Thursday, December 14, 2006

Inequality Wars

In today's Wall Street Journal, Alan Reynolds (free link) says the growth in inequality is overstated:

As was well-documented years ago by economists Roger Gordon and Joel Slemrod, a great deal of the apparent increase in reported high incomes has been due to "tax shifting." That is, lower individual tax rates induced thousands of businesses to shift from filing under the corporate tax system to filing under the individual tax system, often as limited liability companies or Subchapter S corporations.

IRS economist Kelly Luttrell explained that, "The long-term growth of S-corporation returns was encouraged by four legislative acts: the Tax Reform Act of 1986, the Revenue Reconciliation Act of 1990, the Revenue Reconciliation Act of 1993, and the Small Business Protection Act of 1996. Filings of S-corporation returns have increased at an annual rate of nearly 9.0% since the enactment of the Tax Reform Act of 1986."

Switching income from corporate tax returns to individual returns did not make the rich any richer. Yet it caused a growing share of business owners' income to be newly recorded as "individual income" in the Piketty-Saez and Congressional Budget Office studies that rely on a sample of individual income tax returns. Aside from business income, the top 1%'s share of personal income from 2002 to 2004 was just 7.2% -- the same as it was in 1988.

In short, income shifting has exaggerated the growth of top incomes.

Along the same lines, these data from Diana Furchtgott-Roth (Table D) show little change in consumption inequality from 1985 to 2005, a result that reminds me of earlier claims of Dirk Krueger and Fabrizio Perri. By contrast, Jared Bernstein and Jason Furman and Paul Krugman paint a very different picture.

Even as an economic data geek (but not one who specializes in studying inequality), I have a hard time sorting out the competing claims in this literature.

Update: Another piece of this puzzle is a paper by Kopczuk and Saez on wealth inequality. They find (see figures 2 and 5) that wealth concentration has not changed much over the past half century (although their data end in 2000), and it is nowhere near the levels experienced in the 1920s.