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Home Publications Blogs Beat the Press Thomas Edsall on Richard Burkhauser and Inequality

Thomas Edsall on Richard Burkhauser and Inequality

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Thursday, 27 June 2013 04:36

Thomas Edsall has a lengthy blogpost on a new measure of income developed by Cornell University Professor and AEI fellow Richard Burkhauser. Burkhauser's measure reverses the widely reported finding that inequality has increased substantially over the last three decades.

While Edsall went to great lengths to include extensive comments from other economists (including me) on Burkhauser's methodology and concluded himself that Burkhauser's methodology doesn't measure up, readers may still be led to believe that there is more ambiguity on this issue than is actually the case. This is because Burkhauser's measure is so peculiar and counter-intuitive, that it is unlikely that many readers would understand what he has in fact done.

Burkhauser does address a legitimate question -- the treatment of capital gains. Usually economists calculate inequality by both taking income without counting realized capital gains (sales of stock, houses, or businesses) and also including the gains. The latter will generally show higher degrees of inequality since wealthy people are likely to have realized capital gains, whereas middle and lower income people are not.

This approach does pose a problem since the decision to sell an asset is an arbitrary one and does not necessarily reflect when the gain actually took place. Also, a lower capital gains tax rate will encourage people to sell their assets more frequently, which by itself would lead to larger reported income. So a methodology that includes realized capital gains is problematic.

However Burkhauser's response, to include unrealized gains, makes no sense in a serious measure of income. The reason is that asset prices (especially stock, but in recent years housing as well) are hugely volatile. For people who have substantial assets, the movement in these prices in any given year will often swamp their other income. Gary Burtless and I both made this point in our comments.

An implication of Burkhauser's methodology is that our measure of inequality would depend hugely on the exact year we picked for our analysis. In his study, the base year for most of his analysis is 1989, a year in which the S&P 500 rose by more than 27 percent. This hugely increased the earnings of the top quintile in his base year. As a result, the change from 1989 forward would be guaranteed to be small. By contrast, if Burkhauser had chosen 1987, when the S&P fell more than 6 percent, he would have a much lower base. This would make the growth in income for the top quintile appear much larger.

To see this, imagine the average income, not counting capital gains, for the top quintile is $200,000 in both 1987 and 1989. Suppose they own $1 million in stock on average. In Burkhauser's methodology their income in 1989 is $470,000. Their income in 1987 is $140,000. (Number corrected, thanks Yoram.) We would be telling a very different story about the growth of income inequality over the next two decades if we opted to choose 1987 as our base year rather than the year picked by Burkhauser. (The year 1989 is often chosen as a base year because it is a business cycle peak. That makes sense in a measure that is primarily reflecting earnings growth which tends to peak at the peak of the cycle. It makes no sense when taking a measure that is moved primarily by capital gains.)

There could be an argument for taking unrealized capital gains averaged over a longer period, which is not the methodology that Burkhauser chose. By this methodology we would average the capital gains for households over the period being investigated and add the annual amount to their income. This would be a considerably more defensible methodlogy, but it still would give very misleading results because of the housing bubble.

Depending on the exact starting point, the run-up in house prices could easily add 10-20 percent to the annual income of low and middle income households. Of course this is all reversed after the bubble burst in 2007. So this methodology would allow to say that there was little if any rise in inequality in the years between 1989 and 2007, but then a huge surge in inequality since 2007.

That is probably not a helpful way to think about trends in income. It makes more sense to keep income, excluding capital gains, separate from measures of wealth. This would allow us to see that the wealth of low and moderate income families did increase substantially up to the bursting of the housing bubble and then fell sharply.

There are some other serious issues with the Burkhauser methodology (for example the switch from defined benefit pension to defined contribution pensions would make earnings appear to rise), but there is one common item that is worth noting and criticizing. He counts the cost of government provided benefits as income. This has the effect of substantially raising the income of the bottom two quintiles because of Medicare and Medicaid.

The reason these benefits matters so much is that health care is expensive in the United States. The cost of Medicare for a couple is now close to $25,000. That will be very large relative to the income of people in the bottom two quintiles. While these benefits are quite important, the reason they are so expensive is that we pay way more for our health care than any other country. Our per person costs are more than twice the average of other wealthy countries. This is not because we get better care but because we pay more to providers.

This means that by including the cost of government provided health care as income for beneficiaries, if we raise the pay of cardiologists from $400k a year to  $500k a year (thereby raising the value of Medicare and Medicaid benefits) we make the bottom two quintiles look better off. A simple alternative would be to price the value of care in accordance with the cost in reference countries with comparable health outcomes.

Getting back to the basic point, the whole Burkhauser project of trying to find a perverse methodology that will make rising inequality go away, is more than a bit annoying. This would be like an astronomer looking for quirks in planetary motion and using this as a basis for arguing that the sun actually revolves around the earth.

