I’ve always been bemused by this term, in part because I thought it derived linguistically from knotholes in wood. But apparently it derives instead from narrow vertical holes in walls from which inside defenders could shoot arrows.
Tax experts generally don’t use the term “loophole” among themselves, because we consider it too imprecise. We’d be more inclined to discuss tax benefits that might be “unintended,” or else intended by someone but poorly rationalized, or else the product of unforeseen interactions between separate provisions or of linguistic ambiguity or formalism in the tax law, etc.
I’m fairly sure I had never once used it in an article, unless perhaps with reference to public opinion, until we used it in Tax Games 1 and Tax Games 2 given the broad readership that we were seeking (as it happened, far more successfully than we had ever imagined was possible).
But one fun thing at yesterday’s colloquium was hearing from attendees about parallel terms in other languages. Apparently the German term is “schlupfloch,” which (per Wikipedia plus the vagaries of Google Translate) is derived from the term for a small opening from which one can escape from a passage or location.
And the French term is “niche fiscale.” We of course have long since borrowed the term “niche” into English, with some broadening of its most literal sense as a shallow recess or nook (more comparable, perhaps, to “schlupfloch” than “loophole”). But in English it would now have a wholly distinct valence.
What do we learn from this? Nothing, I suppose, beyond what we literally learn from this (i.e., what the words are), but that’s enough for me.
The book is the product of in-depth survey research (via one-hour phone interviews with a broad range of respondents) regarding Americans’ views of the tax system. There are quantitative aspects to the research, but the main contribution is qualitative – exploring people’s beliefs and sentiments in a setting that encourages them to be reflective rather than, say, emphasizing partisan talking points. The interviews were conducted in 2013-2014, hence after the Obama-Romney campaign but before Clinton-Trump.
The title is a bit of a misnomer, picked (I would presume) by the publisher with an eye to sales appeal rather than descriptive precision. The book doesn’t so much document that the respondents are made to feel proud by the act of paying taxes as such, as that they view “taxpayers” as morally superior to “non-taxpayers” – even when they describe themselves as non-taxpayers. The pride attaches to the status, not the act, although it’s true that without the act one presumably can’t get the status..
The research was performed before Trump in 2016 proclaimed that not paying taxes is “smart,” rather than discreditable. So it would be interesting to see if Republican voters’ attitudes have been changed by this. I would like to hope not. Trump presents himself to his adorers as unique and special, a kind of fantasy projection for them. So perhaps they are like nerds who can cheer the violence wreaked by the protagonists in superhero films without either thereby becoming violent themselves or starting to admire violence by peers or even other political leaders. Presumably Trump supporters would still mind if a Democrat (or a “moderate” Republican?) paid no taxes on a large income. But then again, it’s way too early to judge the long-term damage to cooperative social norms generally that the current era is wreaking.
Anyway, back to the underlying common public attitude about taxpayers versus non-taxpayers. I view it as a culturally particular instantiation of a fundamental human psychological frame.
Starting with the more universal part: human beings, like lots of other social species, regularly engage in cooperative undertakings for general benefit, in which it is hard to observe others’ degree of cooperation, or else in which cooperation and thus reliance is sequential. This creates prisoner’s dilemmas that are eased by natural or cultural selection for having some degree of emotional inclination to cooperate (which may help to overcome both short-sightedness and the difficulty of faking a good attitude), while also raising the probability that defectors will be punished when they are found out, and that people will play tit-for-tat when deciding whether to cooperate.
As it happens, vampire bats show such attributes as well. When some have succeeded and others have failed in their nightly blood quests, the former will sometimes regurgitate and share a part of their booty with the latter. They keep track of who shares with them and who doesn’t, which apparently requires having relatively large brains despite the caloric cost. So vampire bats not only sometimes front-end the generosity (someone has to go first), but at the back end distinguish between cooperators and defectors, and play at least a degree of tit-for-tat.
