Thursday, April 28, 2011

Guest Post: Income Distribution

Dr. Skogstad is an Economist and brother Marine who has just joined my blog list, courtesy of another Marine contributor. He gave me permission to post this piece. It reinforces my contention that 95% of the voters are economically ignorant. The politicians may also be ignorant, or more likely perfer to use the voters' ignorance to gain support. ~Bob

Samuel L. Skogstad, Ph.D.
Professor Emeritus of Economics
Georgia State University                                                                
Perhaps no issue in modern American politics excites more spirited controversy than the distribution of income and wealth.  While the issue is never far below the surface, it was brought explicitly to the top of the political dialogue during the 2008 presidential campaign, in the now-famous exchange between candidate Barack Obama and “Joe the Plumber.”  Candidate Obama articulated the view that government’s responsibility includes assuring a fair sharing of exceptional income (over $250,000 per year for couples) and wealth acquired by individuals through success in private business. In this note we examine some of the key quantitative facts about our nation’s income distribution and how it has changed over the past half century.
I.         Shares of Income Paid to Employees and Owners of Capital, and Transfer Payments
 First we examine the shares of total income received by employees (Labor Income), and by the owners of capital assests including real property (Capital Income).  These two components are made up of the incomes received by owners of resources used in producing goods and services.  There is a third category of personal income, (Transfers), that represents payments, mainly from government, through government social programs.  These three components sum to Total Personal Income.  The shares of the total received in each CATEGORY in 1960 and in 2010 are shown below.
                                                  Distribution of Personal Income, 1960 and 2010
                                                                            (Percent of Total)
                                                                                                     1960                 2010
                                                   Income of Labor                       72                      64
                                                   Income of Capital                     26                      26
                                                   Income from Transfers              2                      10
Source: U.S. Bureau of Economic Analysis, NIPA Table 2.1. (Updated March 2011, Downloaded 4/14/11.)
These data offer what many may consider a surprising result.  Not surprisingly, the wage and salary share dropped significantly, but contrary to countless political speeches, the share labor “lost” was not captured by capital. Rather, it was accompanied by an equal increase in the share received by beneficiaries of social programs designed to redistribute income (and perhaps wealth.)  This does not lend support to the often-heard political rhetoric suggesting that the poor and the middle class have suffered as “capitalists” have gained an unfair share of income and wealth.  The capital share was the same in 2010 as it was 50 years ago—26 percent. 
Of course the interpretation of this change in the distribution of income is not a simple matter, as may be implied to some readers by the previous paragraph.  We will set out the main difficulties of interpretation in what follows.  Nevertheless, those difficulties relate to the path of the structural changes described by these data, not to the broader finding ---that there has been a significant structural shift, in which the share reflecting income redistribution gained at the expense of the Labor share, while the Capital Income share was substantially unchanged.
We hasten to point out that the changes in shares over this half century were not perfectly smooth.  The labor share, for example, actually increased from 1960 to 1970, before beginning a fairly steady decline to the 64 percent reported for 2010.  Furthermore, the “compensation of employees” that forms the base of the component includes salaries of executives and other very highly paid employees, many of whom earned much greater annual incomes than, for example, many small, family operated businesses.  Nevertheless, data to be reported in a subsequent section show that blue collar workers experienced share reductions in the same time shape as the component reported above.  A final caution is in order with respect to the “Labor Income” share.  The data used are estimates of income before income taxes.  Yet over this period there were several “tax reform” programs undertaken.  One of the more important consequences of these has been a substantial increase in the income level at which income tax liability kicks in.  As a result, recent estimates suggest that almost half the working age population (47% as of 2009) has no income tax liability at all. 
The observations on the Capital Income share have also fluctuated modestly over this period.  Through the 1960s and most of the 1970s this share remained at or below the 26 percent rate.  It was 24 percent in 1980.  Through the 1990s and until 2008, the share was very steady at around 28 percent, before it dropped back in 2010 to 26 percent.  But for the period as a whole, there was a very slight drift upward with lower and upper boundaries around 24 and 28 percent respectively.  Despite the presence of many factors that can influence this share, one conclusion is compelling.  There has been no dramatic surge or collapse of the share of total personal income received by the owners of capital or real property resources.  It has been the least variable of the three components.
Some caveats are due with respect to the “Transfer Income” component, as well.  This component includes Social Security, Unemployment Compensation, and Veterans Benefits.  Many would argue that these payments are for past services and, significantly, for the most part people receiving them paid into the social insurance funds throughout their working lives.  Thus we have deducted the amounts paid into social insurance funds each year from total transfer payments to better approximate pure transfers. Subsidized housing, food stamps and WIC payments (mainly to single mothers) are examples, and key components, of such programs.
To conclude, all three of the categories of personal income used here are influenced by many economic and non-economic factors.  Considering that virtually every government spending program results in some degree of income redistribution, most people would recognize government’s inevitable influence on the distribution.  In fact, going a step further, it seems likely that most Americans would approve of some redistribution of income in order to assist those who are unable to care for themselves.  Thus the question that would seem to be of greatest relevance in political discussions of the issue is not whether or not the government should influence the distribution of income, but rather how much it should do so, in what directions and through what mechanisms.
Unfortunately for taxpayers and voters, these latter questions are rarely, if ever, asked or answered by political candidates.  At the present time, social programs benefitting target groups represent something like ten percent of total personal income and roughly seven or eight percent of GDP.  It would seem reasonable to expect advocates of more redistribution to specify how much more, if not precisely, at least within some range.  If we do not have a national target, we can never know how successful we have been at reaching what I have called elsewhere the “Goldilocks Distribution of Income.”  Following this point, it should be welcomed if people seeking our votes for national political office were asked to answer as precisely as they are able, three questions.
1.        Should government policy be directed toward significant changes in the share of income collected by government and transferred as judged appropriate by public policy?
2.       If the answer to the above is yes, what is the share that should be used to achieve a “fair” distribution of income.
3.       What specific mix of policy instruments should be used to achieve the desired distribution of income, and who, fairly specifically, would be the net losers and the net gainers of income as a result of the desired redistribution?  (A significant sub-question here asks the extent to which it is “fair” to tax away income earned via production and to hand it out based on social or political criteria.)

It is often argued that there is some degree or kind of income redistribution that will constitute sufficient disincentive to provoke withdrawal of private resources from production, resulting in a slowing in real economic growth and, potentially, per capita real incomes.  This is a possibility of which politicians should be aware, and one about which citizens should concern themselves.  Let it be hoped that this entire subject matter will become a high priority political issue so that voters and the news media keep it before those seeking our votes, and insist on reasonable attempts to respond to it.

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