Yet again and again [economists and other researchers not named Hacker or Pierson] have found themselves at dead ends or have missed crucial evidence.  After countless arrests and interrogations, the demise of broad-based prosperity remains a frustratingly open case, unresolved even as the list of victims grows longer.

All this, we are convinced, is because a crucial suspect has largely escaped careful scrutiny: American politics.
 
– Jacob Hacker and Paul Pierson, Winner Take All Politics


Here's a chart showing trends in the share of income received by the top one percent for all the modern industrialized nations for which data is available going back to the early twentieth century:

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The data is from a new website created by several of the leading scholars studying inequality with tax data.  The American trend, the thick black line, is from the much cited work of Thomas Piketty and Emmanuel Saez, which is part of this new database.

From 1910 to 1970, American inequality trends follow the broad international pattern, and inequality levels are in the middle of the pack.  That's basically still true from 1970 to 1986:
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It's rising a bit over the period, but only by a percentage point.  Note I'm keeping the scale of the charts the same for each one.  Here's the chart for 1988 to 2006:
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Uh-oh.  Now we look like our inequality levels are higher than everywhere else.  What happened?  1986 to 1988 happened, as is evident from the 1970-2006 trend:
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Wow, that's a four percentage point increase in two years—three times the increase over the 16 years from 1970 to 1986, and bigger than the 12-year increase from 1988 to 2000.  Huh. There are two possibilities here.  One is that the data is right.  You can see where I'm going here.

It helps to know that the 1986 tax reform created big incentives for people who had previously reported income on corporate returns (where it is invisible to the datasets above) to report on individual income tax returns (where it appears as an out-of-the-blue increase).  And if this may be considered a permanent change in the tax regime, then the effect is for more income to show up on individual returns after 1986 than before, artificially lifting the top income share in every subsequent year.

Hmmm...which possibility is more likely?  Let's look at another chart showing the trends just for the northern hemisphere Anglophone countries, to which I'll add a new line:
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OK, from about 1940 to 1986, these trends line up strikingly, then the U.S. trend goes AWOL.  However, let's instead assume the post-1986 U.S. trend is an artifact of the 1986 tax reform.  First, let's increase the top one percent share from 1986 to 1988 by the same rate that it increased in the U.K.  Then let's let the top share in the U.S. increase by the same rate that it actually did from 1988 to 2006, but from the new, lower 1988 level.  The result is the revised line above.  This makes the U.S. trend and level consistent with not just the U.K., but Canada. 

Of course, if the 1988 to 2006 top share levels are more accurate in the U.S. after 1988 than before 1986, then rather than lowering the post-1986 trend, we should raise the pre-1988 trend.  That would make U.S. levels uniformly higher than in the U.K. and Canada.  But of course, the measured U.K. and Canadian top share levels may also be artificially low due to tax avoidance.  And of course, the common trend over the three countries would remain.

So, to review, when the post-1986 U.S. trend is corrected, the U.S. experience with inequality over the past 100 years is broadly consistent with the rest of the modern world.  Here's the summary chart for 1910-2006, with the revised U.S. trend.
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Comparing levels is more difficult, but many recent cross-national comparisons related to inequality are about why trends differ.  What these five charts clarify is that explanations for the recent rise in American inequality that focus on uniquely American causes—such as greater political muscle-flexing among corporations and the mega-rich—are insufficient (and unnecessary).

Update: I've received several responses offline that it's going to far to say the experience of the U.S. is like that "everywhere else" and that it is really only like the other Anglophone countries.  To some extent, that's a fair criticism.  But of 15 countries shown here, only Germany, the Netherlands, and Switzerland haven't experienced an increase in inequality since 1980.  And the increases in Norway and Finland are as big or bigger than in the U.S., U.K., and Canada.  Sweden's increase is also nearly as great in relative terms (starting from a much lower level of course).  But even if this is a story about the U.S., U.K., and Canada or the Anglophone countries versus the rest of the world, that's still a problem for Hacker's and Pierson's U.S.-centric theory.
 


Comments

03/10/2011 11:05pm

This is a good post, worth thinking about.

But there are two ways of interpreting what happened between 1986 and 1988, even if we stipulate that the sharp effect is a function of tax law changes.

One is the interpretation that you choose: Rich people already had that income prior to 1986, but they kept the wealth sheltered behind a corporate veil. So there was really no substantive change, just a change in reporting.