There undoubtedly are quirks in the motions of the planets, however no reputable astronomer will use them as a basis for disputing that the earth orbits the sun. Unfortunately economics does not have the same standards. Economists who want to argue the equivalent of the sun orbiting the earth will find substantial funding and an audience for their work. 

 

 

 

Comments (11)Add Comment
For the Many, Win Some Lose Some: For the Few, Win All the Time
written by Last Mover, June 27, 2013 7:37

Compare this:
Depending on the exact starting point, the run-up in house prices could easily add 10-20 percent to the annual income of low and middle income households. Of course this is all reversed after the bubble burst in 2007. So this methodology would allow to say that there was little if any rise in inequality in the years between 1989 and 2007, but then a huge surge in inequality since 2007.


To this:
This means that by including the cost of government provided health care as income for beneficiaries, if we raise the pay of cardiologists from $400k a year to $500k a year (thereby raising the value of Medicare and Medicaid benefits) we make the bottom two quintiles look better off. A simple alternative would be to price the value of care in accordance with the cost in reference countries with comparable health outcomes.


And this:
That is probably not a helpful way to think about trends in income. It makes more sense to keep income, excluding capital gains, separate from measures of wealth.


Therefore when justifying inequality of the 1% the focus is on huge swings in asset prices which nevertheless manage not to dethrone them from said privileged economic status.

They win when the 99% wins and they win when the 99% loses. The standard propaganda passes this off as win-win outcomes necessary to keep these economic predators in the business of creating jobs.
It's what they do. It's ALL they do!
written by Edward Ericson Jr., June 27, 2013 8:17
You give too much credit. Stuff like this is not to be taken seriously: it should be mocked.

But, to play along.

1. The year to start is probably circa 1968-70, when the federal minimum wage was at or near it's apogee in terms of relative purchasing power. Anyone not doing that is diddling.

2. Claiming there was a "surge in middle class wealth" during the housing bubble is just as dishonest as anything else these usual suspects do. The bubble was driven, in part, by desperate white collarites trying to stay middle class. The mortgage fraud machine, developed by million-dollar-a-day guys, was pitched to people whose financial unease was rooted in the deepening economic inequality and instability of the past three decades.

3. "the whole Burkhauser project of trying to find a perverse methodology that will make rising inequality go away is more than a bit annoying." Well, yes. But it's less like your deranged astronomer than the scorpion, stinging the naive frog.

Will we ever learn?
...
written by skeptonomist, June 27, 2013 9:07
By counting Medicare and Medicaid and other government benefits as income Burkhauser is in effect disguising the inequality generated by private enterprise. If actual inequality has not grown so much in Burkhauser's index as indicated by other methods, this has been due to partly to income redistribution. There is nothing wrong with this as a measure of actual inequality, but if you want to claim that the "free market" system does not generate inequality you shouldn't be pretending that the redistribution is not there or is not necessary.
i just love looking at incomes during crashes....
written by pete, June 27, 2013 9:16
I made way more money (including changes in wealth) than Warren Buffet in 2008 (hint, he lost a ton). Same with Mr. Gates. Real return on capital has been wonderful as the inflationary policies have kept real wages down and firms have done pretty good. Probably this will not continue, as inflation is now somewhat under control. Some want more, but this of course would only exacerbate the inequality.
...
written by Perplexed, June 27, 2013 12:31
-"Unfortunately economics does not have the same standards. Economists who want to argue the equivalent of the sun orbiting the earth will find substantial funding and an audience for their work."

So too will economists who want to argue that pay is equal to marginal products. Since economists choose to not measure and report on the amount of GDP that consists of rents, there are no "scientific" constraints on these "arguments." Where's the "arithmetic" on this issue? If we don't have any actual data (or even defensible estimates) on what the actual rents are, they're equally as likely to be 100% as they are 0%. So the expected value, without further information of why it should be different, is 50%. So why aren't economists using this number? Obviously many economists don't want math & statistics interfering with their elaborate theories that need to be protected at all costs.

If we really want to have a discussion about inequality, why don't we stop trying to pretend it doesn't exist and talk about what's really generating it? Our wealth GINI is .87. 40% of the population shares 0.3% of the nations' wealth. Its considerably more plausible to observe the sky and conclude that the sun orbits the earth than it is to observe these measures and conclude they are based on marginal products.

"It's difficult to get a man to understand something, when his salary depends on his not understanding it" -Upton Sinclair
Should be "In Burkhauser's methodology their
written by Yoram Gat, June 27, 2013 1:20
income in 1989 is $470,000. Their income in 1987 is *$140,000*."
Dates and debt
written by Steve Roth, June 27, 2013 2:35
The choice of periods aside, I think there's something fundamentally wrong with this high-level accounting abstraction based on net wealth/worth -- with debt hidden in the consolidated, netted-out wealth measurements this is rooted in.

