OcTaxLaw.com

It is a good rule to question every study on income inequality by asking, “Why those years?”  

The latest version is from the Congressional Research Service (CRS), and the author concludes:

“Changes in income from capital gains and dividends were the single largest contributor to rising income inequality between 1996 and 2006. Changes in tax policy also made a significant contribution to the increase in income inequality, but even in the absence of tax policy changes income inequality would likely have increased.”

And about those years:

“The years 1996 and 2006 are examined for several reasons.  First, both years were at approximately similar points of the business-cycle with moderate inflation (about 3%), a modest unemployment rate (about 5%), and moderate economic growth (3.7% in 1996 and 2.7% in 2006).  Second, 2006 was the year before the August 2007 liquidity crunch and the onset of the severe 2007-2009 recession.  Third, there were major tax policy changes between these two years.  Fourth, both 1996 and 2006 were three years after the enactment of tax legislation that affected tax rates and are unlikely to be affected by short-run behavioral responses to these changes.”

In fact, 1996 and 2006 are not even close to similar points in the business cycle: 1996 was at the beginning of an economic expansion that lasted another four years, while 2006 was at the end of an economic expansion that ended the following year.    

It is deeply misleading to talk about income inequality without properly taking into account the business cycle.  The financial crisis of 2008 and ensuing recession has devastated personal incomes to a degree not seen since the Great Depression.  The most dramatic collapse has been in high incomes, as can be seen with the most recent IRS data.  For example, since 2007 the number of millionaires has dropped 60 percent, while income reported by millionaires has dropped in half.   

Much of this volatility is due to the collapse of capital gains, as the charts below indicate.  Based on IRS data, as a share of income, capital gains went from 9.5 percent in 2006 to 3.0 percent in 2009, and this while the tax rate on capital gains remained 15 percent.  The second chart shows capital gains in dollar terms and compares it to the S&P 500.  First, capital gains track the stock market – that should be obvious.  Second, capital gains realizations went from $771 billion in 2006, peaked at $896 billion in 2007, and then collapsed to $231 billion by 2009 – a drop of 74 percent in two years.

Why is this important?  The CRS acknowledges that capital gains mainly accrue to high-income earners, and this too can be seen from IRS data.  In 2009, it is in fact the largest source of income for those making $10 million or more.  Thus, the collapse of this income since 2007, as well as other sources of income such as business income, completely disrupts the story that income inequality has increased since 1996.

Lastly, the third chart below shows a standard measure of income inequality, the Gini coefficient, for the years 1986 to 2009, again based on the most recent IRS data.

It shows just how much measures of income inequality depend on the business cycle, and why 2006 or 2007 are terribly unrepresentative years.  They are in fact the two peak years for the Gini coefficient over this time period, at 0.567 in 2006 and 0.574 in 2007.  From there, the Gini coefficient falls 7 percent to 0.535 in 2009.  This is not quite as low as it was in the 2002 recession, but then we haven’t seen 2010 data yet.  From the trajectory it seems likely that 2010 will be still lower.  As it is, the Gini coefficient in 2009 is lower than it was in 1998, and close to where it was in 1997.

It must be acknowledged that the Gini coefficient has an underlying upward trend between 1986 and 2000.  The steepest increase follows the 1986 tax reform, which dramatically lowered the top marginal rate on ordinary income (see the last chart below), and began a long trend of business income moving from the corporate code to the personal code in the form of pass-through entities such as partnerships and S-corporations.  This alone might explain much of the measured increase in income inequality over this period.   However, Clinton raised the top marginal rate in 1993 to 39.6 percent, and this also ushered in a long period of increasing income inequality.  The Gini coefficient went from 0.498 in 1993 to 0.555 in 2000 – an increase of 12 percent.

In contrast, the period since 2000 has exhibited no underlying trend in income inequality, but rather dramatic fluctuations resulting from the business cycle.  The CRS is right to connect this to capital gains, which have likewise cycled up and down, but wrong to conclude this represents an underlying trend.  Income inequality at the beginning and end of the Bush years was virtually unchanged, with the Gini coefficient going from 0.555 in 2000 to 0.557 in 2008.  In 2009 the Gini coefficient fell further, to 0.535, for a 4 percent drop since 2000.  There is therefore no evidence that the Bush tax cuts in either the top marginal rate or capital gains rate had any long term effect on inequality.

It may be the case that lowering the tax rate on capital gains created more volatility in the stock market and thus capital gains realizations and personal incomes.  More likely, the stock market moves for many reasons more important than the tax rate on capital gains, such as the internet revolution, war, monetary policy, demographics, and the housing bubble. 

Here is our earlier critique of a CBO study that claims income inequality increased between 1979 and 2007. 

Follow William McBride on Twitter @EconoWill

Today’s new word:

“With his re-election prospects hinging largely on the economy and jobs, President Obama today highlighted what he said is a growing trend under his administration:  the “insourcing” of jobs back to America.”