Blood-sharer = taxpayer? Obviously, here we are in a culturally contingent application of the underlying concept. It’s one thing to say that human beings are often emotionally inclined to adopt a tit-for-tat framework that valorizes contributors while disparaging shirkers, and another to generalize about their predilection to base this on one’s status as a taxpayer or non-taxpayer. And note that the main distinction Williamson’s respondents had in mind was NOT that between users and non-users of aggressive tax shelters, so much as that between higher and lower earners (where the latter can be assumed to pay little or no federal income tax). Pending parallel qualitative surveys conducted in other countries (which would be a great and most-welcome contribution), this might be a distinctively 21st century American way of coding contributor vs. shirker.
I’m certainly as subject as anyone to feeling the emotional tug of the contributor vs. shirker / tit-for-tat psychological frame. But I regard it as preposterous to apply that frame to people who earn enough vs. don’t earn enough to pay significant (income) taxes. For example, (1) it’s a current-year rather than a long-term assessment, (2) it looks at the gross not the net (taxes alone, rather than taxes vs. benefits), and (3) it treats low-earners as shirkers rather than as (a) unfortunate and (b) mostly internalizing the downside of their bad outcomes (it’s not as if we had a generous social safety net).
The viewpoint brings to mind Romney’s infamous “47%” comment in 2012. So why did he get flogged so badly for it in the public sphere? I think his main problem was overdoing it, by smearing 47% of the population as wholly unwilling to take responsibility for their own lives. Just as, back in the day, blatant racists risked offending casual and unconscious racists when they too-clearly stated beliefs that the latter shared, so Romney made problems for himself here. Indeed, one could almost call his statement a Kinsley gaffe – defined as occuring “when a politician tells the truth – some obvious truth he isn’t supposed to say” – except that here it wasn’t an actual truth, but rather something that many people believed to be true.
Viewing “taxpayers” as better than “non-taxpayers,” where the difference lies in having enough earnings rather than in the degree of one’s tax avoidance behavior, is a normative choice, albeit one I find unappealing. So it’s not factually “untrue.” But the Williamson book suggests that people do indeed commit factual error by applying the frame solely with regard to income taxes – as distinct from, say, sales and payroll taxes.
The book further argues, I think persuasively, that this narrow-sightedness reflects differences in the degrees of “effort” associated with paying different taxes. Payroll taxes are collected so seamlessly (other than from independent contractors), and indeed so invisibly so far as the employer half is concerned, that people scarcely notice they are paying them. By contrast, income taxes, despite withholding’s role in easing or even reversing the April 15 out-of-pocket bite, are associated with such stressful acts as getting one’s financial info together, getting the return done, feeling anxiety about whether (amid all the bewildering complications) one has found all the right tricks for reducing one’s liability, etc.
Sales taxes are a funny intermediate case. Williamson finds that poor people, whose budgets even a modest sales tax can stretch, are keenly aware of them. But higher-earners treat the sales tax as invisible on small purchases, and worth noticing only on big purchases where the bite is large enough to notice. Hence, astonishingly, they seem to view flat-rate sales taxes as progressive! In effect, the heuristic of ignoring trivially small amounts leads them to view the sales tax almost as if it were a luxury tax – without, it seems, any reliance on the fact that, say, groceries but not restaurant meals are typically exempted.
Decades of Republican rhetoric has surely done a lot to spread the view that “taxes” just means income taxes, which leads to distorted views of who is a taxpayer. But the book suggests that it is also about the income tax’s being (despite withholding) a relatively high-effort and high-visibility, rather than low-effort, tax instrument.
Here’s a further subtlety from the book regarding what the notion of “effort,” for this purpose, seems to mean. Gasoline taxes are pretty much hidden – you just pay the after-tax price at the pump, and the tax isn’t even separately stated. Yet apparently people are keenly aware that, if you do a whole lot of driving, you will pay a whole lot of gasoline tax. So they notice and complain about it, even though it’s low-visibility apart from the general understanding that it’s there (and rises with mileage).
