May 27, 2013 2:42PM

Imaginary Squabbles Part 4: Krugman and DeLong on the Top 1 Percent

In End This Depression Now! (pages 77-78) Paul Krugman offers the strangest arguments I have seen.   The story opens with familiar fulminations about the “top 1 percent” (those earning more than $366,623 in 2011).  As he put it in a 2011 column, “income inequality in America really is about oligarchs versus everyone else.”

“Incomes of the rich,” his book claims, “are at the heart of what has been happening to America’s economy and society.”  Yet it apparently requires great bravery to even dare to mention “the rising incomes” of the top 1 percent or top 0.1 percent:

Merely to raise the issue was to enter a political war zone: income distribution at the top is one of those areas where anyone who raises his head above the parapet will encounter fierce attacks from what amount to hired guns protecting the interests of the wealthy.  For example, a few years ago Thomas Piketty and Emmanuel Saez . . . found themselves under fire from Alan Reynolds of the Cato Institute, who has spent decades arguing that inequality hasn’t really increased; every time one of his arguments is thoroughly debunked, he pops up with another.

To be called a “hired gun” of the wealthy might be insulting if it was not so ridiculous.  First of all, no employer has ever tried to influence what I write.  Second, I have been a very successful investor and live quite comfortably from realized capital gains plus mandatory distributions from IRA, Keogh and 403(b) accounts that President Obama would regard as much too large.  I negotiated a token salary from Cato (smaller than my Social Security check) but return at least 40 percent of it as a charitable donation.  I am usually in the top 1 percent, at least when stocks are up, and thus not easily bribed.  I would be flabbergasted if Krugman is not also a member of that demonized bunch of oligarchs.

Krugman complains that some of my arguments changed (new ones popped up) over decades, but arguments should change after decades of new data.  I must have made a couple of mistakes since 1992, but mistakes (including Krugman’s) are not evidence of deliberate deception or corruption.

An illustration of the way my work has supposedly been “thoroughly debunked,” was provided by Brad DeLong.  He found it scientifically definitive to rerun Tim Noah’s complaint that, "Reynolds's technique is to bury you under a mountain of hard-to-follow, often irrelevant, and sometimes entirely erroneous statistical quibbles to the point where you cry 'Uncle!'" How this journalist who was admittedly unable to follow my simple charts and graphs was nevertheless able to identify all of them as irrelevant or erroneous quibbles remains a puzzle.

Back to Krugman's book.  Two graphs compare a mean average of real incomes of the top 1 percent of tax units with median income for households from 1947 to 2007.  Did I ever suggest that inequality of pretax, pre-transfer income has not increased since 1947?  Of course not. I wrote that broad measures of the inequality of disposable income, consumption and wealth have not increased since 1988.  

Krugman cites an instantly obsolete 2011 Congressional Budget Office (CBO) report about top 1 percent income shares from 1979 to 2007.  Aside from cyclical ups and down, most swings in top 1 percent shares were due to taxpayer response to (1) deep cuts in individual income tax rates in 1983-88 causing a surge in business income reported by pass-through entities, and to (2) increases in realization of capital gains after the capital gains tax rate was cut in 1997 and 2003.

The disgraceful thing about the October 15, 2011 CBO report was stopping the data with the cyclical peak of 2007 even though the CBO knew perfectly well that many “top 1 percent” businesses and investors were devastated by crashing real estate and stocks.  CBO estimates that the top 1 percent’s share of after tax income fell to 11.5 percent in 2009 – down from 17.4 percent in 2000 and unchanged from the 11.4 percent average of 1986-89.

Incomes of the top 1 percent did not bounce back after 2009, according to Piketty and Saez, merely rising from 18.1 percent of “market income” in 2009 (which arbitrarily excludes rising transfer payments from total incomes) to 19.8 percent in 2011.  Piketty and Saez estimate that average real income of the top 1 percent was $1,322,635 in 2000 (measured in 2011 dollars) but real income dropped 20.7 percent by 2011 to $1,048, 234.   Does a 20.7 percent drop over eleven years justify Krugman’s anguish about “rising income” among the top 1 percent?

In the summer of 2006 I presented a paper at the Western Economic Association International about statistical difficulties with using income reported (rather than unreported) on individual (rather than corporate) tax returns to gauge inequality of living standards.  A condensed 24-page version appeared as a Cato Institute paper, and received some academic attention.  I also wrote a 248-page book, Income and Wealth, with a chapter devoted to this issue, including a reprise of 1992 disagreements with Krugman. 

Piketty and Saez responded only to the first of two short Wall Street Journal articles on the topic, never to  my 2007 or 2012 Cato papers or my book.  Among other things, they asserted that “the emerging consensus is that there can be substantial responses [to tax changes] in the short-run due to retiming of income... but that the long-term response is small.”  On the contrary, all studies by Saez and others, including studies from other countries, find a very large and sustained response (elasticity) of reported income among the top 1 percent to changes in marginal tax rates on income, dividends and capital gains.  

My100-page 2012 working paper offers detailed factual answers to the Piketty and Saez comments on my 2006 op ed, plus a critical examination of CBO and other measures of distribution.  Here are some truncated highlights:

“It has become commonplace to use top 1 percent shares of market income as a shorthand measure of inequality, and as an argument for greater taxes on higher incomes and/or larger transfer payments to the bottom 90 percent. This paper finds the data inappropriate for such purposes for several reasons:

  • Excluding rapidly increased transfer payments and employer-financed benefits from total income results in exaggerating the rise in the top 1 percent’s share between 1979 and 2010 by 23 percent because a growing share of other income is missing.
  • Using estimates of the top 1 percent’s share of pretax, pretransfer income (Piketty and Saez 2003) as an argument for higher tax rates on top incomes or larger transfer payments to others is illogical and contradictory because the data exclude taxes and transfers.
  •  Using highly cyclical top 1 percent shares as a measure of overall inequality leads, paradoxically, to describing most recessions as a welcome reduction in inequality, because poverty and unemployment rates typically rise when the top 1 percent’s share falls, and fall when the top 1 percent’s share rises.
  • Top 1 percent incomes are shown to be extremely sensitive (“elastic”) to changes in the highest tax rates on ordinary income, capital gains and dividends. Although estimates of the elasticity of ordinary income for the top 1 percent range from 0.62 (Saez 2004) to 1.99 (Moffitt and Wilhelm), those estimates fail to account for demonstrably dramatic responses to changes in the highest tax rate on capital gains and dividends.
  • I estimate that more than half of the increase in the top 1 percent’s share of pretax, pretransfer income since 1983, and all of the increase since 2000, is attributable to behavioral reactions to lower marginal tax rates on salaries unincorporated businesses, dividends and capital gains.”

Krugman and DeLong are not obligated to acknowledge my recent research in any way, but they ought to at least avoid the pretense that anyone has “thoroughly debunked” any of it, much less all of it.