Different Data

by Don Boudreaux on November 27, 2007

in Data, Inequality, Myths and Fallacies, Standard of Living

Here’s a letter that I sent today to the New York Times:

Paul Krugman continues his drumbeat message that ordinary Americans are stagnating economically (“Winter of Our Discontent,” November 26).  But data that he frequently cites to support his claim (especially from economists Thomas Piketty and Emmanuel Saez) are not of real flesh-and-blood persons through time; they are of statistical categories such as deciles or quintiles of income earners. Changing demographics and movements of persons from quintile to quintile mask potentially huge changes in the underlying reality.

Sure enough, recent data from the IRS that are of real-life persons reveal that ordinary Americans are prospering.  Economist Thomas Sowell summarizes some germane revelations of these data: “People in the bottom fifth of income-tax filers in 1996 saw their incomes rise 91 percent by 2005. The top 1 percent … saw their incomes decline a whopping 26 percent.  Meanwhile, the average taxpayers’ real income rose 24 percent between 1996 and 2005.”

Donald J. Boudreaux

A caveat: I briefly looked for these IRS data on line and couldn’t find them (a fact, I’m certain, due to my being pressed today for time).  Sowell doesn’t say if these data are adjusted for inflation or not.  My guess is that they are so adjusted.  But even if the reported percentage changes are in nominal dollars, then (1) the growth by 2005 in the real incomes of 1996′s bottom fifth of income-tax filers would still be an impressively large 73 percent, and (2) the fall by 2005 in the incomes of 1996′s top one percent of income-tax filers would be even larger than what the nominal figures (if nominal they be) suggest.

UPDATE: Tom Armstrong sent to me the pdf containing the IRS data.

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dave smith November 27, 2007 at 2:56 pm

Serious question: How can someone as smart as Krugman ignore the aggregation and other problems in the income/wage data? Do you think he does not know or does not care or does not think it matters?

Bret November 27, 2007 at 2:56 pm

Perhaps someone could answer a quick question that I don't think is clear in the treasury report. Is it possible to relate "taxpayer" to "household"? For example, I don't think that many of the homeless are "taxpayers". How about others in the bottom quintile of income? How many of them are "taxpayers"?

Unfortunately, without knowing the answer, "taxpayers" income mobility might be quite good, but non-"taxpayers" may be mired forever in poverty. Or at least Krugman can continue with that viewpoint.

Floccina November 27, 2007 at 3:35 pm

Many painters, plumbers, carpenters, electricians, etc. that I know never file or do not report their full income. I wonder how much income is not being reported and if the share not reported to the IRS is rising or falling. It is my impression that the poor are getting richer along with everyone else.

jurisnaturalist November 27, 2007 at 5:29 pm

The data Sowell reports have to do with annual income, and mobility within percentage groups. He says nothing about wealth groups. Mobility among these groups does occur, less often, and much slower. Marginal changes in wealth have high variance while average total wealth varies little.

Thus the point of his essay is blunted, though it still will cut. Egalitarians fail to recognize that capitalism provides the greatest opportunity for mobility among wealth groups, and hardly ever take charity into consideration when theorizing.

Nathanael Snow
Senior, Econ, NCSU

AT QB November 27, 2007 at 8:18 pm

Re: Krugman, he simply doesn't care….

The WSJ goes green
Let it not be said that the editors of the Wall Street Journal lack ecological awareness. Today they save energy, both theirs and mine, by repeating exactly the same bogus arguments about income inequality that they made — and I refuted — fifteen years ago.
Let me just highlight what I had to say about essentially the same calculation highlighted by the chart in the middle of today’s piece:
We have finally come to the last, and perhaps most effectively confusing, conservative argument.
Let’s give the fact first: families who start out with high income on average have low or negative income growth over the next decade, while families who start out with low income on average see their incomes rise rapidly. This is true in both the Urban Institute and the Treasury data. In the Urban Institute’s numbers, families in the bottom quintile in 1977 saw their income rise 77 percent by 1986, while families in the top quintile saw their income rise only 5 percent. The editorial page of the Wall Street Journal, Paul Craig Roberts, and others have seized upon this kind of number as evidence that the poor actually did better than the rich in the 1980s. Let me call this the “WSJ calculation.”
The WSJ calculation seems striking; but on reflection it is completely consistent with the conclusion that the U.S. has rapidly growing inequality. It shows only that there is indeed some income mobility but nobody denied that. And it is no more a sign that supply-side policies helped the poor than the fact that very few people win the lottery several years in a row.
Unfortunately, it is hard to explain this without a numerical example: Imagine an economy in which in any given year half of the families earn $100,000 and the other half earn $200,000. And imagine also that this economy fits the blender model, so that a family that starts in the bottom half has a 50 percent chance of being in the top half ten years later, and conversely.
Now do the WSJ calculation. Families that start in the bottom half begin with $100,000; ten years later, on average they have $150,000, so they gain 50 percent. Families that start in the top half begin with $200,000; ten years later, on average they also have $150,000, so they lose 33 percent.
But has the distribution of income gotten more equal? No: it is unchanged. All that we see is the familiar statistical phenomenon of “regression toward the mean.” Essentially, the initially rich have nowhere to go but down, the initially poor nowhere to go but up. So if the income distribution were stable, any income mobility would inevitably produce the WSJ result; and it is not surprising that we still get it even when income inequality is rising.

