The Truth About the Top 1%

By ALAN REYNOLDS October 25, 2007; Page A23

Key legislators and presidential hopefuls in the Democratic Party have proposed raising the top two tax rates. They're also suggesting extra surtaxes for war, for alleviating the Alternative Minimum Tax, for Social Security, and for subsidizing compulsory health insurance. Barack Obama and John Edwards advocate taxing capital gains at 28%; Hillary Clinton favors taxing dividends at the surtaxed income-tax rates.

The argument for these proposals has nothing to do with the impact of higher tax rates on incentives and the economy. It is all about "fairness" -- defined as reducing the top 1%'s share of income.

This political exercise invariably begins by citing dubious statistics about pretax incomes among the top 1% (1.3 million tax returns) as an excuse for raising tax rates on the top 5%, among others. Echoing speeches from Sen. Clinton, Business Week recently exclaimed, "According to new Internal Revenue Service data announced last week, income inequality in the U.S. is at its worst since the 1920s (before the Great Depression). The top percentile of wealthy Americans earned 21.2% of all income in 2005, up from 19% in 2004."

These statistics are extremely misleading.

First of all, the figures do not describe the top percentile's share of "all income," but that group's share of "adjusted" gross income (AGI) reported on individual tax returns. For one thing, thousands of professionals and business owners who used to report most of their income under the corporate tax responded to lower individual income-tax rates after 1986 and 2003 by reporting more income under the individual tax as partnerships, LLCs and Sub-S corporations.

Peter Merrill of PricewaterhouseCoopers found that "since the Tax Reform Act of 1986 . . . the share of business income earned through pass-through entities has increased by 75% from 29% in 1987 to 52% in 2004." Business profits accounted for just 11.1% of the income reported by the top 1% in 1986, according to economists Thomas Piketty and Emmanuel Saez, but that business share leaped to 21.2% by 1988 and to 29.1% in 2005.

It is this bookkeeping shift, moving business income from the corporate to the individual tax, not CEO pay, which raised the top 1%'s share on individual tax returns. Income reported on W2 forms -- salaries, bonuses and exercised stock options -- accounted for only 57.2% of total income among the top 1% in 2005, down from 63% in 2000 and 65.7% in 1986. Real compensation among the top 1% actually fell 7% from 2000 to 2005.

Turning to the denominator of this ratio ("all income"), a huge portion of middle and lower income is no longer reported on tax returns. A larger and larger share of middle-class investment income is now accumulating outside of AGI because it is inside IRA, 401(k) and 529 savings plans.

The CBO reckons the top 1% accounted for more than 59% of all capital gains, interest, dividends and rent reported on individual tax returns by 2004. Yet estimates of the share of national wealth of the top 1% range from 21%-33%.

If the top 1% own 21%-33% of all capital, how could they be collecting 59% of the income from capital? They can't and they aren't. The top 1% is simply reporting a rising share of capital income because those with more modest incomes are keeping a rising share of their capital income unreported -- in IRA, 401(k) and 529 accounts. Millions also shrink their "adjusted" incomes by subtracting contributions to IRAs unavailable to the rich.

Another huge swath of middle and lower income is excluded because AGI includes only the taxable portion of Social Security benefits and totally misses most other transfer payments such as Medicaid, food stamps and the Earned Income Credit. The Canberra Group, an international group of experts on income statistics brought together from 1996-2000 by the OECD, World Bank, U.N. and others, insisted household income must include everything that "increases the recipients' potential to consume or save." Government transfers amounted to $1.5 trillion in 2005 -- more than the total income of the top 1% in the basic Piketty and Saez estimates ($1.2 trillion).

As a result of such huge omissions, and tax avoidance, the AGI of $7.5 trillion in 2005 was $3.7 trillion smaller than pretax personal income (personal income was $10.3 trillion in 2005, after subtracting $875 billion of payroll taxes). Anyone suggesting AGI is a more accurate measure than personal income is obliged to argue that GDP in 2005 was exaggerated by 29.4%.

