Piketty’s World Inequality Review: A Critical Analysis

Yves here. It’s surprising to see Piketty and even more so, one of this co-authors, Gabriel Zucman, make such strong claims for tax data as a way to measure income inequality. The rich and super rich engage in tax avoidance and evasion, to the degree that Zucman has estimated that 6% of the world’s wealth is hidden. First, that wealth was hidden to avoid paying taxes on it and/or to hide its criminal origins (such as looting governments). Second, the income on hidden wealth is also by nature hidden.

By James K. Galbraith, Lloyd M. Bentsen Jr. Chair in Government and Business Relations, University of Texas at Austin. Originally published at the Institute of New Economic Thinking website

Thomas Piketty and his colleagues[1] have produced a new exposition of their empirical work, entitled the World Inequality Report 2018 (hereafter: WIR). Their purpose is to showcase the exploration of income and wealth inequalities begun with the World Top Incomes Database (Atkinson and Piketty 2010) and theorized in Piketty’s epic Capital in the XXI Century (2014). In particular the WIR concentrates on the presentation of measures and evidence; the stated goal is to inform a “deliberative process” with “more rigorous and transparent information on income and wealth” than has been available to date. In a review article published on-line and open access in Development and Change on December 24, 2018, I initiate this “deliberative process” by examining the WIR data and the claims made for it.

The ground-breaking, systematic and transparent methodology on which the WIR rests is largely the use of tax records–specifically income tax records–mined to show the income shares of tranches of the income-earning population: top one percent, top ten percent, next forty percent, and bottom fifty percent are the usual divisions. These Piketty and his colleagues argue are more complete, comprehensive, and comparable across countries and through time than the generally-used alternative, which is household or person-based surveys.

The WIR authors write disparagingly of the “Gini index”—the inequality measure most prevalent in such surveys—which they find too “technical” and not sufficiently intuitive. But they also object to survey methods: “The main problem with household surveys, however, is that they usually rely entirely on self-reported information about income and wealth. As a consequence, they misrepresent top income and wealth levels, and therefore overall inequality.” (p. 29) This sweeping critique carries on for several pages, brushing aside a body of research comprising thousands of papers and millions of survey observations, including the work of the Luxembourg Income Studies, the World Bank, Eurostat, the Economic Commission for Latin America, and the United States Census Bureau among scores of national data-collection agencies. It is a repudiation of what almost every previous researcher has done in this field over fifty years.

But are tax data really better? Where survey and tax measures both exist, and report different results, should one systematically prefer a measure based on taxes? The answer depends in part on the quality of the survey measures. But it also must depend in part on the quality, consistency, length and continuity of the national tax record, and in particular of the income tax. The WIR authors acknowledge that tax data have limits, in particular they cannot cover income and wealth hidden from tax authorities in tax havens. But the question of the quality of tax records goes much further than this.

My new essay examines the question from three points of view: the coverage provided by tax data in the world economy, the consistency of tax data with other sources of information on income inequality, and the peculiarities of tax-based measurement of inequality in the United States. It goes on to make a comparison with measures drawn from other forms of administrative data—specifically payroll records, used by the University of Texas Inequality Project—which are generally more consistent with records of inequality measured in household surveys than are the WIR’s tax records.

In brief summary, the review shows that by comparison with payroll and survey data, available records from tax files are relatively sparse, and biased toward wealthier countries and those that were once British colonies, which imposed income tax. It shows that tax data are far less consistent with survey and payroll records than are the latter two with each other. And it shows that even within the United States, a country with good tax records by world standards, changes in tax law distort the WIR’s measures of changes in the top income shares, while a misunderstanding of the nature of low-income tax filers in the US leads to a dramatic but nonsensical claim that the earnings of the bottom 50 percent of Americans have “collapsed” in recent decades.

Overall, the review casts doubt on claims by the authors of the World Inequality Report to have produced major advances in the study of world economic inequality, and documents that many of the findings touted in the Report as new and unprecedented have in fact been reported in the literature for years, even decades in some cases.

