Thursday, June 12, 2014

Avoiding Traps in Arguments About Poverty and Inequality

-- Posted by Neil H. Buchanan

Earlier this week, I published the second part of my two-part series of columns on Verdict regarding the role that "mobility" arguments play in debates over inequality and poverty.  Having first debunked (both on Verdict and the companion Dorf on Law post last Thursday) the claims that America's economy is a great "blender" in which rich and poor find their economic fates easily changed, I turned my attention to various claims about long-term trends in inequality.  At its core, my argument is that the debate over poverty and inequality is ill-served by a focus on whether income and wealth have gotten more or less equal, and on whether they will become more or less equal in the future.  Instead, the focus should be on the consequences of inequality, for whoever happens to experience those consequences at any given time, as well as for society as a whole.

Even if one agrees with me that the present and impending consequences of inequality and poverty are what ultimately matter, one might still ask, "Why would we not care about trends in poverty and inequality?  If things have gotten much worse over time, then that is a spur to action.  And if things are likely to become much better or worse in the future, then we should know about that, too."  Of course, both of those things are true, at least in extreme forms.  Indeed, I could not resist beginning that second Verdict column by comparing our current levels of inequality to Gatsby-era excess, knowing the rhetorical power of that reference.  And if it were actually true that we knew that inequality was hard-wired to all but disappear in, say, ten or twenty years, then I readily acknowledge that our political priorities would change.

Even so, I have recently found myself worried by the focus in the debate on long-term trends (looking either backward or forward), because those arguments seem to be so detached from what ought to matter.  For example, I argue in this week's column that it really should not matter whether inequality has risen or fallen over the last generation or so (even though it has clearly risen), suggesting that a focus on comparisons between 1980 and 2014, for example, somehow makes it sound as if 1980 is the right standard of comparison.  If we say, "Inequality today is unacceptable, because it has risen by some meaningful metrics since 1980," then we are likely to end up trying to get back to that earlier, arbitrary benchmark, no matter how bad things were back then.  We should, instead, be trying to make sure that our policies are minimizing the amount of, and damage from, inequality and poverty.

As I wrote and edited that column, that argument in some ways seemed so obvious that I wondered whether it was even worth making.  I ultimately decided not to drop it from the column, because sometimes obvious points need to be repeated.  After I put the column to bed, however, I remembered specifically what had made me worry that the political discussion was likely to go astray if we became side-tracked by discussions of statistical trends.

Over the past couple of weeks, there was a sudden rush of commentary about an article by Chris Giles, a columnist for the Financial Times, who claimed to have found flaws in Thomas Piketty's blockbuster book.  The fuss ended rather quickly, with Piketty emerging unscathed, but it was interesting to see that Giles's argument, other than attempting to find mere statistical gotchas, ultimately hinged on the substantive claim that Piketty was wrong to argue that inequality had become worse since 1980.  Indeed, one of the reasons that people so quickly dismissed Giles's argument is that he claimed that wealth concentration in the U.S. and Europe has been stable over the last fifty years or so, a claim so at odds with nearly every credible bit of evidence as to be laughable.

Now, it is admittedly fun to see someone make such an obviously bone-headed claim, to be lionized on the right for "taking down Piketty," and then to be exposed as a fraud.  But why act as if his claim ultimately mattered at all?  The unstated assumption appears to have been that it really would have been a big coup if Giles (or anyone) could have proved that inequality has stayed the same, rather than rising dramatically.  As a matter of political salience, that is clearly correct.  My point, however, is that this is a trap into which people who worry about inequality should not allow themselves to be drawn.

In fact, focusing on recent trends in inequality actually makes it easier for conservatives to win the long-term policy battle.  Even though they are clearly wrong to believe that inequality has not recently become much worse, if they can change the terms of debate from inequality itself to changes in inequality over time, then they can simply win by running out the clock.  That is, even if they were to "lose" over the next few years by allowing liberals to adopt weak policies that would simply arrest the rise in inequality, then conservatives could say, "Look, inequality stopped rising.  That's what you liberals were so exercised about, wasn't it?  So shut up."

