Income and Wealth Inequality: Evidence and Policy Implications

Income and Wealth Inequality: Evidence and Policy Implications Emmanuel Saez, UC Berkeley Neubauer Collegium Lecture University of Chicago October 2014

1

MEASURING INEQUALITY Inequality matters because the public cares about it ⇒ Need to provide transparent inequality measures Goals: Understand drivers of inequality trends and the effects of public policy on inequality Two key economic concepts: Income and Wealth Income is a flow = Labor income + Capital income Capital income is the return on Wealth Wealth is a stock accumulated from savings and inheritances 2

BASIC US ECONOMIC FACTS In aggregate, labor income is about 70-75% of total income Capital income is about 25-30% of total income Total wealth is about 400% of total annual income Annual rate of return on wealth = 6-7% Wealth inequality is always much higher than income inequality (bottom 50% families own about zero wealth) Government taxes 1/3 of market incomes to fund transfers and public goods: disposable income inequality lower than market income inequality 3

TOP INCOME SHARES Simple way to measure inequality: what share of total pre-tax market income goes to the top 10% families, top 1%, etc. Individual income tax statistics are the only source (a) covering long-time periods (b) capturing well top incomes 25 countries have been analyzed in the on-going World Top Incomes Database Caveats: Income concept used is narrower than National Income and focus is solely on pre-tax, pre-transfer income 4

Top 10% Pre-‐tax Income Share in the US, 1917-‐2012

45% 40% 35% 30% 25%

1917 1922 1927 1932 1937 1942 1947 1952 1957 1962 1967 1972 1977 1982 1987 1992 1997 2002 2007 2012

Top 10% Income Share

50%

Source: Piketty and Saez, 2003 updated to 2012. Series based on pre-tax cash market income including realized capital gains and excluding government transfers. 2012 data based on preliminary statistics

Decomposing Top 10% into 3 Groups, 1913-2012

20%

15%

10% Top 1% (incomes above $394,000 in 2012)

5%

Top 5-1% (incomes between $161,000 and $394,000)

2008

2003

1998

1993

1988

1983

1978

1973

1968

1963

1958

1953

1948

1943

1938

1933

1928

1923

0%

1918

Top 10-5% (incomes between $114,000 and $161,000)

1913

Share of total income for each group

25%

Source: Piketty and Saez, 2003 updated to 2012. Series based on pre-tax cash market income including realized capital gains and excluding government transfers. 2012 data based on preliminary statistics.

Top 0.1% US Pre-Tax Income Share, 1913-2012

10%

Top 0.1% income share (incomes above $1.91m in 2012)

8% 6% 4% 2% 0%

1913 1918 1923 1928 1933 1938 1943 1948 1953 1958 1963 1968 1973 1978 1983 1988 1993 1998 2003 2008

Top 0.1% Income Share

12%

Source: Piketty and Saez, 2003 updated to 2012. Series based on pre-tax cash market income including or excluding realized capital gains, and always excluding government transfers.

US Top 0.1% Pre-‐Tax Income Share and Composi:on 12% Capital Gains

10%

Capital Income Business Income

8%

Salaries

6% 4%

Source: Piketty and Saez, 2003 updated to 2012 . Series based on pre-tax cash market income including or excluding realized capital gains, and always excluding government transfers.

2011

2006

2001

1996

1991

1986

1981

1976

1971

1966

1961

1956

1951

1946

1941

1936

1931

1926

1921

0%

1916

2%

Table 1. Real Income Growth by Groups

Full period 1993-2012 Clinton Expansion 1993-2000 2001 Recession 2000-2002 Bush Expansion 2002-2007 Great Recession 20072009 Recovery 2009-2012

Average Income Real Growth

Top 1% Incomes Real Growth

Bottom 99% Incomes Real Growth

Fraction of total growth (or loss) captured by top 1%

(1)

(2)

(3)

(4)

17.9%

86.1%

6.6%

68%

31.5%

98.7%

20.3%

45%

-11.7%

-30.8%

-6.5%

57%

16.1%

61.8%

6.8%

65%

-17.4%

-36.3%

-11.6%

49%

6.0%

31.4%

0.4%

95%

Computations based on family market income including realized capital gains (before individual taxes). Incomes exclude government transfers (such as unemployment insurance and social security) and non-taxable fringe benefits. Incomes are deflated using the Consumer Price Index. Column (4) reports the fraction of total real family income growth (or loss) captured by the top 1%. For example, from 2002 to 2007, average real family incomes grew by 16.1% but 65% of that growth accrued to the top 1% while only 35% of that growth accrued to the bottom 99% of US families. Source: Piketty and Saez (2003), series updated to 2012 in August 2013 using IRS preliminary tax statistics for 2012.

