The debate over the accuracy of Thomas Piketty’s book on
wealth inequality now often cites Martin Feldstein’s Wall Street Journal piece
– but commentary on Feldstein’s statements seems to me not to analyze what
Feldstein wrote, to the point where I question whether anyone actually has read
carefully what Feldstein said. I have –
and, frankly, my jaw dropped at both the apparently poor quality of the
analysis and the seemingly huge disconnect with what things are like in the
real world.
So, since no one else per Google seems to be doing so, let
me set forth Feldstein’s core argument and why it seems not only flawed but
wrong-headed. Feldstein says that (a)
wealth disparities in the US are much less than in Piketty’s analysis, and (b)
there has been no increase in these disparities over the last 35 years. Let’s take each of Feldstein’s core
supporting arguments in turn.
First, “Ever-increasing inequality –true if people lived
forever; but they don’t. Cumulative
effect diluted by estate taxes and sharing among children/grandchildren”. To a first approximation, 40-50% of the US
has negative or zero net worth, 49.9% has positive net worth (wealth) primarily
in housing, and 0.1% has wealth primarily in stocks and bonds – those being the
wealthy. As the last few years have shown, the trend has been towards a
slightly greater percentage of the US having zero or negative net worth over
the last 35 years, while housing over that period (if we recognize that for
most of the 49.9%, housing is also for shelter, and hence has major expenses)
has little net return, and per Piketty the wealthy are seeing 7% return on
investment – while if they had invested in Vanguard S & P 500 index funds
during that period, they would have seen about 8.5% return on investment.
So let’s assume (reasonably), on average, that the megarich
earn this return for 40 years before they die.
At, let’s say, a 6% investment advantage over the rest of us, the
megarich have 10.2 times the net worth ratio at the end as they have at the
beginning. Now slice this by 35% under
the old estate tax formulas, adjusted to reflect tax-avoidance strategies, or
25% under the new ones. You’re still up
by 6.7 or 7.7 times after those forty years compared to the rest of us. Even with dilution by (on average) 2.2
beneficiaries, each beneficiary starts at 3 or 3.5 times where his or her
predecessor did relative to the non-wealthy – the only thing that changes is a
slow expansion of the “very rich” category, from, say, 0.09% over that 40 years
to 0.11%.
Think about it: all that “dilution” simply means that every
year, 1/40 of the total rich get a 70 % penalty if you worry about multiple
beneficiaries, or 30% if not (which makes more sense), meaning that the rich
get less than 25 % of their relative increase lopped off by estate-tax effects. In other words, dilution doesn’t get close to
affecting the fact of ever-increasing inequality.
Second, “total wealth grows over time roughly in proportion
to total income [3.2% per year].” Feldstein cites problematic evidence: Federal-Reserve-calculated flow-of-funds since
1960. He doesn’t cite any details, so I
have to guess at the best scenario for his argument, but clearly using Federal
Reserve data meant for an entirely different purpose and not vetted against
Census wealth figures is really questionable.
More importantly, this says nothing about the relative share
of that supposed increase going to the wealthy.
Consider, for example, the median wage ($30,000) versus reported
dividend income from $100 million in an index fund -- $2.4 million. We know that for the bottom 80%, over the
last 35 years, real income has been flat or lower, and for the top 0.1%, it has
increased more than 10 times. We also
know that 90% of the increase in productivity in the last 35 years has
effectively accrued to the wealthy.
Either way, it says that even if the Fed is right about the rate of
growth of wealth and income, 90-120% of that growth is going to the
wealthy. Again, increasing inequality,
and apparently ever-increasing inequality.
And note that since the figures are since 1960, 30% of
Feldstein’s analysis takes place in a world where inequality is not increasing
– stacking the deck, as it were.
Finally, note that if the super-rich were investing in stocks, and
therefore reported only dividends as income (until end of life, if not later),
and dominated the wealth distribution, then you would see total income and
wealth increase in tandem in the same way.
Third, Feldstein gets to the part where he is arguing that
the appearance of increasing inequality is an artifact of the wealthy reporting
more of their income – not wealth, income.
He says, more or less, that with
the passage of changes around 1980 plus tax reform in 1986 there was a strong
incentive to shift investments from low-yielding tax-exempt investments to
higher-yielding taxable investments. This
is ridiculous: bonds were and are priced
to yield the same net return on taxed and tax-exempt investments for the
wealthy who buy them, and so we can be sure that something like ½ of the bond
income was already reported – and, of course, this was a smaller proportion
than stocks. In fact, for the wealthy, over
time, it makes no sense except for diversification to go for (taxable or
otherwise) bonds instead of stock index funds. And so, by any stretch of the imagination, the
effect would apply to no more than 15% of the wealthy’s investments – a
one-time effect over thirty-five years, for a net bump of 0.42%. And, of course, what about what’s happened
since then?
Fourth, Feldstein cites the income tax rate being lowered
from 50% to 28%: result, more taxable
income reported (I guess, from the wealthy, although why this doesn’t apply in
the same proportion to the rest of the top 10% I haven’t a clue). This greater taxable income, claims
Feldstein, comes from more work incentive, more payment as salaries, and reducing
deductions.
Oh, really? On what
planet is this guy living? Over the last
30 years, we have seen more payment as stock options, continued heavy use of
deductions, and (here we go again with the flawed “raise the income, they work
less” income effect on labor) that lowering of tax rates had no effect on
either the work incentives of the wealthy or, for that matter, those with subzero
net wealth (40-50% of the whole). If
anyone was affected, it was the rest of the top 10%.