Estimated income shares from the IRS or Messrs. Piketty and Saez are not about income per household, but income per tax return. That matters because the top fifth of households average two salaries per tax return. The Census Bureau reports that the top fifth accounted for 26.8% of all full-time works last year while the bottom fifth accounted for just 5.7%. In fact, 64.5% of the households in the bottom fifth had nobody working, not even part time for a few weeks. When labor economists discuss income inequality, they habitually switch to speculating about skill-based differences in hourly wages, totally ignoring differences in hours worked.

Third, the latest IRS figures are not comparable with those of 1986, much less with 1929, because the definition of AGI changes with changes in tax law. Such estimates differ greatly, with the IRS saying the top 1% received only 11.3% of income in 1986 (because AGI then excluded 60% of capital gains) while Messrs. Piketty and Saez put that year's figure at 13.1% and the CBO says it was 14%.

The IRS figures only go back to 1986, so the Business Week comparison with the 1920s is invalid. The new figure is from the IRS but the old one is from Messrs. Piketty and Saez. Their recent estimates are also not comparable to their prewar estimates. Before 1944, their figures were obtained by dividing top income shares by 80% of personal income. Their estimates for 2005 were obtained by dividing top incomes by the $6.8 trillion left on tax returns after excluding even taxable transfer payments.

If total income for 2005 was defined as it was for 1928, then the share of the top 1% would have dropped to 13.3% in 2005, compared with 19.8% in 1928. Besides, as Messrs. Piketty and Saez explained, "our long-run series are generally confined to top income and wealth shares and contain little information about bottom segments of the distribution."

A fundamental problem with all tax-based income data involves "taxable income elasticity." Numerous studies, some by Mr. Saez, show that the amount of top income reported on individual tax returns is highly sensitive to changes in marginal tax rates on individual income, corporate income and capital gains. After the tax on dividends was reduced in 2003, for example, top-bracket investors held more dividend-paying stocks in taxable accounts (rather than in nontaxable accounts) and fewer tax-exempt bonds.

When the top tax on capital gains was cut in 1997 and 2003, investors reacted by trading stocks more frequently and realizing more capital gains in taxable accounts. In the Piketty-Saez data, capital gains accounted for only 10.8% of the top 1%'s income from 1987 to 1996, when the capital gains tax was 28%. By contrast, capital gains accounted for 16.9% of the top 1%'s reported income from 1997 through 2002, when the tax was down to 20%.

Even if estimates of the top 1%'s income share were not so sensitive to changes in tax rates, they would still tell us nothing about what happened to incomes among the other 99%. The top 1%'s share always falls in recessions, even aside from capital gains. But that certainly doesn't mean recessions raise everyone else's income.

"It is a disputed question," wrote Messrs. Piketty and Saez, "whether the surge in reported top incomes has been caused by the reduction in taxation at the top through behavioral responses." In fact, their data clearly suggest that higher tax rates on top incomes, dividends and capital gains would sharply reduce top incomes, dividends and capital gains reported on individual tax returns. Such behavioral responses would have little impact on actual income or wealth at the top, while nonetheless leaving middle-income taxpayers stuck with a much larger share of the tax burden.

Mr. Reynolds, a senior fellow with the Cato Institute, is the author of "Income and Wealth" (Greenwood Press 2006).

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Mead Example

This is an example of referring to an offsite MP3 file hosted at www.freedrive.com. Click on the link below and your computer should automatically download and being playing it (I think). Mead MP3

Global Warming links at FreedomKeys

Collection of links from this website "Let's be clear: the work of science has nothing whatever to do with consensus. Consensus is the business of politics. Science, on the contrary, requires only one investigator who happens to be right, which means that he or she has results that are verifiable by reference to the real world. In science consensus is irrelevant. What is relevant is reproducible results. The greatest scientists in history are great precisely because they broke with the consensus." -- Michael Crichton

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Alarmist Claims are Melting Under Scrutiny

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The earth has spent most of its time in ICE AGES. Are YOU smart enough to see WHERE WE ARE NOW on this chart? Also see: "Read the Sunspots"

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WHY POLITICIZED SCIENCE IS DANGEROUS

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SEE THE AMERICAN ECOLOGICAL CHURCH OF GLOBAL WARMING, HERE.