[1]   The credited co-authors are Facundo Alvaredo, Lucas Chancel, Thomas Piketty, Emmanuel Saez and Gabriel Zucman.

piketty inequality chart

Figure 1 Top One Percent Shares from the World Inequality Database, showing an unacknowledged data break due to the US Tax Reform Act of 1986. Adjusting the data for the change in the tax definition of income would show that the US top share tracks the UK and Canada very closely. Low numbers for France and Italy are likely due to inferior tax recording of high income persons, not an underlying condition of less inequality.

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14 comments

  1. Mark

    I do not see your and the essay’s point about tax evasion impacting actual reported income more harshly than surveys. Even in cases where answers to surveys are required by law, the penalties and effort undertaken by enforcement agencies are going to be several orders of magnitude greater in cases of tax evasion compared to incorrect survey answers. Furthermore income taxes are frequently automated which makes correct or at least some reporting the default case while the default state of surveys is no data at all. Only by taking action is any data generated. While it is theoreticaly possible that surveys are more accurate because the incentive of lower taxes is also stronger, the logic argument given here is not self-evident and actual empirical data is needed for prove.
    The critic regarding change in tax reporting over time is quite correct altough I am far from certain that neither survey methods nor questions haven’t changed over the last century. A feature not talked about at all is samplesize which always favours actual tax data over surveys given that everyone with an income over a small threshold must pay taxes.
    The only empirical evidence provided in the essay is self-referential. If one proxy (survey data) is faulty correlation between it and another proxy (payroll records) does not prove that the first proxy is correct because it remains possible that both proxies have the same deficiencies and are therefore correlated – instead of both being a good approximation of reality.
    This is not to say that the essay must be wrong or Piketty et al’s assertions must be right, but with only the information provided here a lack of evidence still exists in my opinion.

    Reply
    1. Yves Smith Post author

      With all due respect, your comment indicates a lack of familiarity with tax reporting and accounting, as well as tax avoidance and evasion.

      Income taxes are not automated in the US. Income for the rich and super rich consists to a significant degree of capital gains, not labor income. And the idea that officials can or do crack down on tax evasion effectively or even much is false. You can walk through Manhattan and identify businesses that are probable money launderer due to being in low-end cash taking activities (pizza parlors, cheap jewelry) and not having remotely enough activity to support the rent. At the higher end, you have the use of vehicles in secrecy jurisdictions like the Isle of Man or the Caymans.

      The IRS does virtually no enforcement and what it does is concentrated on small fry, because rich taxpayers usually beat the IRS in court.

      Reply
      1. Mark

        Well, I stand corrected and you are correct in assuming that I am not familiar with US tax accounting. In Germany and to my knowledge much of Europe payroll taxes are deducted by the employer and directly payed to the state while banks keep a certain percentage of dividends and capital gains directly. A tax declaration is only necessary if one has a reason to get some money back, dealings with foreign banks or income from non bank sources like real estate, partnerships or direct business ownership. Thus I said tax reporting is at least in part automated. Given that we are talking about a worldview project this should be at least somewhat relevant.
        Thank you for replying.

        Reply
      2. John Zelnicker

        @Yves Smith
        January 3, 2019 at 10:32 pm
        ——-

        You are correct that the IRS focuses on lower income audits rather than the wealthy. However, I’m not sure it’s because the wealthy usually win in court, although that may be true.

        Congress, in it’s infinite wisdom (/s), has decided that the greatest threat to our tax collection system are the low income folks who might pad or understate some of their income in order to get a few hundred extra dollars in their refund. The IRS is mandated to examine tax returns claiming the Earned Income Tax Credit and the Child Tax Credit much more closely than those who do not claim these credits.

        And, tax preparers like me are held to a far higher standard of due diligence in determining the taxpayer’s qualifications for those credits.

        With the severe budget cuts the IRS has suffered over the past ten or so years, there just aren’t enough resources to do this and audit the wealthy to the extent that they should. (And the examiners I have spoken with all would rather be going after potential collections in the tens or hundreds of thousands of dollars rather than in the tens or hundreds.)