One obvious payoff to these findings is that, if you are a policymaker who likes Tax A better than Tax B, you should try to structure things so that Tax A is low-effort or relatively invisible, whole Tax B is more high-effort and visible. So perhaps the Democrats ought to go all-in on seeking to enact automatic filing a la ReadyReturn in California. The aim would be, not to win votes ex ante by promising it, or gratitude ex post by delivering it, but rather to reshape the cognitive fiscal landscape in their favor once automatic presumptive filing was in place. But this would require the Democrats to be strategic and forward-looking, which is asking quite a lot of them.
One further set of findings from the book is as follows: While people tend to have mixed feelings about progressive redistribution of market income – seeming to combine an implicit “equal sacrifice” theory, plus aversion to high-end inequality even though they immensely under-estimate its scope, with concern about work effort and high-earners’ distributive desert – they do on balance seem to favor rising marginal and average tax rates. (Which is not to say that they have a firm grasp of the distinction between these two measures.)
Yet people erroneously think that a “flat tax” would be more progressive than the then-existing (pre-2017) graduated income tax, because they exaggerate the empirical significance of “loopholes.” What they think the term “flat tax” means is unclear. No “deductions”? But presumably they don’t think it would be a tax on the gross, rather than the net, from a given business. And of course, the question of what constitutes a “loophole,” or for that matter a deduction, may not be well-understood.
Not clear how much any of this matters to actual political outcomes, given the falsity (as per Achen and Bartels) of the “folk theory of democracy,” under which voters’ policy preferences guide outcomes. But still all worth knowing, as information about our world.
Not to put too fine a point on this, but, with the article’s current download total standing at only about .06% of that for Games 1 plus Games 2, I suppose it’s only fair to say that, at least so far, it is not exactly flying off the virtual shelves.
It’s clearly a piece that’s aimed at tax policy experts, not at the broader public. And yes, the DBCFT does not currently appear to be a live policy option, at least in the US. But it should still be of interest to those who like to follow, and wish to understand, the decades-long and still-continuing business tax reform debate. E.g., the piece compares the DBCFT to earlier, but still well-known, tax reform proposals such as the flat tax and the VAT, and explains why I think the proposal as such (i.e., within its particular packaging) does not merit a continuing place at the ideas table, even though its overall substance has significant potential merit. Goodbye to All That also briefly addresses some other topics of continuing interest, such as why the US has no VAT, and how we should think about the merits and demerits of origin-based corporate income taxation.
So I’ll just mention it one more time: Act now while (virtual) supplies last!
The Tax Prof blog, which posted a link to the event, also gave this summary of the paper, taken from its conclusion. With correction of a typo, here goes:
“Bad as the passthrough rules look by themselves, in some ways they look even worse when paired with the lower corporate rate and absence of significant safeguards against using corporations as tax shelters. From now on, anyone who is thinking of running a business or being an independent contractor, and for whom the dollar stakes are large enough, is going to have to think seriously about both the C corporation and passthrough alternatives. Tax advisors will need to be consulted, and large bills run up (although the tax savings may more than pay for these). Had the Congressional Republicans in 2017 expressly set out to make the tax system a far more intrusive nuisance and headache (albeit, in the guise of tax planning opportunities) than it already was, they could hardly have done ‘better’ than they did.
“The passthrough rules ought to be repealed as soon as possible. Even if this were to happen, however, the dark message that they send about contempt at high levels of government for basic principles of competence, transparency, and fair governance will continue to linger.”
Yes, I realize that sounds a bit harsh. And believe me, it doesn’t get less harsh-sounding (if anything, more so) when one reads the rest of the paper. But I believe the harshness is justifiable in context.
Someone at the session asked me if I anticipated that tax sheltering problems, coming out of the passthrough rules and the failure to enact safeguards around misuse of the 21% corporate rate to shelter labor income, would be as bad as those we have experienced in the past. I answered: It’s hard to tell, not necessarily given possible practical obstacles to maximum conceivable exploitation. But on the other hand it’s going to be the Wild West with no sheriff, given IRS funding levels. But even if it’s not as bad as the earlier tax shelter eras, I said, what sets this apart is its being so gratuitously self-inflicted by Congress, rather than (like the tax shelter eras of the 1970s-1980s and late 1990s to early 2000s) the byproduct of taxpayers initiating the rampant exploitation of soft spots in the law that had arisen for far less egregious reasons.