Yes, this is all very good for America, but it reflects mainly the fact that Europe is going down the tubes, with many countries reporting economic contraction in the 4^th quarter.  Add to that the fact that many emerging economies, like China, are slowing down and showing signs of a burst credit bubble.  But the danger is here:

“Obama plans to propose “in the next few weeks” a series of new tax breaks for companies to help accelerate the return of jobs to the U.S. and end special tax treatment for those that ship work overseas. Neither he nor administration officials offered further details.” 

The only special tax treatment that U.S. companies face in operating overseas is our antiquated and out-of-step system of worldwide taxation, whereby the IRS attempts to track down the foreign profits of U.S. corporations and applies a toll charge for bringing those profits back home.  Any attempt to further restrict the free movement of capital or labor makes about as much sense as restricting the flow from California to Ohio.  Imagine if the governor of California tried to prevent California companies from expanding outside the state.  Would that create California jobs?  No.  Companies like Apple would curtail their out-of-state operations, such as manufacturing, distribution, and retail, and in turn curtail their complementary in-state operations, such as headquarters and research and development.  There might be some “insourcing” of out-of-state manufacturing jobs, but at a higher cost, such that Apple as a whole would have to shrink, hurting workers, consumers, and shareholders, many of whom are Californians.

Protectionism doesn’t work at the state level, or the national level.  President Obama seems to recognize that domestic jobs come from lowering the costs of hiring, including the tax costs.  The most straight forward way to accomplish this is by cutting the corporate tax rate for all corporations.

Follow William McBride on Twitter @EconoWill

Sporting Intelligence reports this morning that:

Leading football clubs are being heavily targeted by HMRC over perks afforded to players and WAGs partially because the taxman has already received information and tip-offs relating to major financial discrepancies at at least one top Premier League club,Sportingintelligencecan reveal.

The finance directors at all Premier League were recently sent a questionnaire containing 181 questions looking closely into the financial affairs of the clubs and players, specifically the issue of perks, as HMRC looks to crack down on blatant abuses of the system.

And as they also note:

The sheer scale of the questionnaire has surprised even tax experts.

Sportingintelligencecan exclusively reveal the questions from the questionnaire, including:

• 4.14 Are any payments made into trusts or sub-trusts, whether in the UK or abroad, for which employees or family members are, or are potentially, the beneficiaries?
• 1.2 Are any expenses paid, or benefits provided, to players or other employees spouses, partners or other family members, whether in the UK or abroad?
• 11.6 Has the club paid any expenses relating to an employees private holiday costs? If so please provide details.
• 11.7 Are there any circumstances where the cost of spouse travel will be paid for by the Company? If so please provide details.
• 22.1 Are complimentary tickets, use of a box, etc. provided for employees? If so please provide full details.

Sportingintelligencealso understands the tax affairs of foreign players will come under greater scrutiny. In some cases players have been found not to have paid National Insurance contributions (NIC).Other questions asked:

• 5.3 How does the club treat payments to foreign players for payroll purposes?
• 4.2 What controls are in place to ensure that any amounts which are paid out are treated correctly for tax and NI purposes?

Quite right too.

Rumour has it there’s not just smoke in this case, but a fire too. And tackling such issues in such a high profile way is wholly appropriate.

And there’s muchmorein thearticlethan the bits I’ve noted.

In 2009, the top 1 percent of taxpayers—1,379,822 of them—paid more than the bottom 90% combined.  Geographically, this is equivalent to a city the size of San Antonio, TX paying more in income taxes than every person living west of the Mississippi.

Likewise, the top 0.1 percent—138,000 taxpayers—paid a greater share than the bottom 75%.  In other words, a city the size of Dayton, OH would have paid more than a country the size of Germany.

Would Dayton San Antonio be agreeable to such a reality?

Doubtful. 

Follow David S. Logan on Twitter @Loganomix

The following statement was issued by the Dean and Chapter of St Paul’s Cathedral this morning:

The Dean & Chapter of St Pauls Cathedral issued the following statement this morning (Monday 17th October):

“Services at St Pauls Cathedral were able to take place as normal this weekend but the last few days have not been without various challenges. Our chief concern is that St Pauls be allowed to operate as normally as possible and for all people to be respectful of this need.

Public safety has been a major concern. We have been in constant touch with the police and community leaders. As the City of London returns to work this morning we are monitoring the situation carefully.

On Sunday the protestors did reduce their presence on the landing and steps of the West Doors enough to allow people to come in to worship throughout the day.

It is also now important that the thousands of visitors wishing to visit the cathedral and to enjoy our hospitality this week are able to do so freely and that the daily life of St Pauls Cathedral can continue without serious interruption.”

It’s an extraordinary comment to issue. What’s important to them? That the Cathedral can carry in as normal. What does that really mean? That its turnstiles can continue to take the money. That is what that statement really means. This, as they make very clear, is their chief concern.

Any mention of the poor and those protesting on their behalf? No, none at all. Any Christian message at all? No, none. Just a wish that things carry on as normal and the cash keeps flowing.

That’s appalling. And what it confirms is that they really do think two things. The first is that their neighbours in the City have no questions to answer. The second is that the prime concern of the Dean and Chapter is running a tourist attraction.

Shame on them.