A second interpretation is that, prior to 1986, income was kept within corporations, where the benefits of that wealth were split among a wide variety of stakeholders. The disposition of corporate wealth, after all, is always contested. Economists may wish to label wealth that shareholders would like to appropriate but that ends up dispersed among other stakeholders "agency costs". But that labeling has no bearing questions of income distribution. Even in the "worst case" (from a perspective of concentrated distribution) wherein shareholder-managers paid themselves directly in fringe benefits, that implies simultaneous receipt and expenditure of income, and reduces the efficiency of use by shareholder managers relative to direct cash expenditure, both of which effects reduce the real income of shareholder-managers relative to other parties in real terms. But that "worst case" is exceedingly unlikely. Most shareholders are not managers who can pay themselves fringe benefits, and within a business firm (even now and moreso 25 years ago), compensation and benefits are bureaucratically managed with some attention paid to "fairness and morale" concerns. It is unlikely that the member of the executive suite with the most stock appropriates fringe benefits proportionate to her ownership. Instead, use of the corporate jet and gold-plated health plans get distributed to all C-level executives. And even that is "too efficient" a characterization. Distributable cash is retained in a firm for tax reasons ultimately affects the bargaining power of employees generally. Profitable, cash-rich corporations have a harder time refusing to share profits with their workers than "lean, disciplined" corporations whose cash is quickly returned to shareholders (and arguably must be returned to shareholders to maintain competitive stock valuations and avoid a change of control).

This is a commonplace argument in corporate finance: prompt distribution disciplines firms and reduces agency costs, retention of cash when there are not clear, high NPV projects ready to absorb it invites loss of value to shareholders. But loss of value to shareholders may not be loss of enterprise value, just redistribution of value among claimants. And that redistribution of corporate value, while "inefficient" for shareholders, may have significantly mitigated income inequality.

So rather than characterizing tax related changes in income dispersion in 1986 - 1988 as a data glitch, we could characterize those tax changes has having increased the efficiency with which capital owners at the top of the income distribution were able to appropriate corporate wealth.

Both stories can be simultaneously true: Some of the unreported pre-1986 corporate wealth would have been appropriated as fringe benefits etc. by the same shareholders who ultimately reported new income, and some would have been dispersed to other stakeholders. I suspect that the "inefficiency" of distribution to shareholders pre-1986 was quite high. You might take the opposite side of that argument. It won't an easy question to resolve empirically.

Internationally I think it's pretty clear that corporate wealth is less efficiently distributed to shareholders in preference to other stakeholders than in the United States. Changes in the relative efficiency with which shareholders appropriate corporate wealth are certainly relevant to cross-natural comparisons of income inequality trends.

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Scott
03/11/2011 8:51am

Thanks for the comment Steve, and I realized that I owe you a reply to an earlier comment you left. I think you're right about corporate taxation further complicating things (early in the 20th century there was a shift away from paying out dividends that may have over-stated the *decline* in inequality in the 1930s and 1940s). But if you look at the specifics around the 1986 law, the big change was a shift from closely-held corporations reporting as Subchapter C corporations and filing corporate returns to reporting as Subchapter S corporations and filing individual returns. This is somewhat complicated by the fact that even some *banks* played this game, so we're not just talking about the primary care doc running his own practice.

I'll have to think about your comments some more....

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03/16/2011 1:23pm

Scott, the problem I see here is that the data you are using from Pikkety and Saez don't include capital gains. If you go to this link:

http://www.politifact.com/truth-o-meter/statements/2010/dec/10/bernie-s/bernie-sanders-viral-speech-says-top-1-percent-ear/

you'll see a spreadsheet, also from Pikkety and Saez, but you can observe the effects of capital gains. It looks to me like the 1986 tax law changes shifted the way income was reported away from capital gains and towards income. On net the real divide starts at about 1980. In my view it derives chiefly from the dissolution of Bretton Woods and subsequent financialization of the economy.

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Scott
03/16/2011 2:10pm

Hi Jon,
I used the version w/o capital gains because there are fewer countries for which the version w/ capital gains is available. Plus, capital gains makes things that much more complicated--we only see realized capital gains, not unrealized, and how much of gains are realized also depends on tax law changes. 1986 to 1988 changes when you include capital gains, but it can be completely explained by incentives to realize capital gains that derive from tax law changes.

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Snorri Godhi
03/17/2011 7:39am

Please excuse my ignorance, but is this pre-tax, pre-benefits income? would the charts look the same if, say, the US started taxing and redistributing more? (Assuming that the changed incentives do not affect pre-tax incomes.)

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Scott
03/17/2011 10:11am

Snorri,
Pre-tax, pre-benefits for the U.S. (pre-tax for all countries, not sure about pre-benefits). It would definitely be interesting to see how the chart would look differently if benefits and taxes were included, but since they aren't included, changes in policy wouldn't affect the lines shown.

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Snorri Godhi
03/18/2011 5:03am

Thank you Scott. In this context, you might be interested in the work of Willem Adema on net social spending. When he accounted for taxation of benefits as income (in continental Europe), sales tax rates, and other means by which the government gets social money back, the difference in social spending between the USA and Europe is reduced, eg in 2001 the USA spent as much as the Netherlands:
http://www.nationmaster.com/graph/eco_net_soc_exp_of_gdp-economy-net-social-expenditure-gdp
But that must have been a good year for the Dutch economy.