        Reply
  2. CanCyn

    this line towards the end: “… nonsensical claim that the earnings of the bottom 50 percent of Americans have “collapsed” in recent decades.” is nonsensical itself. Anyone who doesn’t believe that low and middle income earners’ incomes have collapsed is living in a very opaque bubble, head firmly planted up *ss.
    I earned $12.00 per hour in retail with only a high school education in the early 1980s. I’m Canadian but I don’t think the two countries are so different in this regard. In 2018 dollars, according to the Bank of Canada inflation calculator that is $26.00 per hour!! Do you know anyone in retail with only a high school education earning $26.00 per hour today? My husband, again, no high school, was making twice that amount in a steel mill in the eighties. Know anyone earning almost $60 per hour in any kind of factory work today? I sure don’t. That includes the people who work in that factory now, it is mostly precarious contract work, at much lower wages, the union having been busted long ago
    Further, I went back to school in the late 80s and ended with my Masters in Library Science, my first full-time job in the early 90s had me earning the 1990ish equivalent of that $12.00 per hour, things were already going south. It took me quite a few more years to outpace that 1980 retail wage. My husband and I are living proof that wages have collapsed. I don’t care how anecdotal that is, I know the truth, just by looking around and talking to people.
    It is beyond frustrating to have to argue against this stuff.

    Reply
    1. CanCyn

      one correction, that should be “only high school” not “no high school” with regard to my husband’s education.

      Reply
    2. The Rev Kev

      The second chart at the top of the page at https://aneconomicsense.org/2015/02/13/why-wages-have-stagnated-while-gdp-has-grown-the-proximate-factors/ tells the story. You can see wages tracking with GDP until the 1970s when it starts to flat-line. As a suggestion, draw this chart when explaining it to people but fold it over on the 1975 point so they cannot see what happens after. Show them how wages & GDP both go up in tandem and understand that point. Then unfold the second half and show them what happens next. Tell them that between the two levels by 2014 that there must be trillions of dollars. Then ask them how if workers are not getting any of it since wages are the same, just where exactly all that money went. A person understands more when hit in the hip-pocket nerve.

      Reply
    3. Al

      I was unaware that personal anecdotes are comparable to data sets that can run into the tens of millions and more, fascinating.

      Reply
  3. L

    One question for the author. How do you account for the fact that payroll records, at least as I understand them, generally omit capital gains which is where the upper income generally get most of their real wealth. Stock buybacks and share disbursements are not generally considered “payroll” as I understand it.

    The advantage of tax is that it should, at least in theory, show money received by individuals rather than just money sent out in one category.

    Reply
  4. Pookah Harvey

    From the Guardian:

    The bosses of the UK’s biggest companies are facing renewed scrutiny over excessive pay deals, after new figures showed top executives earned the average worker’s annual salary within the first three working days of 2019.

    Dubbed “Fat Cat Friday”, 4 January is the date by which the average CEO of a FTSE 100 company pockets the equivalent take-home pay of a typical full-time worker in the UK.

    Calculations by the High Pay Centre thinktank and the professional HR body the Chartered Institute of Personnel and Development (CIPD) show top executives are earning 133 times more than the average worker, at a rate of around £1,020 per hour or £3.9m annually. That’s up 11% compared to a year earlier.

    Reply
  5. Oh Yeah

    Republicans have been attacking unions (Kock Brothers) and the I.R.S. for years. The end game is winning and the rules went out the window years ago.

    Reply
  6. Ben

    Of those commenting here, how many have read the book? I know I am late to this conversation, but wanted to add my two cents.
    If the critique offered here is real and legit, then income/wealth inequality is quite likely even worse than Pikkety and Saez show in their book. Which in no way (that I can see) devalues the message of their work.
    And second, having read as much of the book as my cognition allows me to, I don’t think that specific levels of inequality are as an important take away from ‘Capital’ as understanding the mechanisms that led us to this point.
    So whether income/wealth inequality is really really bad, or it is really really really bad, IMHO Pikkety and Saez work is still on the money.

    Reply

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