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See: “the world’s southernmost continent shows that temperatures during the late 20th century did not climb as had been predicted by many global climate models” HERE

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So far, 15,000 scientists have signed the petition saying the global warming is NOT caused enough by humans, if at all, to make public policy about it. See who they are HERE.

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TOTAL greenhouse gas contributions FROM HUMANS add up to only about .0028 of the greenhouse effect.

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Michael Crichton's State of Fear and the END of Radical Environmentalism

A divide thanks to regulation

Culture And Commerce November 2007 Atlantic Monthly

Real estate may be as important as religion in explaining the infamous gap between red and blue states.

by Virginia Postrel

A Tale of Two Town Houses

In 2000, my husband and I moved out of our mid-1970s three-bedroom town house in Los Angeles and into a brand-new three-bedroom town house in Uptown Dallas. At the time, the two were worth about the same, but the Dallas place was 1,000 square feet bigger. We’ve moved back to L.A., and we’re glad we kept our old house. Over the past seven years, its value has roughly doubled. By contrast, we sold our Dallas place for $6,500 less than we paid for it.

It’s not that we bought into a declining Dallas neighborhood: Uptown is one of the hottest in the city, with block upon block of new construction. But the supply of housing in Dallas is elastic. When demand increases, because of growing population or rising incomes, so does the amount of housing; prices stay roughly the same. That’s true not only in the outlying suburbs, but also in old neighborhoods like ours, where dense clusters of town houses and multistory apartment buildings are replacing two-story fourplexes and single-family homes. It’s easy to build new housing in Dallas.

Not so in Los Angeles. There, in-creased demand generates little new supply. Even within zoning rules, it’s hard to get permission to build. When a local developer bought three small 1920s duplexes on our block, planning to replace them with a big condo building, neighbors campaigned to stop the proj­ect. The city declared the charming but architecturally undistinguished buildings historic landmarks, blocking demolition for a year. The developer gave up, leaving the neighborhood’s landscape—and its housing supply—unchanged. In Los Angeles, when demand for housing increases, prices rise.

Dallas and Los Angeles represent two distinct models for successful American cities, which both reflect and reinforce different cultural and political attitudes. One model fosters a family-oriented, middle-class lifestyle—the proverbial home-centered “balanced life.” The other rewards highly productive, work-driven people with a yen for stimulating public activities, for arts venues, world-class universities, luxury shopping, restaurants that aren’t kid-friendly. One makes room for a wide range of incomes, offering most working people a comfortable life. The other, over time, becomes an enclave for the rich. Since day-to-day experience shapes people’s sense of what is typical and normal, these differences in turn lead to contrasting perceptions of economic and social reality. It’s easy to believe the middle class is vanishing when you live in Los Angeles, much harder in Dallas. These differences also reinforce different norms and values—different ideas of what it means to live a good life. Real estate may be as important as religion in explaining the infamous gap between red and blue states.

The Dallas model, prominent in the South and Southwest, sees a growing population as a sign of urban health. Cities liberally permit housing construction to accommodate new residents. The Los Angeles model, common on the West Coast and in the Northeast Corridor, discourages growth by limiting new housing. Instead of inviting newcomers, this approach rewards longtime residents with big capital gains and the political clout to block projects they don’t like.

The direct results of these strategies are predictable: cheap, plentiful housing in some places, and expensive, scarce housing in others. A remodeler working on my L.A. town house a couple of years ago wistfully recalled visiting a cousin in Arlington, Texas, between Dallas and Fort Worth. He wanted to move there himself. In Arlington, he said, “you can buy a million-dollar house for $200,000.” According to Coldwell Banker’s annual sur- vey, a 2,200-square-foot, four-bedroom “middle-management” home costs around $141,000 in Arlington (or, for big spenders, $288,000 in Dallas), compared with $1 million or more in the L.A. area. One man’s million-dollar dream home is another’s plain old tract house.