Joel Schneider November 29, 2007 at 10:24 am

Isn't Sowell's result just regression to the mean?

Eric November 29, 2007 at 8:11 pm

There is no natural law governing income mobility that would result in "regression to the mean". The mean is not like gravity in the real world. (It is kind of like gravity in Krugman's stupid coin-flip model, though.)

I challenge anyone to explain how "regression to the mean" (or anything that would cause regression to the mean in this case) governs income distributions. And don't tell me that it just 'tends to happen', because that isn't an explanation.

I'll tell you why I think this happens, though: because young people get better jobs and old people retire, which is fine.

John Dewey November 30, 2007 at 11:11 am

eric: "young people get better jobs and old people retire, which is fine."

And middle-aged people in higher-paying jobs save more, according to the life-cycle hypothesis. I'm not sure my Boomer generation as a whole is saving more, though. I've read that expansion of social security benefits has reduced the Boomers' motivation to save, and perhaps made the life-cycle hypothesis less valid.

Eric November 30, 2007 at 4:05 pm

John — I'm not sure that declines in the savings rate would weaken the life-cycle hypothesis. I think low savings rates would tie income more closely to age.

High levels of savings over a lifetime would push income declines further into the future for retirees, which would slow (or even stop or temporarily reverse) the income decline for the group.

Low savings rates might exacerbate the life-cycle effects, as income (SS benefits aside) drops immediately to near zero if you weren't saving, emphasizing the difference.

I've been wrong before, though, and I could easily be wrong now.

John Dewey November 30, 2007 at 6:39 pm

Eric, as I understand it, the life-cycle hypothesis says that:

1. Young adults consume as much or more than they earn when they buy education, houses, and durable goods.

2. Middle aged adults consume less than they earn, putting aside funds in savings in order to maintain their lifestyles in retirement.

3. Retirees liquidate savings in order to somewhat maintain pre-retirement lifestyles.

4. These life-cycle changes allow consumers to maintain relatively constant consumption throughout their lives.

I think both Modigliani and Friedman independently developed this hypothesis in the 50's or 60's.

Social security and employer-based retirement assets have replaced the normal savings of mid-life adults. So, actually, the life cycle hypothesis may remain valid. Mid-life adults are still "saving" for retirement, but their savings do not always get counted in the savings rate.

I think employer retirement contributions get counted in the savings rate, but gains of pension assets do not. Some pension plans do not make pension contributions in years when asset growth leaves their plans overfunded.

vidyohs December 1, 2007 at 8:27 am

If I may, I can shed some light on the convuluted thinking represented in America on the subject of taxation, "taxpayer". See below.

"For example, I don't think that many of the homeless are "taxpayers". How about others in the bottom quintile of income? How many of them are "taxpayers"?

Unfortunately, without knowing the answer, "taxpayers" income mobility might be quite good, but non-"taxpayers" may be mired forever in poverty. Or at least Krugman can continue with that viewpoint.

Posted by: Bret | Nov 27, 2007 2:56:58 PM"

First and foremost there it is virtually impossible to not be a "taxpayer" in the USA. There might actually be one somewhere but I would have to see it to believe it.

All of those brown guys that come across the border are taxpayers, I am a taxpayer, you are a taxpayer, those homeless are taxpayers.

That is positive fact.

Now the argument proceeds to defining what kind of taxpayer are you, they, we, or it? Do you not only pay all the excise taxes that are inescapable, but do you also pay those voluntary taxes known as "income taxes"?

This taxpayer argument just rips my ass because I know that it is impossible to buy a single thing without paying a tax and that goes for me, the brown guys, you, and everyone else.

If you walk into a convenience store and buy a single coke, you have become a "taxpayer". And, now they are indeed wanting to tax the "very air you breathe". Coming soon to your country, a tax on carbon dioxide emmissions that you thought would only apply to industry and not to you.

A sales tax, useage taxes, fees, etc. are all excise taxes, indirect taxes, and therefore constitutionally legal taxes. You have idiots out there that want to take the voluntary income tax, kill it, and then move that taxation to an excise tax (natl sales tax – VAT tax) and make it involuntary so no one can escape it.

And, please before you argue about paying "fair shares" towards services please google the Grace Report and see for yourself where every penny of your "income taxes" goes.

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