Just to show that I am not congenitally angry, even regarding the 2017 act, here is what I have to say, in an early draft of the introduction to my new work-in-progress regarding the 2017 act’s international tax rules:
“In general, I find two main grounds for judging the new provisions leniently. First, prior law was so bad that, even if the provisions, as they stand, have not improved U.S. international tax law – a low bar indeed – they could be tweaked to do so. Second, at least some of the provisions respond meaningfully, and not entirely unreasonably, to important tradeoffs in international tax policy that lack clear answers. On the other hand, the provisions have a number of significant design flaws, along with poorly worked out implementation details, that may reflect their highly rushed enactment with only minimal vetting and public feedback. Thus, how positively one should view them depends in part on whether one is assessing them exactly as they now are, or at a level of Platonic abstraction that permits one to discern underlying purposes that might have been (and perhaps might still be) more artfully accomplished.”
As noted in the previous post, U.S. income distribution looks more even than it otherwise would if one includes, at the bottom, the cash value of healthcare that poor people get from sources such as Medicaid and (if they are old enough) Medicare. This also reduces the percentage of the pie that one measures as sticking to the top. So it makes things look more even than otherwise.
In the Auten-Splinter measure, this is a key reason why things look less unequal than they otherwise would. US healthcare costs have been exploding relative to GDP over the last couple of decades, this does reflect technology-driven improvements in care, and the bottom 50% of the distribution are getting some of this care.
Piketty, Saez, and Zucman spin this same data point differently, arguing that a huge proportion of any income gains at the bottom are being swallowed up by rising healthcare costs. This also is unmistakably true; the question is what to make of it.
Auten and Splinter, rightly in terms of their purposes, view the question as one of whether poor people are getting full cash value. Arguably they are, given how important healthcare can be to one’s quality and length of life, and especially if one forces on them the hypothetical calculation of whether they’d swap it for cash (and whether it would be rational for them to do so) in the absence of free emergency care when things get truly dire.
I certainly wouldn’t favor eliminating Medicaid and Medicare for the poor and handing them the cash instead (in the amount of how much the services cost), even if it were politically stable to continue doing so. But this admittedly reflects not just the value I see it as having to them, but also the altruistic externality to others (such as myself) from their not being denied vital medical care even if they’d rationally spend the money on something else given the other great deficits in what good things in life they can afford to buy.
But now let’s add another point to the mix.US healthcare is by far the costliest in the world, pre capita and relative to GDP, and does not provide better results than other economically advanced countries get at a far lower cost. From the example of other countries, it’s plausible that we ought to be able to get healthcare that is just as good (judged by results) for half the costs. I don’t mean, of course, that it’s realistic to think that we can get there from where we are now, but rather that, had the system evolved in a different fashion over decades, that’s where we might be. It’s also plausible that rent seeking is an important part of the story of why we are where we are, rather than there.
Now let’s imagine a world where the U.S. is like that, hence people in the bottom 50% are getting healthcare of the same value for half the present cost. Suddenly, all else equal, their incomes have substantially declined (as measured by Auten-Splinter and anyone else who values the healthcare at cost), so, at least before we make any other conforming changes, the society looks far more unequal in the statistical measures.
Next step, of course, is that someone is being paid less, so distribution higher up will change as well. Plus, we then have to run the thought experiment, what else happens instead? E.g., is GDP simply lower since healthcare costs less, although by hypothesis everyone is just as well off as before except that some people have been paid less by other people? Consistency suggests trying to think this through a bit further, e.g., in terms of other output that occurs instead, but by now we’re not only in the realm of speculative fantasy but far beyond what distributional measures can reasonably give us.
Multiple bottom lines are possible off this speculative chain, but here’s one. In a distributional measure that (perhaps reasonably) views healthcare as worth its market cost to poor people, the fact that it is more expensive due to all the defects in how our system has evolved causes poor people, in a sense, to look spuriously better-off than they would, all else equal, in the scenario where we didn’t get on a different healthcare path than peer countries. On the other hand, despite its high cost, we are in fact still giving this care to poor people (to the extent that, as per the measures, we actually are). To some extent it all comes down to how you want to think about it, apart from the undeniable point that these measures really can’t tell us everything that we would like to know about inequality.
