Grumpy Economists Make Me Grumpy

8/16/2012 11:06:00 AM
John Cochrane is elated to find a study (here) rebutting "liberal claims" about inequality in America. At the risk of doing this, some of their points need to be addressed.

First off, they try to claim that income inequality isn't so bad if you count government transfer payments as income (they also mention other types of income such as benefits--which are definitely already included in existing studies--black-market income, and family support, but these are largely irrelevant to the issue). Fair enough. That says that federal welfare programs have been fairly successful at reducing inequality in the US--lets keep those programs then! But a bigger question is how can we reduce the inequality in pre-tax income, so that there is less need to rely on welfare programs?

Next, they do the classic laundry list of how great it is to be poor in the US--look, they have 514 square feet to live in! Microwaves! Refrigerators! Cars! There are several issues here. First is that what the poor have is not at all relevant to the issue of inequality--simply because they meet some minimum standard of living does not grant us a pass in excluding them from the growing wealth of the country overall. Additionally, a lot of that has to do with how "poor" is defined--the same study claims that we overestimate the number of people who should be called "poor;" when you make the correction, you see much larger disparities in wealth. Finally, a lot of those items, like cars and refrigerators, are available to the poor primarily through generosity--both from private charities and government support. That says that such initiatives have been reasonably successful, and that we ought to continue to support and expand them. But it does not fundamentally resolve the important issue about inequality of pre-tax income.

Then there is this gem:
"...median disposable personal income in the U.S., adjusted to reflect purchasing power parity, was 19.3 percent higher than in Canada; 68 percent higher than in Finland; 45 percent higher than in Germany; 59 percent higher than in Italy; 31 percent higher than in Norway; 73 percent higher than in Sweden; and 31 percent higher than in the United Kingdom."
Did you catch that? They are comparing disposable income, which is income after taxes. What they neglect to mention is that people in all these countries get far more in government benefits than we do--and those benefits are distributed evenly regardless of pre-tax incomes. That 19.3% difference between the US and Canada gives Canadians free healthcare and far lower college tuition prices than the US, for example. All of these countries have healthcare systems that are almost entirely free, and vastly cheaper, if not free, college education, among many other things. So it makes no sense to say that they are worse off because they are taxed more. Referring to disposable income as a measure of well being is deliberately deceptive and misleading. Its also worth noting that Cochrane's sly remark that "averages matter" is wrong. The fact is that inequality is much lower in Europe than here, and that is not a point that that study disagrees with. Hence when Europe "doesn't look so bad" when you visit, realize that for the vast majority of Europeans, it isn't so bad.

Now here is a really blatant lie:
"The U.S. income tax system is, by any measure, quite progressive."
The fact is that taxes in the US are not progressive at all. My source is the congressional research service, which found that the progressivity in the US federal income tax is offset by regressive federal payroll income taxes and other state, local, and federal taxes so that overall US taxes are roughly a flat rate regardless of income. Moreover, the federal income tax is not nearly as progressive as it seems when you look across individuals' life-long income--for the most part, the fact that incomes slide between tax brackets and different types of tax benefits over their lifetimes means that federal income taxes are only slightly progressive, taxing people with higher life-long incomes at only slightly higher average rates than those with lower life-long incomes.

And it doesn't matter one bit what share of tax revenues come from the rich versus the poor. The fact that more of the tax revenue comes from the rich reflects entirely the fact that they have all the money--this is actually some of the best evidence we have of why income inequality is such a dire problem!

Finally, addressing the issue of whether redistribution of income will make the poor better off, the study concludes that they "are unaware of persuasive evidence" of that. Well, they actually documented a lot of that evidence in that very same article--see the second paragraph, above. Clearly they didn't look very hard for the evidence. I'm actually always a little surprised what a big difference income redistribution seems to make in increasing not only the quality of life of the poorest, but also of the average American overall. For a real-world look rather than tedious data, I found this post by Krugman really revealing: overall, the america of 1955 was far more prosperous than the 1920s, yet the top marginal tax rate was 90%, and inequality was pretty low--the ultra-rich we know today simply did not exist in 1955. Of course, there were racial and gender inequalities that mar that record, but the point about taxes is still applicable.