Fifth (again with the taxable income), Feldstein sees a “shift
from business income to subchapter S” – i.e., what was reported before as
business profits is now being reported as income to the wealthy from new
subchapter S corporations. Is Feldstein
seriously pretending that most CEOs are the owners of their businesses, or that
most wealth involves small corporations suitable for subchapter S? Even if he isn’t, he again conflates wannabe
wealthy who are getting high income to get into the charmed circle with those
who are already wealthy and are getting most of their income from stocks. And, of course, this is a one-shot effect,
even if it existed.
Sixth, Feldstein gets back partially to wealth. “Calculations of income [and, I have to
guess, wealth] exclude Social Security
[actuarial value], health benefits, and food stamps”, says Feldstein, resulting
in much more in the way of relative income gains (and, apparently, relative
wealth gains) to the non-wealthy, and much less to the wealthy. By all means, Feldstein, undercut your
previous argument about income rising at the same rate as wealth. But don’t count Social Security, health
benefits, and food stamps as wealth.
These mainly accrue to the bottom 50%, and have done so since the 1930s
and 1960s, respectively. Negative wealth
is not the same as positive wealth. With
negative wealth, you spend all of the benefits you get when you get them, leaving
you still in the general category of “negative to zero wealth”. So trying to create a giant sum and saying,
well, by decreasing negative wealth, this increases the relative share of the
wealth of the bottom 50%, is not even close to a good way of calculating net
worth.
Let’s run this one into the ground. What happens if you take away SS, food
stamps, and health benefits? A lot of
those people die – as they did before 1933.
In that case, they aren’t counted as part of total wealth and total
income. A reasonable figure might be a
50% difference, when these benefits are used, i.e., primarily after retirement
– remember, only 1 in 10 potential SS beneficiaries lived to retirement age in
1933. And yet, at that point, the
negative-net-worth folks were still apparently around 40-50%. And so, the maximum 25% reduction in the debt
of the negative-wealth non-wealthy is partially to wholly counterbalanced by a
10% increase in the retired negative-to-zero-net-worth percentage of the
population. We may also note that the
use of an overall actuarial value almost certainly ignores that the poor die
much younger than the wealthy.
Then Feldstein makes the jaw-dropping undocumented assertion
that this putting of SS and health benefits into the income column results in a
much smaller rise in relative income of the wealthy. Let’s go back to our previous example: Adding on today’s median yearly (actuarial)
Social Security (and probably health benefits), and factoring in the fact that
this would be received by 1 in 2 of today’s median workers who survive to
retirement age and in old age are not receiving other income, would result in
income in today’s terms of a maximum of $60K instead of $30K. So now, we are talking about comparing $2.4
million in income from the $100-millionaire to $60K instead of $30K. That’s a smaller ratio, but certainly not a
smaller rise. And it is by no means
significant.
[extended note:
health benefits includes benefits during work days (through much of this
period, available only to ½ of Americans, and decreasing over time) and
Medicare after retirement – which is not guaranteed to rise with
inflation. Thus, translating this into
money, especially without factoring in the 1/3 share of company health
insurance that the large corporations are asking workers to pony up, means that
health benefits run around $7,000 per year or less before retirement, and more
later – but probably not the equivalent of $7,000 more per year. Then we have “pensions”, apparently including
401(k)s and IRAs. Obviously, company pensions these days are worth far less as
an annuity than promised, and both IRAs and 401(k)s suffer from both eventual
income-tax application for those who actually have significant amounts in
them. Moreover, IRAs and 401(k)s have
had 2 ½ % fees and poor diversification choices, leading to a 3.5-4 %
investment penalty relative to a Vanguard fund, or perhaps a 2% return in real
terms, if you’re lucky, over an average of about 20 years. In effect, this allows a withdrawal of maybe
$10,000 a year over your 10 years of life after retirement – and that’s
optimistic. Total: $14,000 plus $7,000
plus $9,000, or $30,000 on top of your median wage. Again, we are moving after-retirement income
to working days, and comparing it to rich whose investment income operates at
the same pace before and after retirement.]
Then Feldstein completes the argument by saying “Count SS,
health benefits, and pensions in wealth figures”. I’m sorry, but this person is really
clueless. I just disposed of that one.
But really, we could have skipped the entire analysis above
and applied some simple real-world observations. This is one case where examples really are
representative of the whole, because there are pretty few wealthy – I estimate
150,000 people (not households) with more than 8 million in net worth, and so
looking at the top 10 or 100 billionaires gives a pretty good picture of that
group. So we have, in the top few, the
Waltons, Trump, and the Koch brothers, all of whom inherited plenty of wealth,
and increased it. We also have the upper
ranks dominated by CEOs of major corporations
and hedge fund upper management – and it should be clear that both have seen
compensation including stocks (a large proportion, for CEOs) grow by 10-30
times over the last 35 years – in contrast to almost all of the rest of the
population. Or I can cite the experience
of an acquaintance who is seeing far more income and a far faster increase in
net worth from a multi-million-dollar inheritance converted to index funds than
from previous periods of top-0.2% job income and little investment income.
The kindest thing I can say about Feldstein’s analysis is
that it seems to take what he did as part of Reagan’s economic team, using
unexamined assumptions and figures available at the time, and assume that these
figures and assumptions can be extended beyond 1992. The nature of the corporation, the types of
and returns from investment, and government taxation (or lack thereof) were
changing as he served, and have changed dramatically since then, and yet there
is no real trace of these changes in his argument. Instead, we have conservative shibboleths
justified by 1980s statistical analysis that even then was not satisfactory.
So don’t, as Prof. deLong does, say that it’s a good
analysis with a poor WSJ title. Let’s
lay the blame where it really is: Martin
Feldstein did it to himself.
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