Reason 1 for caring about high-end inequality is that we care about the distribution of the total.
Reason 2 is that we draw inferences from it about marginal utility. All else equal, if the rich are richer and the poor poorer, the marginal utility gain from transfering a quantum of consumption from the former to the latter might be expected to increase.
Reason 3: “decreasing institutional accountability due to concentrated power,”
Reason 4: “decreasing economic efficiency due to rent-seeking,” and
Reason 5: “stagnating middle-class wages due in part to shifts in relative bargaining power.”
Reason 7: Research by Richard Wilkinson and Kate Pickett powerfully suggests that greater inequality is correlated with, and apparently causes, increases in social gradient ills, ranging from violence to drug abuse to alcoholism to suicide to other stress-related health problems. Even the rich are affected. This matters not just for its own sake (social gradient ills are bad), but as a diagnostic indicating broader negative effects on people’s subjective wellbeing in more unequal societies.
This list is not necessarily exhaustive. One may wish to add other reasons, or delete those listed above that one deems not to be serious concerns. But here’s the thing: If you still have several reasons on your list, they are unlikely to motivate identical measures of high-end inequality for purposes of assessing them.
Here is a simple example. AS address the question of whether we should think of, say, healthcare benefits provided through Medicare, Medicaid, and employer-provided health insurance as providing benefits that are worth their cost to the recipients. This clearly must be addressed with regard to Reason 1 – it tells us about the value of the “pieces” of the “pie” that people in different households are getting.
But how much does it affect, say, Reason 4 or Reason 6? Do we think there’s less rent-seeking at the top if poor people are getting good rather than mediocre value from Medicaid? Really no, except insofar as prevalent rent-seeking might increase the likelihood that they might be handed bad healthcare. Do we think there will be less by way of “expenditure cascades” that are mainly a product of visible public Veblenesque consumption? People aren’t competing over cancer and diabetes treatment in quite the same way as they might be over their homes, weddings, vacations, food consumption, and air travel.
One reason AS find that high-end inequality hasn’t risen as much as one might otherwise have thought is that people lower in the distribution, due to advances in medical technology, are getting far more expensive – but also better – healthcare than previously. PSZ note in their work that wage increases among the bottom 50% have been substantially eaten up by rising healthcare costs. These are two different ways of saying the same thing. The AS way of putting it might be better in relation to Reason 1, but it’s conceivable that all of Reasons 2 through 7 (to the extent affected at all) are better aligned with PSZ’s framing.
Here’s another tough measurement issue that both AS and PSZ have had to wrestle with. Say I save during my working years for my retirement years, perhaps through tax-favored retirement saving that I accumulate upfront and withdraw/use at the back end. How should we measure this?
Measuring it on an accrual basis rightly captures that the individual who accumulates retirement saving during her working years is better off than one who consumes the same amount that year but doesn’t have anything left over for retirement saving. The saver preferred to save – why should she be treated as worse-off than if she had spent more on current consumption in lieu of saving for retirement.
But if you measure consistently on an accrual basis, then the person who is living off her savings once she retires appears, in the measure, to be poor, even though she isn’t. And double-counting it for both periods leads to a falsely high measure of lifetime income.
To add in a factor that both AS and PSZ leave out for methodological reasons (since they are doing annual snapshots), what about life expectancy differences? If I have $X (and let’s suppose it’s a tidy sum) at retirement, perfectly self-annuitize, and spend it all before I die, was I better-off in the scenario where (a) I correctly forecast that I would live a very short time and hence blew through it rapidly, than (b) in that where I correctly forecast that I have many years left, and prudently spread it over a longer period?
Annual scenarios make me look worse-off in (b) than (a), whereas the truth is the other way around. Even under a pure accrual method, which misclassifies me as poor in my retirement years because the retirement savings have already been counted during the build-up years, I appear to be poor for more periods, by reason of my living longer, so I make high-end inequality look worse even if in fact I’m at the top throughout in any real sense.