Bottom 90% wealth share in the United States, 1917-2012 40%

% of total household wealth

35% 30% 25% 20% 15% 10%

2012

2007

2002

1997

1992

1987

1982

1977

1972

1967

1962

1957

1952

1947

1942

1937

1932

1927

1922

0%

1917

5%

Wealth shares estimated using capitalization method by Saez and Zucman (2014)

Composition of the bottom 90% wealth share

40% 35%

25%

Pensions

20%

Equities & fixed claims (net of non-mortgage debt)

15%

Business assets

10% 5%

2012

2007

2002

1997

1992

1987

1982

1977

1972

1967

1962

1957

1952

1947

1942

1937

1932

1927

1922

0%

Housing (net of mortgages) 1917


30%

Top 1% wealth share in the United States, 1913-2012 50%

30%

20%

This figure depicts the share of total household wealth held by the 1% richest families, as estimated by capitalizing income tax returns. Source: Saez and Zucman (2014).

2013

2008

2003

1998

1993

1988

1983

1978

1973

1968

1963

1958

1953

1948

1943

1938

1933

1928

1923

0%

1918

10%

1913


40%

0% 2013

2008

2003

1998

1993

1988

1983

1978

1973

1968

1963

1958

1953

1948

1943

1938

1933

1928

1923

1918

1913

% of total household wealth 30%

Top 0.1% wealth share in the United States, 1913-2012

25%

20%

15%

10%

5%

Real average wealth of bottom 90% and top 1% families 140,000

Top 1% (left y-axis)

120,000

Bottom 90% (right y-axis)

10,000,000

100,000

8,000,000

80,000

6,000,000

60,000

4,000,000

40,000

2,000,000

20,000

Real values are obtained by using the GDP deflator, 2010 dollars. Source: Appendix Tables B3.

2010

2006

2002

1998

1994

1990

1986

1982

1978

1974

1970

1966

1962

1958

1950

0

1946

0

1954

Top 1% real average welath

12,000,000

Bottom 90% real average wealth

14,000,000

SUMMARY OF US RESULTS 1) Dramatic reduction in income and wealth concentration during the first part of the 20th century 2) Much lower income and wealth inequality in decades following World War II 3) Sharp increase in income and wealth inequality since 1970s 4) US now combines extremely high labor income inequality with very high wealth inequality Analyzing international evidence is useful to understand drivers of inequality 15

0 2010

2005

2000

1995

1990

1985

1980

1975

1970

1965

1960

1955

1950

1945

1940

1935

1930

1925

1920

5

1915

1910

Top 1% Income Share (in %)

Top 1% share: English Speaking countries (U-shaped)

20

15

10

United States

United Kingdom

Canada

0 2010

2005

2000

1995

1990

1985

1980

15

1975

20

1970

1965

1960

1955

1950

1945

1940

1935

1930

1925

1920

1915

1910

Top 1% Income Share (in %)

Top 1% share: Continenal Europe and Japan (L-shaped) France Japan

Sweden

10

5

Result 1: Drop in Inequality in 1st Half of 20th Century All advanced countries had very high income concentration one century ago (explains pessimism of Piketty 2014) All countries experience sharp reduction in income concentration during the first part of the 20th century 1) This is primarily a capital income phenomenon 2) War and depression shocks hit top capital earners (drop follows each country specific history) 3) Government policy responses–regulations and progressive income and inheritance taxation–make this drop permanent 18

Result 2: Recent Surge in Inequality 1) Driven by surge in top labor incomes which then fuels wealth inequality 2) Difference across countries rules out technical change/globalization as the sole explanation 3) Policies play a key role in shaping inequality (tax and transfer policies, regulations, education) 4) Key debate: do gains of the top 1% reflect productivity or do they come at the expense of the 99%? Looking at the role of top tax rates helps shed light on this 19

