For those who believe in social justice, the unexpected success of Thomas Piketty’s Capital in the Twenty-First Century is a breath of fresh air that brings the discussion of income and wealth inequality into the forefront. There is no doubt that inequality is up, and Piketty has done a good job explaining the rise of the one percent. But he has not done as good a job of explaining what has happened to everyone else, and particularly to the middle class.
Piketty’s data on income distribution has been used repeatedly over the last ten years to argue that virtually all of the gains over the last three decades have gone to the richest 10 percent and that the growth in the middle has been negligible—only three percent from 1979 to 2010. (His American collaborator, Emmanuel Saez, has all of their data on his website). But Piketty has ignored major sources of income and wealth for the middle class.
The Congressional Budget Office (CBO), which conducts an extensive study of American income trends, found that the incomes of middle-income households experienced a rise of 35 percent during this period. The dramatic difference in the two findings is based on Piketty’s selection of only tax records to measure inequality. By contrast, the CBO combines tax records with data on transfers and on household composition from Census social surveys.READ MORE: The Last Time Fatcats Tanked the Economy, the Backlash Was Huge. Why Didn't That Happen This Time?
Relying only on IRS forms leads to understating median incomes. Because IRS forms are created to determine taxable income, there are many elderly filers who appear to have little or no income when in fact they receive Social Security checks (with an average monthly benefit of $2,100 a month for an elderly couple both receiving benefits) and Medicare (which provides an average of $12,000 a year for each beneficiary). In addition, there are many young people who live at home and a few low-earning spouses who file separately. Because of this skewing of the data, the median income of tax filers is considerably lower than the median household income found in Census surveys.
By contrast, the Congressional Budget Office has developed an approach that reflects living standards—it uses post-tax income, includes capital gains and government and employer-provided benefits, and adjusts for the number of people in the household (because people can live better if there are fewer people sharing the income). In the period from 1979 to 2010, Piketty and Saez report that the income of the top 1 percent grew by 260 percent while those in the middle of the income distribution saw only a 3 percent gain. While the CBO reports that the income of the top 1 percent grew by 200 percent (which is not seriously different from Piketty’s figure), their estimate of 35 percent income growth for middle income Americans is, by contract, very different. In essence, the CBO income gains mean that today’s consumers have larger homes, travel more, purchase many more gadgets (HDTVs, smart phones, etc.), eat out more often, and live longer and healthier lives.
So where does the extra income middle class growth in the CBO reports come from? First, there is a substantial increase in non-elderly earnings. The stagnation of average earnings hides the fact that women workers have had huge earnings gains across the board due to higher hourly earnings and more hours worked per year. In contrast, men in the bottom half of the earnings ladder had almost the exact same earnings in both periods, while men in the top half saw their pay rise. Second, employer-paid benefits (that are included in the CBO approach but not in the Piketty or Census surveys) as a share of earnings rose from 11 percent in 1979 to 19 percent of in 2010. Third, the share of elderly households in the middle quintile increased from 14 percent in 1979 to 26 percent in 2010, while the value of Social Security, Medicare, and other government programs has gone from $15,700 to $34,300 (2010 dollars in both years). Fourth, in an odd technical twist, these income gains appear diluted in Census and IRS data because of the fast growth of small single adult households; but the CBO avoids this diminution by adjusting reported income for household size.
Piketty also argues that wealth (what we own—the value of financial and tangible assets minus debts) is becoming more concentrated in the top ten or one percent at the expense of the middle class. Besides being reinvested, wealth can support future consumption or be passed on to heirs. As Piketty notes in his technical appendix, this stream of benefits can be “capitalized” into a single value today. In fact, it is estimated that a private annuity that generates the inflation-adjusted Social Security payments plus Medicare and other benefits would cost the average earner approximately $600,000. Piketty chooses not to include this value and thus underestimates the effective wealth of the middle class.
Consequently, including the capitalized public benefits significantly changes the distribution of wealth of retirees and those nearing or in retirement. Take date from the 2010 Survey of Consumer Finances, which doesn’t include benefits. It shows that among 55-74 year olds, the wealthiest ten percent control 68 percent and the bottom 90 percent 32 percent of assets. Adding the capitalized value of public retirement programs would change this division to 44 percent for the top ten and 56 percent for the bottom 90 percent.
These benefits, which don’t figure in Piketty’s calculations, also have a profound effect on how people live and how much they decide to work and save. Without these known benefits (everyone gets a yearly statement now telling them what their expected benefits will be) most would be forced to save much more and work longer. People actually live in the post-tax, post-transfer world, but Piketty focuses solely on market income that is reported on tax records. The advantages of tax records are that they are very extensive, have a large number of high-income individuals, and have been collected for a long time in many countries. But, as I have argued, tax records have many weaknesses and shouldn’t be used as the sole basis of calculating income and wealth inequality.
Even though polls show that most people think that our economy is not doing very well, they remain very optimistic about their own futures, and those with the highest levels of optimism are young adults. Furthermore, the biannual General Social Survey continues to ask: “compared with your parents at a similar age, is your standard of living better, the same, or lower?” In the 1990s and 2000s, almost two out of three answered better; in the midst of the deep recession the share with a positive response declined to 60 percent for 2008 and 2010.
Today inequality is much talked about and little acted upon. The Occupy Wall Street movement had little staying power, and Republicans have responded to the discussion of inequality by saying that this is simply “class warfare” rhetoric that does not apply to our open and productive economy. I am suggesting that if middle class living conditions were as bad as Piketty paints them to be, the political situation in the US and other countries over the last 30 years would have been very different.