The 1% Conundrum: How Much Income Inequality Is There, Really?

Guest post by Scott Winship, Brookings Institution. Follow him on Twitter: @swinshi

My last post provided an initial look at the inequality figures focusing on "the top one percent," which show sharply rising income concentration over the past 30 years.  But those figures rely entirely or heavily on tax return data from the IRS.  This creates some issues that warrant skepticism about the magnitude of the increase I described.

Piketty and Saez rank order and compare tax returns to isolate "the top one percent."  But that is not the same thing as rank-ordering and comparing householdsPiketty and Saez themselves note that even after a small adjustment to add in non-filers, there are 30 percent more tax returns than there are households, and average tax-return income is 25 percent smaller than average household income.  Research by the Federal Reserve Board looking at tax returns in 2000 estimated that the number of tax returns filed exceeded the number of tax returns filed by household heads and their partners by 25 percent. 

There are two reasons for the discrepancy.  First, unmarried couples (and many married couples) file separate tax returns, as do teens with summer jobs and college kids on work-study. You can see why this might be a problem: the "top 1 percent" of tax returns ends up being a bigger group than the top 1 percent of households because the bottom "99 percent" is padded with these extra people.  That's fine as far as it goes, and if the ratio of tax returns to households hasn't risen appreciably, then the trend might be the same for households even if the share of income received by the top one percent of households is overstated by the share received by the top one percent of tax returns.

The other reason that average tax-return income is smaller than average household income is that the IRS data excludes income from nontaxable sources, the most important of which include nontaxable amounts of government benefits and of pensions and employer-provided health insurance. Including these sources of income would tend to lower the share of income going to the top, and it might reduce the increase too.

CBO's figures are theoretically based on households, and they include all public benefits and employer-provided health coverage as income.  But in some sense, the CBO figures are even trickier to interpret than the Piketty/Saez figures.  That's because CBO analysts start with households in the Current Population Survey data, attempt to disaggregate households and their incomes to tax-return-like units, and append actual IRS tax return data from similar-looking tax-return-like units to the disaggregated household data.  They then aggregate the incomes back into households and combine income from the tax return data with income from the household survey.  Finally, they rank people (not households or tax returns) on the basis of incomes adjusted to account for household size differences, but report household incomes and shares going to the top and going to other groups in non-adjusted dollars.

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Megan McArdle is a columnist at Bloomberg View and a former senior editor at The Atlantic. Her new book is The Up Side of Down.

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