It certainly matters to the assessment of high-end inequality that the life expectancy gap between rich and poor has been growing in the United States. But if we go back to Reasons 1 through 7, it doesn’t matter identically for all of them! It clearly makes #1 look worse, as assessed from a longer than merely annual perspective, it has ambiguous effects on #2 (we could really benefit poorer people if we enable them to live longer, but if we take the discrepancy as given then having a longer lifespan increases the marginal utility of a dollar of lifetime income), and, as to the rest, who knows (or at least, it would require more analysis).
So we have complex and ambiguous issues, not reducible to being assessed via a single-bullet measure of current annual shares of the pie. Plus, you could have exactly the same such measure in Society 1 as opposed to Society 2 – thus equalizing them in terms of Reason 1 – yet the two societies might differ substantially with regard to Reasons 2 through 7. Hence the point, for example, that even if high-end income concentration in 1960 was closer than we thought to being similar to that today, its adverse effects may have been less, e.g., because people were less inclined to use their wealth aggressively in either politics or Veblenesque status competition through conspicuous consumption.
One last point before I close: How does the AS versus PSZ standoff look today? The latter have shifted from Piketty-Saez approach of starting from taxable income and moving up (effectively critiqued by AS in various respects) to an approach of starting with a measure of national income and allocating it down.
AS find that the top 1% have a national income share of 10.2%, whereas PSZ come out at 15.7%. This is still a sizeable different – albeit, not necessarily large enough to motivate fundamentally different bottom line viewpoints about whether we have a problem from rising high-end inequality.
PSZ report that their finding 5.5% more of national income concentrated at the top arises as follows:
1) 1% comes from PSZ’s including retirement savings as it accrues, rather than when it is later spent. As noted above, there is clearly some merit to this position (although its upside of more properly measuring the income of workers who save comes with a downside of overestimating the poverty of retirees who have saved).
2) 0.4% comes from assuming that deficits will be funded half through tax increases and half through spending cuts, rather than all through tax increases as AS assume. I find the PSZ scenario more plausible, although either alternative raises the question of how we should think about the current distributional implications of future policy changes that have not been adopted yet and that remain deeply unpredictable.
3) 0.2% comes from differences in how they treat married couples. This is a very interesting and intricate subject – we spent a lot of time on it at yesterday’s AM and PM colloquium sessions, but I lack the time and space to cover it properly here.
4) 0.3% comes from only AS’s removing young and dependent filers from the lists, on the view that their low income measures may be wholly uninformative if, say, they are living with affluent parents.
5) 2.6% comes from PSZ’s treating unreported income as concentrated at the top, whereas AS allocate it ratably to reported income. I see a number of strong reasons (although, again, no time or room to run through them here) for leaning heavily towards PSZ on this issue.
6) 1% comes from other methodological and data source differences between AS and PSZ.
Suppose one were to run a totally back-of-the-envelope scoresheet on this. For example, say we gave PSZ half of #1, all of #2, half of #3, none of #4, and all of #5. Then, even if we gave them none of #6, we would still have raised the AS estimate of a top 1% income share of 10.2% by 3.6%, to 13.8% – almost two-thirds of the total difference. Plus, I’ve suggested that some of the reasons why the top 1% income share isn’t higher – e.g., because people at the bottom do at least get some medical treatment that is not only costly but also valuable – might not matter so much for Reasons 2-7, even if quite relevant to Reason 1.
I think this plausibly puts us in a scenario where concern about high-end income inequality that we believe to be both high and rising is by no means rebutted or shown to be an “illusion” by AS’s nonetheless valuable and admirable contribution to the debate.
This paper is an important entry in the ongoing empirical debate among economists regarding the rise of high-end inequality. I think it’s worth offering a bit of the backstory here.
