuler October 27, 2011 at 5:15 pm

BTW, according to this study, apparently the most recent reference, people in finance account for about 14% of the 1%, people who aren’t non-financial managers account for 69% of those in the top 1%, and those who are neither non-financial managers nor in finance account for 55%, a solid majority, of those in the top 1%.

Also, according to the IRS between 2007 and 2009 incomes for the top 1% fell roughly 15%. Others say 20%.

steve October 27, 2011 at 7:59 pm

“Also, according to the IRS between 2007 and 2009 incomes for the top 1% fell roughly 15%”

Peak to trough. Wanna bet on whether it is back up? If you want to breed financial instability, it takes money in the millions. You need to be in the top 0.1%.

Steve

Icepick October 27, 2011 at 8:22 pm

If the economy tanks it automatically stabilizes employment, and when the economy recovers the program winds itself down.

And what if it doesn’t recover?

Ben Wolf October 27, 2011 at 8:38 pm

@Dave

Speculation as I use it refers to taking a long or short position in some particular asset class, i.e. hedging risk. When it provides security for, say, a trading concern which might be negatively affected by fluctuations in FX rates this can be beneficial. According to the BIS, however:

“FX turnover is several times larger than the total output of the economy … The FX turnover/GDP ratio is smallest for the largest economies, the United States and Japan. In these two countries, FX turnover is more than 14 times GDP. In most cases … FX market turnover is many times larger than equity trading volumes. Again, the ratio of FX turnover to equity turnover is smallest for the United States and Japan, but still sizeable …

Gross trade flows are defined as the sum of imports and exports of goods and services. FX turnover is much higher than underlying trade flows …

Overall, looking at developments since 1992, it is clear that FX turnover has increased more than underlying economic activity, whether measured by GDP, equity turnover or gross trade flows.”
http://www.bis.org/publ/qtrpdf/r_qt1012e.pdf

In other words most speculative activity is simply a form of betting rather than a manner of facilitating trade. It is economically worthless.

@Steve Verdon

The point regarding the derivatives market is that the money isn’t there NOW. That capital represents claims against global production that simply cannot service that much debt.

P.S. “We tried that and it didn’t work” isn’t the greatest argument in the world, considering GDP decline stopped and some small growth occurred with stimulus. Ditto for every country which attempted stimulus. The government’s deficits are the private sector’s savings.

Ben Wolf October 27, 2011 at 8:45 pm

@Dave Schuler

The point of pegging the Jobs Guarantee wage to the minimum wage was simply to demonstrate that Steve need not worry about the program being so attractive people wouldn’t transition to the private sector. As for eliminating the minimum wage to create work: the problem we have is not one of wages, but of insufficient demand.

Andy October 27, 2011 at 11:08 pm

Ben,

I don’t see how that is superior to unemployment compensation which, here in Ohio, can be as much as the equivalent of $13/hour assuming a 40 hour work week. The minimum wage is 1/2 that.

So, what are these people going to be doing? Are you going to have 50 year old overweight advertising managers “building infrastructure?” If you expect them to work, how are they going to find time to actually look for a job? What about administration costs? Presumably you’ll need an army of federal employees to manage and supervise the 14 million unemployed if you actually want them to do productive work. Assuming a worker-supervisor ration of 30-1, you’d need 460,000 supervisors plus whatever administrators would be required. How are you going to handle insurance, healthcare, etc.?

What about all the private firms who do work in the same areas as this program? How are you going to keep from driving them out of business or forcing them to layoff employees because this government program is taking away their work?

It seems to me this is the kind of thing that sounds good in theory, but fails once the details of implementation are considered. It’s not the 1930′s anymore.

Zachriel October 28, 2011 at 6:35 am

PD Shaw: On taxes, the CBO found that the top 1% paid just under 30% of their income in taxes.

Might want to point out that the calculation is based on all federal taxes, income, payroll, excise, corporate; and uses adjusted income, that is, comprehensive income divided by sqrt(size of household).

Andy: I can certainly confirm that kids are very expensive, but that is partially offset by tax breaks – our effective federal income tax rate is usually around 3-4%.

This might answer your question. Your payroll taxes are going to be 15.3%, and you pay excise tax every time you refuel your car.

Ben Wolf: As government must tax, however, the best and most permanent solution is to pass the Jobs Guarantee making government the Employer of Last Resort.

This would act as an automatic stabilizer, however, it would tend to prevent the adjustment of the labor force for new skills and by region. You could end up with a large proportion of the workforce in low skilled, unproductive jobs. In the Great Depression, it was still possible to be productive with a shovel. That is no longer true.

Markets are much better at making these sorts of adjustments. It might be better to offer more support for job training and relocation.

Dave Schuler October 28, 2011 at 8:04 am

Speculation as I use it refers to taking a long or short position in some particular asset class, i.e. hedging risk.

Colloquially, then. I think you’re overgeneralizing. “Speculation” as you’re defining it is currently being used successfully by farmers to mitigate the risks of price swings and by airlines to mitigate the risks of fuel price changes (although sometimes you get the bear and sometimes the bear gets you).

I gather that you’re opposed to insurance, another mechanism for mitigating risk. How about 30 year fixed rate mortgages?

Please note that bans on “speculation” will have only a marginal impact on income inequality. A majority of those in the top 1% aren’t there because of “speculation”.

IMO there’s a better argument against HST and I’ve entertained the idea of Tobin taxes here in the past.

Zachriel October 28, 2011 at 9:13 am

Ben Wolf: Speculation as I use it refers to taking a long or short position in some particular asset class, i.e. hedging risk.

Huh? That’s seems quite contrary to normal usage. A hedge is avoiding risk, speculation is indulging risk.

Andy October 28, 2011 at 10:25 am

This might answer your question. Your payroll taxes are going to be 15.3%, and you pay excise tax every time you refuel your car.

Yes, I understand that, which is why I said “effective federal income tax rate.” I was purposely specific.

Steve Verdon October 28, 2011 at 10:57 am

Ben,

P.S. “We tried that and it didn’t work” isn’t the greatest argument in the world, considering GDP decline stopped and some small growth occurred with stimulus. Ditto for every country which attempted stimulus. The government’s deficits are the private sector’s savings.

And unemployment has remained stubbornly high, and many of the potholes in my area are still there….

Oh and yeah, your definition of speculation needs lots of work, it counts as risk taking activities that are specifically designed to mitigate risk.

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