Great article about "the top 1%"
It is an article of political faith on the left today that "the rich are getting richer and the middle class is getting left behind." But before we accept this claim as a matter of faith, we should ask a few questions.
Whenever anyone talks about how the top X% of the population earns Y% of the income, we should ask: top X% of *whom*? Households, individuals, or tax returns? Income as measured *how*? Those who would gloss over these issues commit the crime of lying with statistics, as the following article by Alan Reynolds explains.
One of the main sources we have for this data is tax returns. Unfortunately, "economic income" and "taxable income" are only loosely correlated with each other. For example, right now, you can earn about 5.1% on your money in Vanguard's taxable money market fund, or 3.4% in their California municipal money market fund. So, anyone in the upper tax brackets, like the 33%+9.3% or 35%+9.3% tax brackets, is much better off putting their money in the tax-free muni fund. This would cause their taxable income to decrease even as their economic income has increased.
Or, to take another example mentioned in the article: both my Roth IRA and my 401(k) investments have gained about 20% in value year-to-date (after subtracting out the increase in account value due to my annual contributions). This is certainly real economic income, but that gain isn't showing up on my 2006 tax return. The 401(k) gain will probably show up as income in my tax return circa 2040 or even later, while the Roth IRA gain will *never* show up in *any* tax return, *ever*, unless the tax laws on Roth IRAs are changed.
Of course, this is small beans next to the big one: corporations and the treatment of business income. High income earners frequently get a large fraction of their income from their business. Depending on how I structure my business (sole proprietorship, S-corporation, or C-corporation), the tax consequences are radically different. In the first two cases, the business income shows up as personal income on personal income tax returns. In the latter case, it shows up first on a corporate tax return, and then later may show up (possibly at a much later date) as capital gains or dividends on a personal income tax return. To the extent that rich people reincorporate their businesses as S-corporations, it is natural to expect that their taxable income will increase. That is, you have simply shifted income around between "personal" and "corporate" income, even though the impact of this shift on economic income is comparatively small.
Since Piketty and Saez excluded capital gains income from their main time series (!), it is not at all surprising to see that rich people's "personal" income increased dramatically after the 1986 tax reform law, which made S-corporations far more attractive than they were previously tax-wise.
The reality is that people change their behavior as tax laws change, moving money around to try to avoid taxes. If you do not take this into account when looking at the numbers, you will probably draw extremely faulty conclusions. Anyone who shows you a comparison of income shares pre-1986 and post-1986, for example, had better take those behavioral shifts into account, or they, too, will be "lying with statistics." Even worse are comparisons of pre-1981 and post-1986. It is too easy to forget that before Ronald Reagan the top personal income tax rate was 70%, and when he left office, it was 28%! To think that people didn't change their behavior between those two eras, when they went from keeping 30 cents on every dollar to 72 cents on every dollar they earned, is simply implausible.
Reynolds puts it best:
The incessantly repeated claim that income inequality has widened dramatically over the past 20 years is founded entirely on these seriously flawed and greatly misunderstood estimates of the top 1%'s alleged share of something-or-other.