This essay was adapted from a longer one titled, “Is Inequality Growing Out of Control?”
Has income concentration soared in the United States in recent decades? To ask the question is to sound like some sort of inequality truther in today’s post-Occupy world. Many believe the evidence leaves no doubt that income concentration has increased dramatically. Thomas Piketty devotes most of Part Three of his celebrated Capital in the Twenty-First Century to an examination of the inequality trendlines he and others have produced over the past fifteen years.
But research on American income concentration, building on Piketty’s paradigm-changing research with Saez, raises substantial doubts about the degree to which income has become more concentrated.
According to the Piketty and Saez estimates shown in the familiar chart below, income concentration fell sharply with the Great Crash in 1929 and continued to fall through the 1960s. At the end of the 1970s, income concentration started rising, taking off after 1981.
The figure below shows several different trendlines for the share of aggregate income in the United States accruing to the richest one percent of Americans. The top line is taken from the latest estimates published by Saez on his University of California-Berkeley website. It shows the top one percent’s income share rising from 10 percent in 1979 to 24 percent in 2007. Income concentration dropped sharply between 2007 and 2009, but it was approaching the 2007 peak by 2012, the last year for which estimates are available.
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All of the estimates cited so far include capital gains—the increase (or decline) in the value of a tradable asset one owns—but only some of them, and allocated in a problematic way. Specifically, both the Piketty-Saez estimates and those from the Congressional Budget Office count capital gains only if they are reported on tax returns. Capital gains are generally reported only in the year in which the asset is sold, and only if they are taxable. This creates two problems.
First, most gains received by the poor and middle class are not taxable, including typical gains realized from the sale of a home and gains that accrue in retirement accounts such as 401(k)s and IRAs. Second, when capital gains are realized—disproportionately accruing to the top—all of the gains that have accrued over the entire time an asset was owned are counted as income received in a single year. Economists agree that the right way to count income from an asset that appreciates in value is to ignore whether or not the asset is sold; either way, there is a flow of resources that is either consumed or saved. Put another way, Piketty’s fear about wealth accumulation and about the return on wealth (r) exceeding economic growth (g) implicitly recognizes that capital gains enrich people even if they are not realized. The gains to the non-working rich are simply reinvested to take advantage of the high r. They are enriched year-by-year, not all at once upon deciding to sell an asset.
This issue of accumulated capital gains being counted in the year they are realized interacts with strategic timing on the part of the wealthy of when gains are realized. Together, they produce the notable peaks in the Piketty-Saez series during the tech-stock boom of the late 1990s and the housing boom of the aughts, along with the drops associated with the bursting of those bubbles. It does not require any gift of imagination to envision the impact on the Piketty-Saez series if extraordinarily wealthy people with assets they have held for ten or twenty years all choose to sell their assets at or near a market peak, thereby realizing large capital gains that were actually accrued over many years. The impact would be particularly large if, oh I don’t know, the number of older Americans—more likely to have long-held assets—was growing.
This line of criticism was advanced by Cato Institute scholar Alan Reynolds as early as 2005, but it would be several years before research was conducted to assess the potential impact of the problem. Last year, Richard Burkhauser, Phillip Armour, and Jeff Larrimore built on an earlier one from 2011 by Timothy Smeeding and Jeffrey Thompson to estimate changes in inequality while fully accounting for capital gains. They assigned households in two different surveys to each other to take advantage of the strengths of both datasets. They imputed capital gains to assets using the returns typical of the previous year. Their results are not the final word, but there is a good chance that they will necessitate a fundamental rethinking of income concentration trends, at least in the United States.
In the chart below, I focus on the top five percent’s post-tax and -transfer income share, since the Burkhauser data did not allow them to reliably look at the top one percent. The line running from 1980 to 2010 is from the Congressional Budget Office data used in my first chart and includes taxable realized capital gains as income. It tracks the top one percent trend from the earlier chart very closely. More surprisingly, the Burkhauser estimates for post-tax and –transfer income including taxable realized capital gains track the CBO ones very closely as well, as shown by the green line. (His study could only examine every three years between 1989 and 2007.) Since the Burkhauser estimates follow the CBO trend so well, we can be confident that his other trends are not simply the result of using inferior household survey data or of the statistical merging of the two datasets he uses.
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The third line in the chart shows the trend Burkhauser and his colleagues estimated when they imputed annual capital gains to all households based on their asset portfolios, whether or not they sold their assets. The trend is much more volatile, but it is clearly downward. One can pick any of the first three years in the series (1989, 1992, and 1995) and any of the last three years (2001, 2004, and 2007) and seven of the nine possible comparisons indicate income concentration declined. The Burkhauser estimates are likely to understate the share of income going to the top, but they are likely to understate it by a similar amount each year, so the trend need not be affected.
In the end, it would not surprise me at all if the paper’s conclusion that income concentration fell turns out to be too strong. There is a lot of evidence that income concentration has risen, including income concentration when capital gains are entirely excluded and earnings concentration, as I will show below. Income concentration has risen in numerous countries (though those results are based on tax return data too, so…). Complicated forms of income like exercised stock options are unlikely to be well-reported in the CPS. I agree with Dean Baker of the Center for Economic and Policy Research that an important implication of the Burkhauser paper is that ideally we should probably average multiple years of income together in order to look at inequality trends that incorporate unrealized capital gains. Otherwise year-to-year incomes look much more volatile and could obscure the underlying inequality trend. Unfortunately, that may not be possible with existing datasets.
But the Burkhauser paper needs to be reckoned with. Ultimately, at a minimum, his results are likely to lead us to conclude that, at least in the U.S. since 1989, the Piketty-Saez and CBO income concentration estimates have overstated the increase in inequality substantially. Interestingly, a wide array of research has found that inequality between the middle class and poor has not risen meaningfully since the 1980s. And Piketty and Saez’s own data indicate that the share of earnings received by the top one percent rose from just 9 percent to 12 percent between 1989 and 2007. Earnings are less affected by capital gains, though because some income from stock options is taxed as earnings, and because those types of stock options have grown more common, even this increase may be exaggerated.
Incomes below the top ten percent have grown more in the U.S. than Thomas Piketty thinks, and it may very well be that incomes at the top are growing less than he believes. At the very least, the U.S. is probably less distinctive in its income concentration than Capital in the Twenty-First Century suggests. For that matter, because many of the flaws noted here of tax return data generalize to other countries, readers should approach his conclusions and policy recommendations with healthy skepticism. This is an issue where we need more and better evidence before declaring economic inequality the fundamental policy challenge of our time, let alone a threat to our prosperity.
Scott Winship is the Walter B. Wriston Fellow at the Manhattan Institute for Policy Research. You can follow him on Twitter here.
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