Pre−tax Top 1% share

Top MTR

1913 1923 1933 1943 1953 1963 1973 1983 1993 2003 2013 Year

0

0

Top 1% Income Shares (%) 5 10 15 20

25

10 20 30 40 50 60 70 80 90 100 Top Marginal Tax Rate (%)

Top 1% Income Share (pre−tax) and Top Marginal Tax Rate

16

18

A. Top 1% Share and Top Marginal Tax Rate in 1960−4

Top 1% Income Share (%) 8 10 12 14

Elasticity= .07 (.15) Germany Switzerland

Netherlands Finland

France

Canada Japan

Spain

6

Australia Sweden NZ Ireland

US

UK

Italy Norway Portugal

4

Denmark

40

50

60 70 Top Marginal Tax Rate (%)

80

90

Top tax rates include central+local income taxes (Piketty-Saez-Stancheva ’14)

US

Elasticity= 1.90 (.43)

UK Canada Ireland Germany Norway Portugal Italy Spain Australia NZ France Japan Finland Switzerland Netherlands Sweden

6

Top 1% Income Share (%) 8 10 12 14

16

18

B. Top 1% Share and Top Marginal Tax Rate in 2005−9

4

Denmark

40

50

60 70 Top Marginal Tax Rate (%)

80

90


10 Change in Top 1% Income Share (points) 0 2 4 6 8

US

Elasticity= .47 (.11)

UK Ireland

Portugal

Norway Canada Italy

Australia Spain

NZ Japan

Sweden

Denmark

France Finland

Germany Switzerland

Netherlands

−40

−30 −20 −10 Change in Top Marginal Tax Rate (points)

0

10


ECONOMIC EFFECTS OF TAXING THE TOP 1% Strong empirical evidence that pre-tax top incomes are affected by top tax rates 3 potential scenarios with very different policy consequences 1) Supply-Side: Top earners work less and earn less when top tax rate increases ⇒ Top tax rates should not be too high 2) Tax Avoidance/Evasion: Top earners avoid/evade more when top tax rate increases ⇒ a) Eliminate loopholes, b) Then increase top tax rates 3) Rent-seeking: Top earners extract more pay (at the expense of the 99%) when top tax rates are low ⇒ High top tax rates are desirable 20


Top MTR

1913 1923 1933 1943 1953 1963 1973 1983 1993 2003 2013 Year

0

0


25



Real changes vs. tax Avoidance? Test using charitable giving behavior of top income earners Because charitable is tax deductible, incentives to give are stronger when tax rates are higher Under the tax avoidance scenario, reported incomes and reported charitable giving should move in opposite directions Empirically, charitable giving of top income earners has grown in close tandem with top incomes ⇒ Incomes at the top have grown for real

21

90% 80% 70% 60% 50% 40% 30% 20%

Mean charitable giving of top 1% divided by mean income [leA y-‐axis]

2010

2006

2002

1998

1994

1990

1986

1982

1978

1974

1970

0%

1966

10%

1962

Mean charitable giving of top 1% incomes / mean income

Charitable Giving of Top 1% Incomes

Source: Appendix Table XX. The figure depicts average charitable giving of top 1% inomes (normalized by average income per family) on the left y-axis.

90%

25%

80%

60% 15%

50% 40%

10%

30% Mean charitable giving of top 1% divided by mean income [leA y-‐axis]

20%

2010

2006

2002

1998

1994

1990

1986

1982

1978

1974

1970

0%

1966

Top 1% Income Share [right y-‐axis]

10%

5%

0%

Source: Appendix Table XX. The figure depicts average charitable giving of top 1% inomes (normalized by average income per family) on the left y-axis. For comparison, the figure reports the top 1% income share (on the right y-axis).