If somebody has net worth of $100K and debt of $1 million, the effects/dynamics of asset-price changes are utterly different from net worth of $100K with no debt.

Pre-crash middle-class net wealth increase was based on RE value runup exceeding household debt runup, but: *driven* by that debt runup.

The words debt, leverage, lend, and borrow don't appear in this paper, and "liability" only re: tax liabilities.

I haven't formulated a cogent discussion of this, but I think it's at the crux.

...
written by NWsteve, June 27, 2013 8:47
with all of the more technical reasons for casting doubts on Prof. Burkhauser's work, as summarized above, perhaps it might also be useful to check-in on some arithmetic spotlights from the data presented..

let's see:

within the body of his blog, Mr. Edsall lists an excerpt from an email from Prof. Burkhauser in which a median household from the middle quintile is compared to a median household from the top 5% cohort..the Prof. states that the middle household saw virtually no change in it's income between 1989 and 2007 while the 5% household experienced a decline in it's income...

HOWEVER: Burkhauser lists $20,000. of "income" in 1989 and $65,000 of "income" in 2007 for the 5% household derived from the sale of "stocks/assets"...these two income items are not included in his subsequent summary...
(the middle household is listed with no income from similar "sales" in either year)...
why are these facts excluded?

in other words, instead of an income decline of $12,000 between 1989 and 2007, the 5% household actually has a gain of $33,000...
while the median household still has NO gain whatsoever...

let's see, very rough approximate:
$33,000.x 9 years = $297,000. for the 5%...
$0.x 9 years =$0. for the middle...

we also should reconsider the numbers provided in Burkhauser's email:
in 1989 the 5% had an income factor of 4.356 times the middle household's (220/50.5);
in 2007 this factor rose to 4.836 (295/61.0)...
continuing our review:
in 1989 the 5% had a held asset factor of 3.383 times the middle household's (450/133);
in 2007 this factor rose to 4.255 (1000/235)...
thus:
the income factor increased 11%...
the asset factor increased nearly 26%...

now, i am certain that it will be "argued" that the income from the "stock" sales is irrelevant, each a one-off from years of prior activities...
Burkhauser doesn't tell us this and the fact that he included it in both of the years of his "sampling" suggests that such activity "might' occur
each year for the 5%...
and, in any event, if one choses to exclude this "income" one should be required to restate the total asset holdings and their respective "gains" for 1989 and 2007 as if the "sales" had not occurred...
clearly the 5% have more resources at their disposal than the middle does...

'course it would be far more useful if we could construct a "disposable" income comparison, but the AEI would never make such a request...
...
written by watermelonpunch, June 28, 2013 9:00
He counts the cost of government provided benefits as income. This has the effect of substantially raising the income of the bottom two quintiles because of Medicare and Medicaid.


You've got to be kidding me!

Is he also counting everyone's employer provided insurance? Every time someone gets medical care and doesn't pay for it?

Maybe he should've included illegal kickbacks and illegal drug sales?

Maybe he should've tallied up what homeless people receive from soup kitchens?

Are there any standards to be had in measures of income?
Or can people just do a study and include or exclude whatever data they like willy-nilly?
counting unrealized gains is idiotic period.
written by Robert Weiler, June 29, 2013 11:31
Speaking as somebody that 'lost' a large amount of money in the dot com bust, the idea that you can count unrealized gains as income is just completely idiotic. I never had that money even for a second and thus couldn't spend it which is what matters. Had I been foolish enough to execute and hold through the crash I would have had to pay taxes on the 'gain' though so the IRS agrees with Burkhauser on this one.
The top-earning 1% increases income by 275% but their wealth share decreases inexplicably
written by Ben Leet, July 01, 2013 11:31
The percentage of total household net worth held by the top-saving 1% is recorded by the Survey of Consumer Finances, from the FRB, and was reported on by the Congressional Research Service, June 2012. It shows from 1995 to 2010 the top 1% actually decreased their share of wealth from 34.6% to 34.5%. This is very unlikely, almost laughable. More likely the wealth was shunted into tax havens far from U.S. shores. The CBO report Trends in the Distribution of Income between 1979 and 2007 shows income trends favored the top 1%, who increased their after-tax and after-transfer income share from 8% to 17% -- this while the entire economy expanded its GDP/capita by 66% -- their income almost quadrupled, increased by 275% as reported in the first page of the CBO report. Now the top 1% has total income greater than the total income of the lower-earning 60%, and the lower-saving 50% has total share of saving at 1.1%.
Here is the CRS report: http://www.fas.org/sgp/crs/misc/RL33433.pdf -- How do you measure gains in savings when much of it is hidden from view? This has been a topic of reporting from the Tax Justice Network, and reported at The Real News Network, with reports from former head economist at McKinsey Associates, James Henry I think his name is.

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Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.

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