The Agenda

Note on Alan Krueger’s Speech

Many thoughts came to mind as I read Wonkblog’s excerpts from Alan Krueger’s speech to the Center for American Progress. So naturally I had to read the speech itself. There is a great deal to say, but let’s look at just a couple of aspects of it:

“Our income tax system is less progressive than that in other countries. This chart shows the Gini coefficient for OECD countries, with the blue bars indicating inequality in before-tax income and the red bars inequality in after-tax income [Figure 10]. The difference in the height between the bars is a measure of how much the tax code reduces inequality. Of all the OECD countries, only Chile, Korea, and Switzerland have tax systems that reduce inequality by less than the U.S.”

The chart itself reads “Gini Coefficient Before and After Taxes and Transfers, 2010.” There are a few things that are striking about the chart, e.g., that market income inequality in the U.S. is comparable to market income inequality in a few other non-Anglo-Saxon OECD countries. 

But let’s focus on the role of transfers as opposed to taxes. The House Budget Committee’s Republican staffers released a report on this subject:

One key metric in the [CBO] study is after-tax, after-transfer household income, which the CBO refers to as “real after-tax income.” This adjusts income for inflation, government transfers received (i.e. Social Security, food stamps, unemployment insurance, Medicare, etc.) and taxes paid. Real after-tax income is used as a proxy for economic well-being.Next, the study divides the population into fifths, or “quintiles,” based on this definition of income.    

Considering the population as a whole, real average after-tax household income in the United States grew by 62 percent over this 30-year period. After-tax median income (half of thepopulation is above the median, half is below) grew by 35 percent. But the trend of absolute gains across all income levels was not the focus of the study. Instead, the CBO sought to analyze the distribution of these income gains and their uneven growth over time.

Between 1979 and 2007, real average after-tax income grew by 275 percent for the top 1 percent. Average after-tax household income for the lowest quintile increased by significantly less, growing by 18 percent over the period studied (see Figure 1). …

One underreported conclusion from the CBO study is that shifts in government transfers and federal taxes have contributed to increasing inequality over time. Both taxes and government transfers remain progressive, but the equalizing effect of transfers and taxes on household income was smaller in 2007 than it was in 1979 (see Figure 3).

This is mainly because the distribution of government transfers has moved away from households in the lower part of the income scale. For instance, in 1979, households in the lowest income quintile received 54 percent of all transfer payments. In 2007, those households received just 36 percent of transfers.

This shift reflects a growth in programs that focus on the elderly population and are not for the most part income-adjusted, such as Social Security and Medicare. In other words, the structure of some of the nation’s largest entitlement programs has decreased the share of government transfer payments going tolower-income households and directed an increasing share of government spending to wealthier seniors. According to the CBO’s findings, this trend, accelerated by the retirement of the baby-boom generation, contributes to an increase in inequality.

The tax system has also become slightly less of an equalizing factor today than it was in 1979. The composition of federal taxes changed between 1979 and 2007, as less-progressive payroll taxes grew faster than more-progressive income taxes. The average payroll tax rate was slightly higher at the end of the period, while the average individual income tax rate was slightly lower. [Emphasis added]

It is easy to understand why Krueger would want to focus on taxes rather than on transfers — indeed, I couldn’t find any reference to Social Security or Medicare in his prepared remarks — but it seems that making taxes and transfers more progressive could involve a few different strategies:

(1) We could merge FICA and the personal income tax and create a new graduated tax with a large exemption. This would sever the link between FICA and Social Security benefits, but we’ve arguably gone fairly far down that road already. Alvin Rabushka offered another related approach in 1999 — by lifting the FICA cap and exempting the first $30,000 from a single-rate personal income tax, you’d create a tax system in which the rich pay more but marginal tax rates are lower.

(2) We might also reform Social Security and Medicare by, as Andrew Biggs has proposed, limiting benefits based on lifetime earnings.