My view, and that of many others, has been that the rise of high-end inequality in the U.S. (and elsewhere) in recent decades is both unmistakable and highly consequential. Let me offer here just a few anecdotal examples off the Internet, illustrating this pervasive (I would argue) phenomenon:
–A 2016 NYT article, entitled “In an age of privilege, not everyone is in the same boat,” describing how consumer businesses increasingly direct their efforts towards extremely high-end consumers, creating sectors that feature a “money-based caste system.”
–A 2015 WaPo article, entitled “In 2016 campaign, lament of the not quite rich enough,” describing how, in the days when Jeb Bush appeared to be riding high, campaign finance had moved in such a way that presidential campaigns had little interest in courting mere multi-millionaires. One needed to be a billionaire to really get all those lap kisses and special access.
–A pair of delightful 2014 blog posts by economists, the first called “Inequality in the Skies” and the second “Fly Air Gini,” describing how the allocation of seat space inside commercial airplanes has become more high-end skewed. (This despite the fact that the real high-flyers, or top 0.1 percent, aren’t to be found in business class or even first class – they are using their own personal or corporate jets. The influience they nonetheless have on commercial flights is related to what my recent High-End Inequality Colloquium teaching colleague, Robert Frank, calls “expenditure cascades,” involving the radiation downward through the wealth distribution of influence from high-end consumption patterns.)
Anyway, it seems to me verging on undeniable that this thing at the top has happened. Widespread agreement about the reality and importance of this phenomenon helped to trigger the extremely high-profile reception of Thomas Piketty’s 2014 tome, Capital in the 21st Century.
The Piketty book, and its underlying research (much of it conducted with Emmanuel Saez, and subsequently also with Gabriel Zucman), had a lot going for it. It took a fresh look at previously under-utilized data, it reached important conclusions that seemed clearly correct, and Piketty even made the book more fun by discussing the novels of Austen and Balzac.
But there were a couple of things to create potential unease about this work. First, there was reason to question Piketty’s causal theory for the rise in high-end inequality, which he based on “r > g” – the excess of the rate of return over the rate of growth in the economy, causing capital-owners to hold an ever-increasing share of the overall pie. Not only were there some soft spots in the underlying theoretical reasoning, but it seemed clear that, in the U.S. at least, the rise of high-end inequality was driven primarily by rising high-end labor income inequality. (Joe Bankman and I wrote about Piketty’s work, in part critically, here, in connection with an interdisciplinary NYU-UCLA conference on the book that Piketty attended.) Ought the problems with the underlying theory support broader skepticism about the work – or was it simply a causal dispute? It was hard to know.
Second, while I am not myself an empiricist, I began to hear suggestions from various economists – straight-up folks without intellectual axes to grind – that they were uneasy about some of the details in the (at that stage mainly) Piketty-Saez work. Reading the footnotes, in effect, seemed not to inspire universal confidence. And there are people to whom it sometimes seemed that debatable interpretive choices – although inevitable, given the data challenges in the enterprise – seemed to have a tendency to lean towards making the estimates of rising high-end inequality higher, rather than lower.
Yesterday’s colloquium presenter, Gerald Auten, got into the debate as a consequence of his in effect carefully reading the footnotes in connection with IRS tax data. Among the things he noticed was that the Piketty and Saez (“PS”) methodology seemed to show a huge uptick in high-end inequality right around the enactment of the Tax Reform Act of 1986.
Now, as an aside, it is plausible that TRA 86 might have tended over time to boost high-end inequality (it aimed to be distributionally neutral, but only within a 5-year budget window and without looking at the top 1% – it was designed in light of effects on income quintiles). But not quite so immediately. The jump one computed by replicating the PS methodology seemed to rely a lot on (a) the fact that TRA 86 induced a lot of people to shift out of corporate form, so that the same earnings they had previously been generating through C corporations now appeared on their individual returns, and (b) the fact that, under TRA 86 provisions targeting tax avoidance by rich people, more children of rich people now had to file tax returns on which they might have trivial amounts of taxable income. These looked as if they were the tax returns of poor people, but actually weren’t. The growth in seemingly “poor” taxpayers made the income concentration at the top look greater than it would have, had the kids (as previously) not filed.