Again, it is obviously advantageous politically for liberals to point out that the problem is not just poverty and inequality but rising poverty and inequality -- and, even better from a political point of view, that poverty and inequality are rising at an ever-faster rate -- but that is the trap.  Just as I have long argued that Democrats made a huge mistake by castigating Reagan and the Bushes for deficit hypocrisy, which merely reinforced the deficits-are-bad narrative that lured Obama so disastrously into his policy mistakes, it is a mistake to argue that we need to do something about poverty and inequality because they are becoming so much more extreme.  That makes it too easy to redefine what it means to succeed in a way that will leave important work undone.

Using somewhat related reasoning, I also use this week's Verdict column to question the actual importance of Piketty's main argument in his book.  Remember, his proposal to impose taxes on wealth (an idea with which I heartily agree) is based on his claim that we are on our way back to "patrimonial capitalism," in which inherited wealth inexorably sucks up more of the economy, simply by the rules of mathematics.  But again, does it really matter whether he is right or wrong?  Here, we are not being lured into thinking about accepting inequality that already exists, but we are instead being told that we need to impose taxes on wealth now in order to prevent a predicted convergence in wealth that, according to Piketty's calculations, will take generations to unfold.  His prediction ought to be an interesting curiosity, at best, not the basis for a sea-change in our political economy.

We take our victories where we find them, of course, and if this argument by Piketty has gained more traction than other arguments favoring redistribution (many of which gain support from much of Piketty's other work), then so be it.  We are now discussing wealth taxes, and we probably would not have been doing so without the unexpectedly enormous popularity of that book.  We are, however, hitching our wagon to something that might not get us to where we want to be.  If better research were to emerge, showing that Piketty's key inequality (r > g) is likely not to be true for the next few centuries, then the retort from the right will be, "You guys said you were worried that wealth concentration would become irreversible.  Well, you were wrong, so your arguments against inequality are unimportant."  Liberal redistributionists could, and should, then say that this misses the point, but they will be in a very weak position.  It is a trap.


Unknown said...

Your being vague.

Is there or is there not an important question of poverty in the US as distinct from the issue of inequality.

In other words do you contend that there is some total amount of wealth that could be achieved by the least well off part of society that would qualify as having banished poverty but that we have yet to achieve it?

Or are you merely using poverty in a way that allows it to be nothing but a synonym for inequality? Since most people assume that poverty means lacking in overall wealth (not being less wealthy than the next guy) if you are using the word as such it's far from clear.

Unknown said...

In particular, noting that conservatives often switch between the terms poverty and inequality is ambiguous.

It could be that you are accepting this conflation as definitional (what it means to have poverty is just to have a problematic level of inequality),

I, at least, read that part of your piece (coming as part of an accusation that they do it to avoid discomforting the risk) as a condemnation and thus in all likelihood a rejection of such a conflation.


Which it is matters a lot. One might eliminate poverty by simply being rich enough everyone has enough resources not to be poor (though why it should be at some yet to be achieved level and not at the current level is unclear). One can reduce total inequality but it is unlikely you can completely eliminate it.

Moreover, unlike an absolute lack of wealth a society it's unclear how much we can really do to eliminate inequality. One can make sure everyone gets the some allocation of dollars but you can't force people to be friends, let them into your elite social groups etc.. etc.. This kind of exclusivity can ensure that the "right" kind of people can do more with the same number of dollars because they are given preferential access to information, decision makers etc..

So will society react to governmental policies that reduce the variance in incomes with equally exclusionary social norms? Interesting question.

For instance hipsters may not be always materially wealthy but are deeply classist and one can easily imagine this substituting for income inequality in the face of governmental equalization.

David Ricardo said...

Mr. Buchanan’s joining with Mr. Piketty in supporting a wealth tax as a policy prescription for reducing inequality is a great example of where academics support policy that is unworkable in the real world. While taxation of wealth appeals conceptually to those in the ivy covered world, in the real world of taxation where the rest of us tax advisers work the impracticality of wealth taxes render them ineligible for substantial policy implementation.

