Piketty versus Hassett: a primer on after-tax income and inequality

The Director of Economic Policy Studies at the American Enterprise Institute, Kevin Hassett, asserts that Thomas Piketty—the author of “Capital in the 21^st Century”—is mistaken to focus on pre-tax and transfer income inequality because it obscures the countervailing increase in the generosity of the welfare state since 1979. According to this view, the political system has a natural way of dealing with a rise in the inequality of market-based income: transfer more income to the disadvantaged.

Is he correct? Well, according to the data Piketty and his coauthors compiled at the World Top Incomes Database, the evolution of market (pre-tax-and pre-transfer) income since 1979 looks like this:

But Hassett says that this view of pre-tax, pre-transfer income ignores the vast increase in government transfer payments—paid for by a progressive income tax—that is generously timed to counteract the “market” trend. Here’s a data series that shows the increase in gross transfer payments:

Hassett’s praise for the potential for income redistribution to rectify injustice in market outcomes is notable, but in fact there have been many comparisons of pre- and post-tax-and-transfer income distributions, starting with this one from the Congressional Budget Office. Spoiler alert: they’re not very different from Piketty’s analysis. The reason? While transfer payments have increased (mostly thanks to an aging population), effective tax rates at the top of the income distribution have fallen sharply since 1980 (and we have the government debt to prove it). The CBO writes:

“The equalizing effect of transfers and taxes on household income was smaller in 2007 than it had been in 1979. The equalizing effect of transfers depends on their size relative to market income and their distribution across the income scale. The size of transfer payments—as measured in this study—rose by a small amount between 1979 and 2007. The distribution of transfers shifted, however, moving away from households in the lower part of the income scale. In 1979, households in the bottom quintile received more than 50 percent of transfer payments. In 2007, similar households received about 35 percent of transfers. That shift reflects the growth in spending for programs focused on the elderly population (such as Social Security and Medicare), in which benefits are not limited to low-income households. As a result, government transfers reduced the dispersion of household income by less in 2007 than in 1979.

Likewise, the equalizing effect of federal taxes depends on both the amount of federal taxes relative to income (the average tax rate) and the distribution of taxes among households at different income levels. Over the 1979–2007 period, the overall average federal tax rate fell by a small amount, the composition of federal revenues shifted away from progressive income taxes to less progressive payroll taxes, and income taxes became slightly more concentrated at the higher end of the income scale. The effect of the first two factors outweighed the effect of the third, reducing the extent to which taxes lessened the dispersion of household income.”

In short, income-redistribution policies failed to counteract growing income stratification over the past four decades. What’s more, these policies did less to equalize post-tax income now than it did in percentage terms in 1979, directly contradicting Hassett’s contention. Indeed, all the studies that have been done confirm the magnitude of income inequality as it has evolved whether you’re looking at pre- or post-tax-and-transfer income. Hassett should go back to defending inequality as economically efficient—at least that argument isn’t refutable with a swift look at the data.