Can we trust US interwar inequality figures?

This question is the one that me and Phil Magness have been asking for some time and we have now assembled our thoughts and measures in the first of a series of papers. In this paper, we take issue with the quality of the measurements that will be extracted from tax records during the interwar years (1918 to 1941).

More precisely, we point out that tax rates at the federal level fluctuated wildly and were at relatively high levels. Since most of our inequality measures are drawn from the federal tax data contained in the Statistics of Income, this is problematic. Indeed, high tax rates might deter honest reporting while rapidly changing rates will affect reporting behavior (causing artificial variations in the measure of market income). As such, both the level and the trend of inequality might be off.  That is our concern in very simple words.

To assess whether or not we are worrying for nothing, we went around to find different sources to assess the robustness of the inequality estimates based on the federal tax data. We found what we were looking for in Wisconsin whose tax rates were much lower (never above 7%) and less variable than those at the federal levels. As such, we found the perfect dataset to see if there are measurement problems in the data itself (through a varying selection bias).

From the Wisconsin data, we find that there are good reasons to be skeptical of the existing inequality measured based on federal tax data. The comparison of the IRS data for Wisconsin with the data from the state income tax shows a different pattern of evolution and a different level (especially when deductions are accounted for). First of all, the level is always inferior with the WTC data (Wisconsin Tax Commission). Secondly, the trend differs for the 1930s.

Table1 for Blog

I am not sure what it means in terms of the true level of inequality for the period. However, it suggests that we ought to be careful towards the estimations advanced if two data sources of a similar nature (tax data) with arguably minor conceptual differences (low and stable tax rates) tell dramatically different stories.  Maybe its time to try to further improve the pre-1945 series on inequality.

On the (big) conditions for a BIG

This week, EconTalk featured a podcast between Russ Roberts and Michael Munger (he of the famous Munger-proviso which I live by) discussed the Basic Income Guarantee (BIG). In the discussion, there is little I ended up disagreeing with (I would have probably said some things differently though). However, I was disappointed about a point (which I made here in the past) which economists often ignore when discussing a BIG: labor demand.

In all discussions of the BIG, the debates always revolve around the issue of labor supply assuming that it will induce some leftward shift of the supply curve. While this is true, it is irrelevant in my opinion because there is a more important effect: the rightward shift of the labor demand curve.

To make this argument, I must underline the conditions of a BIG for this to happen. The first thing to say is that a) the social welfare net must be inefficient relative to the alternative of simply giving money to people (shifting to a BIG must be Pareto-efficient); b) the shift mean that – for a fixed level of utility we wish to insure – the government needs to spend less and; c) the lower level of expenditures allows for a reduction in taxation.  With these three conditions, the labor demand curve could shift rightward. As I said when I initially made this point back in January 2016:

Yet, the case is relatively straightforward: current transfers are inefficient, basic income is more efficient at obtaining each unit of poverty reduction, basic income requires lower taxes, basic income means lower marginal tax rates, lower marginal tax rates mean more demand for investment and labor and thus more long-term growth and a counter-balance to any supply-side effect.

As I pointed out back then, the Canadian experiment (in Manitoba) with a minimum income led to substantial improvements in health outcomes which meant lower expenditures for healthcare. As a result, b) is satisfied and (by definition) so is a). If, during a shift to a BIG, condition c) is met, the entire discussion regarding the supply effects becomes a mere empirical issue.

I mean, equilibrium effects are best analyzed when we consider both demand and supply…

P.S. I am not necessarily a fan, in practice, of BIG. Theoretically, the case is sound. However, I can easily foresee policy drifts where politicians expand the BIG beyond a sound level for electoral reasons (or even tweak the details in order to add features that go against the spirit of the proposal). The debate between Kevin Vallier (arguing that this public choice reasoning is not relevant) and Phil Magness (who argues the reverse) on this issue is pretty favorable to Magness (in my opinion). UPDATE: Jason Clemens over at the Fraser Institute pointed to a study they made regarding the implementation of a BIG in Canada. The practical challenges the study points too build upon the Magness argument as applied in a Canadian perspective.