Many people do pack up and move, if not to Arlington, then to Las Vegas or Charlotte. Historically a magnet for educated migrants, California has begun losing college-educated residents, on net, to other states, in large part because of the high cost of housing. Most of the South’s population growth since the 1980s has come from the lure of cheap housing created by liberal permitting policies, according to new research by the Harvard economists Edward Glaeser and Kristina Tobio. By lowering the cost of housing, these policies give residents higher real incomes compared with similarly paid workers elsewhere—a strong incentive to move, even if you don’t like bugs or hot summers. The mobile middle class gravitates to the cities where housing is affordable. “If you’re your basic $85,000-a-year person, you can’t own in Los Angeles. You can’t do it,” says the Wharton School economist Joseph Gyourko. And if you’re your basic $45,000-a-year person, closer to the U.S. median household income, you’d better pack for Texas.

That doesn’t mean Los Angeles and San Francisco are in any danger of turning into Detroit and Buffalo. To the contrary, Gyourko calls them “superstar cities,” places that offer “a rare blend” of stimulating leisure activities and a highly productive work environment. A life that looks “rushed” and “materialistic” to the folks headed for North Carolina feels exciting and creative to die-hard urbanites. As a friend who recently moved from Manhattan to Santa Monica once said to me, “When people say a place is ‘good for raising children,’ that means it’s boring.” But not everyone with a taste for urban amenities can afford the superstar life. As the number of affluent Americans grows, the rich are bidding up the price of living in these special places, increasing the gap between the superstar cities and everyplace else.

People in these high-price areas respond that they have no control over housing costs. Everyone wants to live in California, and the land is already full of houses. This isn’t Texas, with its miles and miles of empty old cotton fields. True, land is cheaper and more plentiful in less-developed parts of the country. But high-price areas could put many more units on the land they have. Research by Gyourko, Glaeser, and Raven Saks found that the lowest-density areas around expensive cities tend to have the least new construction and the most land-use restrictions. It’s actually somewhat easier to build in more densely populated towns and neighborhoods—the opposite of what you’d expect if a shortage of empty land were the problem.

Some of the higher price of L.A. real estate does reflect the intrinsic pleasure of living there, as I’m reminded every time I walk out my door into the perfect weather. Some of the price reflects the productivity advantages of being near others doing similar work (try selling a screenplay from Arlington, Texas). All of these benefits—and the negatives of traffic and smog—are reflected in the price of land.

But what exactly is that price? Consider two ways of computing the price of a quarter acre of land. You can compare the value of a house on a quarter acre with that of a similar house on a half acre. Or you can take the price of a house on a quarter acre and subtract the cost of the house itself—the price of construction. Either way, you get the value of an empty quarter acre. The two numbers should be roughly the same. But they aren’t. The second one is always bigger, because it includes not just the property but the right to build. Expanding your quarter-acre lot to a half acre doesn’t give you per- mission to add a second house.

In a 2003 article, Glaeser and Gyourko calculated the two different land values for 26 cities (using data from 1999). They found wide disparities. In Los Angeles, an extra quarter acre cost about $28,000—the pure price of land. But the cost of empty land isn’t the whole story, or even most of it. A quarter- acre lot minus the cost of the house came out to about $331,000—nearly 12 times as much as the extra quarter acre. The difference between the first and second prices, around $303,000, was what L.A. home buyers paid for local land-use controls in bureaucratic delays, density restrictions, fees, political contributions. That’s the cost of the right to build.

And that right costs much less in Dallas. There, adding an extra quarter acre ran about $2,300—raw land really is much cheaper—and a quarter acre minus the cost of construction was about $59,000. The right to build was nearly a quarter million dollars less than in L.A. Hence the huge difference in housing prices. Land is indeed more expensive in superstar cities. But getting permission to build is way, way more expensive. These cities, says Gyourko, “just control the heck out of land use.”

The unintended consequence of these land-use policies is that Americans are sorting themselves geographically by income and lifestyle—not across neighborhoods, as they used to, but across regions. People are more likely to live surrounded by others like themselves, creating a more-polarized cultural map. In the superstar cities, where opinion leaders congregate, the perception is growing that the country no longer has a place for middle-class life. Yet the same urban sophisticates who fret that you can’t live decently on less than $100,000 a year often argue vociferously that increasing density will degrade their quality of life. They may be right—but, like any other luxury good, that quality commands a high price.

The URL for this page is http://www.theatlantic.com/doc/200711/housing.