Top 1% income share

20%

70%

1962

Mean charitable giving of top 1% incomes / mean income

Charitable Giving of Top 1% Incomes, 1962-‐2012

Supply-Side or Rent-seeking Under rent-seeking scenario, growth in top 1% incomes should come at the expense of bottom 99% (and conversely) US Evidence: Top 1% incomes grow slowly from 1933 to 1975 and fast afterwards. Bottom 99% incomes grow fast from 1933 to 1975 and slowly afterwards International evidence: Hard to find an effect of top rate cuts on economic growth ⇒ Consistent with rent-seeking effects More research needed on this critical question 24

0

Top MTR

Bottom 99%

1913 1923 1933 1943 1953 1963 1973 1983 1993 2003 2013 Year

10 20 30 40 50 60 70 80 90 100 Marginal Tax Rate (%)

Top 1%

0

Real Income per adult (1913=100) 100 200 300 400 500

Top 1% and Bottom 99% Income Growth

POLICY CONCLUSIONS 1) US historical evidence and international evidence shows that tax policy plays a key role in the shaping inequality 2) High top tax rates reduce the pre-tax income gap without visible effect on economic growth 3) Public will favor more progressive taxation only if it is convinced that top income gains are detrimental to the 99% 4) In globalized world, progressive taxation will require international coordination to keep tax avoidance/evasion low

25

SUPPLEMENTARY SLIDES

26


Top MTR

1913 1923 1933 1943 1953 1963 1973 1983 1993 2003 2013 Year

0

0


25



Top MTR

Top 1% (excl. KG)

MTR K gains

1913 1923 1933 1943 1953 1963 1973 1983 1993 2003 2013 Year

10 20 30 40 50 60 70 80 90 100 Marginal Tax Rates (%)

Top 1% Share

0

0


25

Tax Avoidance: Top 1% Income Shares and Top MTR

2.5

United States

Italy

2.0

Switzerland Germany Canada

1.5

United Kingdom Ireland Australia Netherlands

1.0

CEO pay($ million, log−scale)

3.0 3.5

A. Average CEO compensation

Sweden

France Norway

Belgium

.4

.5

.6

.7

.8

Top Income Marginal Tax Rate

Link between top tax rate and CEO pay in 2006 across countries

3.0

United Kingdom Australia Ireland Canada

2.5

Italy

United States

2.0

Switzerland GermanyNetherlands

1.5

Norway

France Belgium Sweden

1.0

CEO pay($ million, log−scale) with controls

3.5

B. Average CEO compensation with controls

.4

.5

.6

.7

.8

Top Income Marginal Tax Rate

Controlling for firm profitability, governance, size, and industry

50 40 30

Rank-Rank Slope (U.S) = 0.341 (0.0003) 20

Mean Child Income Rank

60

70

Mean Child Percentile Rank vs. Parent Percentile Rank

0

10

20

30

40

50

60

Parent Income Rank

70

80

90

100

50 40 30

Rank-Rank Slope (U.S) = 0.341 Rank-Rank Slope (Denmark) = 0.180 20

Mean Child Income Rank

60

70

Intergenerational Mobility in the United States vs. Denmark

0

10

20

30

40

50

60

Parent Income Rank Denmark [Boserup, Kreiner, Kopczuk 2013]

70

80

90

100

United States

REFERENCES Alvaredo, Facundo, Atkinson, Anthony, Thomas Piketty, and Emmanuel Saez, The World Top Incomes Database (web) Atkinson, Anthony, Thomas Piketty, and Emmanuel Saez “Top Incomes in the Long Run of History,” Journal of Economic Literature 49(1), 2011, 3-71. (web) Chetty, Raj, Nathan Hendren, Patrick Kline, and Emmanuel Saez, “Where is the Land of Opportunity? The Geography of Intergenerational Mobility in the United States,” NBER Working Paper No. 19843, January 2014, forthcoming Quarterly Journal of Economics (web) Piketty, Thomas, Capital in the 21st Century, Cambridge: Harvard University Press, 2014, (web) Piketty, Thomas and Emmanuel Saez “Income Inequality in the United States, 1913-1998”, Quarterly Journal of Economics, 118(1), 2003, 1-39. (web) Piketty, Thomas and Emmanuel Saez “Inequality in the Long-Run”, Science 344, 2014, 838-843 (web) Piketty, Thomas, Emmanuel Saez, and Stefanie Stantcheva “Optimal Taxation of Top Labor Incomes: A Tale of Three Elasticities,” American Economic Journal: Economic Policy 2014, 6(1), 2014, 230-271. (web) 28

Saez, Emmanuel and Gabriel Zucman, “Wealth Inequality in the United States since 1913: Evidence from Capitalized Income Tax Data,” slides July 2014. (web)