There are two major wealth taxes in the United States, the Estate Tax at the federal and state levels and the real property tax (and in some cases a tax on intangible property) at the local level. Neither work very well. Both of these taxes, like all wealth taxes suffer serious flaws in implementation. For example,

1. They tax illiquid assets.

2. There is the question and issue of valuation of assets, a difficult and in some cases impossible task.

3. Evasion, both legal and illegal is available and incentivized. With a large degree of wealth denominated in financial assets moving that wealth to a low tax jurisdiction is relatively easy. Hiding assets can also take place.

4. The administration and compliance cost of such taxes is large relative to taxation on income and transactions.

So the idea of a wealth tax may be theoretically ideal but it is realistically impossible. A better substitute could be a large tax on transactions involving the sale of securities in the secondary market, a national sales tax on luxury items and a more progressive, more simplified individual and corporate income tax so that effective tax rates approach statutory tax rates. Setting out a solution such as a significant tax on wealth that is not practical (or politically possible) does not contribute to the policy debate.

Also the economics profession needs to explain to the populace that the historical justification for income and wealth inequality, which was the creation of capital needed to fund investment has not been valid for at least 100 years. With the evolution of capital markets and financial institutions and strong central governments the supply of capital is currently a glut and does need private wealth creation to support investment. This is not 1890. The limiting factor in investment today is lack of demand in the private sector and lack of political will in the public sector. And reducing inequality is one element towards fixing both of those problems.

TruePath said...

@David Ricardo,

In short either you can transfer your property into cash or it isn't really worth what you think it is worth. It might take time but ultimately what it *means* to be wealthy is not to have a hereditary title (which might be neat and very rare but isn't exchangeable for general goods and thus isn't wealth).

One can avoid your objections and simply tax, at time of realization, the tax due based on your length of ownership of the item. Choose the tax so that holding an asset whose value grows at the rate of stock asset growth for a longer period generates the same total value as selling that stock and buying another in the meantime. This avoids both the problem of computation between purchase and sale and avoids discouraging people from moving between assets.

The only way to get around this tax without also avoiding income tax (so it's just as good) is by hiding asset value in things that are legally not regarded as assets (education, social networks, etc...) or by taking on the risk of nonpayment by blackmarket asset holders. I don't think there is a worry the very wealthy will be able to stash all their cash in more diplomas (grad school doesn't pay that well).

The problem of people letting their assets go to churches and other institutions that then act on their behalf seems not substantially larger than the risk that one can do this with income tax. Sure there are problems but they all exist in income tax as well.

David Ricardo said...

@Peter Gerdes

You are correct in your statement “In short either you can transfer your property into cash or it isn't really worth what you think it is worth” and the practice of asset valuation confronts this issue by assessing a discount for lack of liquidity when valuing assets that have no readily available public market.

But that point just illustrates the problem with a wealth tax. The valuation of a single asset must involve the question of how much the discount should be and what value is it to be applied against. No matter how desirable in theory, it is simply administratively impossible to annually apply a wealth tax to a valuation of a highly diversified portfolio of liquid and illiquid assets, of real and intangible assets, of debt and equity in non-publically traded companies, in short, the kind of portfolio wealthy individuals possess. This is done of course at death or in a gift situation, and it is a very complex, expensive and drawn out process. If litigation is involved it can take years. Trust me, been there, done that many times.

Oversimplification with respect to policy recommendations is something that politicians do on a regular basis. It should not be done by trained, experienced and highly educated economists.

Shak Olreal said...

The unstated assumption appears to have been that it really would have been a big coup if Giles (or anyone) could have proved that inequality has stayed the same, rather than rising dramatically. As a matter of political salience, that is clearly correct. My point, however, is that this is a trap into which people who worry about inequality should not allow themselves to be drawn.Buy LOL Boosting
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