(3) We might instead flatten the basic Social Security benefit, per AEI’s Peterson proposal:

The policy changewould be implemented by first granting the flat minimum benefit, which would be fully phased in by 2017, then gradually reducing the traditional PIA replacement factors from 2020 through 2050 until allbeneficiaries receive the flat benefit payment. The benefit would be granted to all individuals reachingretirement age, regardless of work history, and would assume the responsibilities of both theredistributive element of Social Security as well as the pure welfare approach of Supplemental SecurityIncome (SSI). The base benefit would be equal to approximately 25 percent of the average wage ofworkers at the time. Because the benefit is a fixed value, it would be relatively more generous to lowerearning individuals. Effectively immediately, survivors would receive 75 percent of the couple’s totalbenefit when both spouses were alive, better enabling the widow or widower to retain their priorstandard of living. In effect, the flat benefit payment would guarantee that no Social Security beneficiarywas forced to live below the poverty line. Relative to current law, where roughly 10 percent of theelderly live in poverty, the Social Security safety net would be strengthened considerably. However, thisflat benefit would come at the cost that middle and high earning individuals must save more forretirement, as they would receive lower benefits than under current law.

This would improve the progressivity of U.S. transfers considerably. 

Suffice it to say, none of these ideas are a focus of Krueger’s remarks. Rather, he emphasizes the importance of the Buffett Rule. 

I’ll also note that Krueger’s discussion of the evidence concerning taxes struck me as a little odd:

Now, I could see why someone could support tax cuts for top income earners if they had materially benefited the U.S. economy, but the macro evidence is clear that the economy did not perform better after last decade’s tax cuts than it did after taxes were increased on top earners in the early 1990s.  I already showed you evidence that income growth was stronger for lower and middle income families in the 1990s than it was in the last 40 years overall.  This next chart shows that there was more job growth in start-ups in the 1990s than in the 2001-2007 period [Figure 11].  Across all businesses, job growth was much weaker in the 2000s than in the 1990s.  So there is little empirical support for the claim that reducing the progressivity of the tax code has spurred income growth, business formation or job growth. [Emphasis added]   

Note the highlighted passage. Is that the right question to ask? That is, should we look at economic growth before and after the 2001 and 2003 tax cuts and treat marginal tax rates as the only relevant variable? Or do we want to develop a better sense of how labor supply, and labor supply across different groups, responds to marginal tax rates? 

Arpit Gupta offers a richer discussion of labor supply and taxes, and recent findings from Micheal Keane and Raj Chetty, Adam Guren, Day Manoli, and Andrea Weber in a recent guest post here at The Agenda.

Krueger references how families impact life chances. This raises a number of interesting public policy questions. It also reminds me of our recent discussion of Valerie Ramey and time devoted to childcare. It also reminds me of the rather stark divide between James Heckman and Alan Krueger on the usefulness of human capital policies other than early childhood interventions.

One small quibble is this:

The next chart shows how much after-tax income has grown for different parts of the income distribution since 1979, after adjusting for inflation [Figure 4].  As the Congressional Budget Office noted in a recent report, the top 1% of families saw a 278 percent increase in their real after-tax income from 1979 to 2007, while the middle 60% had an increase of less than 40 percent. …

The magnitude of these shifts is mindboggling. The share of all income accruing to the top 1% increased by 13.5 percentage points from 1979 to 2007.  This is the equivalent of shifting $1.1 trillion of annual income to the top 1 percent of families.  Put another way, the increase in the share of income going to the top 1% over this period exceeds the total amount of income that the entire bottom 40 percent of households receives.  

Small but worthy of note: the composition of the top 1 percent of families has changed over this period of time. To be sure sure, one assumes that most of these families have remained within, say, the top decile over these decades. But it’s important to be clear.

My broad impression of Krueger’s remarks is that he considers increasing taxes on high-earners urgently important. He doesn’t seem to think public sector productivity is an important part of the picture or that the fact that our largest transfer programs are growing steadily less progressive merits discussion in this context.  

I would suggest that one could present the same facts and then raise legitimate questions about the extraordinary increase in federal public social expenditures and how poorly these funds have been deployed. Moreover, if the aim of taxes is to improve the after-tax distribution of income yet we’ve seen that spending increases haven’t led to a concomitant increase in the quality of public services, perhaps we can put these equality-enhancing taxes into an escrow fund that will not flow into salaries for public employees and various government contractors? 

Reihan Salam — Reihan Salam is executive editor of National Review and a National Review Institute policy fellow.

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