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Scott
03/20/2011 10:24pm

Thanks Snorri--I'll check Adema out!

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Lawrence de Martin
03/22/2011 11:52am

Scott, I make my living providing personal services to billionaires and cento-millionaires in and around Manhattan. I can assure you that my micro-economic view gives the lie to your "facts".

First, the upper 1% are far better at tax sheltering, the opportunities for which have shifted dramatically in the last three decades since the inflection in your curves; so tax data is highly distorted.

Second, income is not a good measure in a debt-financed economy. If you track net worth, you will see that the bottom 40% has none, and an alarming percentage have negative cash flow as well as zero net worth or worse. If you discount 30 years' hyper-inflation of US Real Estate to a sustainable value, the country is under water and the retirement funds have been raped by manipulation of the stock and Real Estate markets.

Third, the shift of the domestic economy from real goods and labor to financial services and the the concurrent shift from infra-structure investment and other government services for the common weal to personal luxuries assures a downward spiral for the bottom 60%.

Our current situation is just like the 1930's when large cars and residences where on an upswing and the other side of the see-saw (workers) descended. It is just a better engineered soft-landing and media campaign, including your damned lies of government statistics.

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ScottB
03/24/2011 2:32am

You mention that the 1986 tax law changed the way income was declared. When did tax laws first allow/encourage income to be declared on corporate returns? Is it possible that the pre-1986 (and post-whenever) period was too low for the U.S., as opposed to post-86 being 'too high'?

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Scott
04/07/2011 11:28am

Sorry for the delay in approving comments--Weebly didn't send me alert emails for some reason (or Gmail threw 'em into the spam filter).

Lawrence, I'd love to hear more about how tax avoidance has changed in the past 30 years. I happen to think that tax avoidance is a huge problem for these share-of-top-1-percent estimates in general, but if you assume that tax avoidance rises when taxes rise and falls when taxes fall, then the implication is that the decline in the top share in the 1940s and the increase in the 1980s are both overstated and that the trend should be flatter than it is (though the level should be higher between 1950 and 1980). Also, wealth inequality is near historic lows according to Saez's research (see his website).

ScottB, I definitely think that the ideal adjustment would be to raise the pre-1988 line rather than to lower the post-1986 line, but then the question is how far back you should go. My hunch is that the 1940ish-1986 levels should all be raised, so that the trend is much more shallow than the figures below. That would put the U.S. levels on the high end, although presumably the levels in the other countries are also understated for similar reasons.

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Walter Ackroyd
04/26/2011 8:06pm

Hi Scott,

Thanks for the informative analysis. I think it's useful to point out that the jump in income inequality in '86 was just a fluke and hence subsequent numbers aren't out of line with the numbers in other Western countries. But I think it's disingenuous to pretend that there isn't massive income inequality in the US, and that it isn't a product of the American mindset, and likely politics. There's the old thing of looking at CEO salary as a multiple of the lowest paid employee, for instance. I first read about those kinds of stats in a magazine, so I don't know what a good online source for them would be, but 30 seconds of search found at least this:
http://heritageinstitute.com/governance/compensation.htm
Just scroll down to "Average World-Wide CEO Compensation as a Multiple of Average Employee Compensation in 2000". The point is just that the US is off the charts. Plus, it's more helpful to look at things starting from the corporate side, as individuals have become very debt at hiding money from the taxman in corporate structures, so -- just as the '86 jump shows that the figures are unreliable, they entire datasets are likely to be massive underestimates.

W

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06/22/2011 7:07am

Your essential point about tax policy affecting the reported distribution of income is very good and interesting. I like a lot of the comments as well.

I would ask you whether the 1986 tax change which reduced the value of investing in non-economic assets - dry oil wells for example. Doesn't that create a shift of the wealth into productive assets, which would disproportionately affect the top 1%.

Since you are looking at tax policy changes, I am surprised that there isn't more about the Bush Tax Cuts. Lowering the income tax rate on dividends encourages companies to distribute dividends?

Another question I would ask is about stock options which grew rapidly in the 90s. How do those appear in your figures. At the worker level where I was, these were just wages which bypassed FICA. People would liquidate them as soon as they arrived.

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Roark
05/13/2012 7:50am

All your chart shows is the emergence of "S" corp filings by individuals.

Prior to 1984 most small/mid size corporations were "C" corporations - in 1984 the law changed. S corporations file as individuals not corporations.

In a lot of cases "S" corps owners while seeming to make a lot of money don't. A corporation has a profitable year and reinvest this income in operations - the individuals who own this corporation will pay taxes on this investment by the corporation as it's profit. The don't get this money as a distribution.

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