In short, there were technical reasons unrelated to the true growth of high-end inequality why it seemed to grow sharply, under the PS methodology, right around 1986. And if one took that growth away from the estimates, what was left seemed potentially much smaller than PS had been trumpeting.
Auten and Splinter therefore started preparing their own estimates of high-end inequality trends from 1960 through the early twenty-first century, and came up with a much more modest growth estimate. Indeed, the current paper draft concludes that its findings support an “alternative narrative … [to that in PS] when consistent and broad measures of pre-tax and after-tax incomes are used: changes in the top one percent income shares over the last half century are likely to have been relatively modest.”
As I see it, this can put one in a strange place, as a consumer of the empirical debate. Much of what Auten and Splinter (AS) do – such as addressing the anomalies that I noted above – seems clearly correct. What’s more, they clearly have no axe to grind, and simply want to get the data analysis right.
On the other hand, it kind of seems like their bottom line conclusion can’t quite be correct. I’m reminded of the old joke: “Who are you gonna believe, honey – me or your lying eyes?” It’s not just bias or media trends – our not so lying eyes surely have seen a real phenomenon unfolding over time. How could it not be happening after all?
This angle is well-captured in a recent Vox blogpost by Dylan Matthews, entitled “A new study says much of the rise in inequality is an illusion. Should you believe it?” This in the end is not ultimately my take on how to think about the significance of the AS paper, but I will admit that I started there.
Now, as I’ll discuss in a follow-up blog entry, there may actually be several good reasons, based purely on data interpretation, for revising the AS “narrative” very substantially towards that in PS. Indeed, the latest version of the latter – PSZ for Piketty-Saez-Zucman – really helps in framing the empirical gap in ways that could well come out sufficiently in their favor to revive their “narrative” relative to that in AS.
Let us suppose, however, that this remains indeterminate. How should one’s prior about the compelling, even if anecdotal, evidence of the contemporary rise in high-end inequality affect one’s response to the empirical analysis in AS? Here are two possibilities:
–It can function as a Bayesian prior, influencing how one evaluates uncertainties in the data, even though one must always be open-minded,
–It can motivate considering how the AS analysis and what one has seen happening over the last three decades could BOTH be true. For example, if empirical measures of high-end inequality came out exactly the same in 1960 as today – which would go well beyond their finding merely “modest” high-end growth – might the changes we’ve observed nonetheless have been happening? I find it very plausible that cultural and behavioral changes since that time could have this upshot. If people at the top, in 1960, didn’t flaunt and flex their wealth to nearly the same degree then as they do now, either in consumer markets or in politics, then the changes so many of us have observed could reflect that, rather than (just) material changes in distribution.
I’ll develop all this further in the next blog entry (after participating, in a few minutes, in an NYU Law Forum where I and three colleagues will discuss the 2017 tax act with an audience mainly of law students).
But first, a last quick point to sharpen (I hope) interest in the follow-up. High-end inequality is not a single entirely well-defined “thing,” nor does it matter for just one reason. For each reason why it might matter, a different mode of measurement might be appropriate. So there is no unitary answer to the measurement issues that are raised by AS, PS, and PSZ.
And this may have been (technically and conceptually more advanced) Neanderthal art, also depicting a face.
OK, I realize that we don’t know for sure that this is a correct interpretation in either case. But interesting to contemplate.
It’s based on an ever-evolving talk that I gave multiple times in 2017, most recently at the interdisciplinary conference, “International Tax Policy in a Disruptive Environment,” that the Max Planck Institute for Tax Law and Public Finance held in Munich on December 14-15, 2017. A final version of the paper will be appearing in a forthcoming conference volume of the Bulletin for International Taxation, to be published by IBFD.
Its abstract goes something like this:
In the aftermath of the short but spectacular career of the destination-based cash flow tax (DBCFT) as a widely-discussed tax reform option in U.S. tax policy debate, this paper argues that we should generally move on from focusing on the DBCFT as a discrete package. While its political future (if any) is hard to predict, discussing it as a package tends to impede, rather than advance, clear thinking about the underlying issues.