A New Look at Income Inequality in the US

Yesterday, at the Hoover Economic Policy Working Group (EPWG), David Splinter of the Staff of the Joint Committee on Taxation discussed a paper he wrote with Gerald Auten of the Office of Tax Analysis at the Department of Treasury. A video of Splinter’s presentation, including many questions and answers, is posted on the EPWG web page here along with the paper “Income Inequality in the United States: Using Tax Data to Measure Long-term Trends” My internet went down so the video is really nice to have. There are also links there to Splinter’s excellent web page.

The paper and presentation explore in fascinating detail various data sources that bear on the widely reported finding of Thomas Piketty and Emmanuel Saez that the income distribution has widened. By adjusting for key technical issues and examining alternative assumptions for distributing income, their paper shows that there was little change in after-tax top income shares since the early 1960s, in contrast to the findings of Piketty and Saez (2003), which are based on individual tax returns.

Many have written about this topic and many, including me, have noted limitations of the data, including that IRS data are not ideal for measuring income because, for example, people report more income when the tax rate goes down, or because transfers are not in the data.  The important and highly original contribution of Splinter and Auten is that they have actually done the empirical work in a convincing quantitative way. Here is a graph from their paper which illustrates the difference.

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But even if the Piketty-Saez series are correct, policy should focus on the cause of the change. Is it a poor education system in which educational opportunities are restricted, especially for those who are disadvantaged, a fact that COVID 19 has made very clear? More generally, the explanation for the widening inequality may be restrictions on economic freedom. Not extending economic freedom to all in education is one example. Regulatory capture, crony capitalism, deviations from the rule of law are other examples.

Ironically some argue that moving away from the principles of economic freedom—higher marginal tax rates, more regulations, more discretion for regulators, more interventionist macro policy—is the way to change the distribution of income.  That would be a great tragedy since history shows that it has been more economic freedom that has pulled people out of poverty. And as Splinter and Auten show, it may not even be a distribution problem.

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Time for a Reentry to a Monetary Policy Strategy

In a new paper I examine the ways for the Fed to engage in a reentry to a rules-based monetary policy. For several years, starting around 2017, the Fed had begun to move to a rules-based monetary policy that had worked well in the US in the 1980s, 1990s, and in other years. Many papers were written at the Fed about the benefits, and the Fed began to report on rules-based policy in its Monetary Policy Report.

That move was interrupted in the first quarter of 2020 when COVID-19 hit. The Fed took a number of actions to deal with the effects and by most accounts these actions were special and were not consistent with rules-based policies. The Fed also stopped reporting on rules-based policy in its Monetary Policy Report.

Later in 2020 the Fed completed a review of its monetary policy and reported on possible changes in policy. By early 2021 the Fed began to put rules back in its Monetary Policy Report and the new rules reflected some of these changes.  But these changes have not yet affected actual monetary policy decisions and there is evidence of big difference between the rules-based policy and the actions of the Fed.

To develop an optimal reentry, I consider a recent paper by David Papell and Ruxandra Prodan.  For the Taylor (shortfalls) rule & the balanced approach (shortfalls) rule, they replaced the difference between the unemployment rate in the long run and actual unemployment rate with minimum of the difference and 0. If the unemployment rate is 3.5 percent and long run level is 4.0 percent, the interest rate is not raised.  That is, zero is the minimum of .5 percent (=4.0-3.5) and zero.

They also considered another adjustment which results in a Taylor (consistent) rule and a balanced approach (consistent) rule. They assume that the Fed would not adjust the interest rate if inflation is 2.0 or 2.1 percent; rather it would watch for inflation going above 2.2 percent.  Also assumed is that the equilibrium real interest rate is .5 percent.

I looked at the period from the 4th quarter of 2020 through the 4th quarter of 2023. Figure 9 from the paper copied below shows a big difference between the rules-based policy and the actions of the Fed.

It is time for reentry.

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Principles of Economics — Open – Online – Ready To Go

This spring we will be offering an open online version of the Principles of Economics course. To get more information and sign up, go to https://www.edx.org/course/principles-of-economics. The course begins on Monday, March 29, 2021. It is self-paced so students can move ahead at the most appropriate pace. The video-lectures are based on my Stanford course.  People who watch the video-lectures and take short quizzes can earn a Certificate. There is an on-line forum on which Yiming He and I will be commenting and answering questions.

This on-line course covers all of economics at a basic level.  It stresses the key idea that economics is about making purposeful choice with limited resources and about people interacting with other people as they make these choices. Most of those interactions occur in markets, and this course is mainly about markets, including product markets, labor markets, and capital markets.  We will show why free competitive markets work well to improve people’s lives and how they have removed millions from people from poverty around the world, with many more, we hope, still to come.

The textbook for the course, Principles of Economics by John B. Taylor and Akila Weerapana, is available online here: https://catalog.flatworldknowledge.com/catalog/editions/principles-of-economics-9. It covers the key issues related to COVID-19 and the economic policy responses. I am looking forward to the course. Virtual online economics courses are becoming much more popular with the Coronavirus epidemic. But, economics is more important than ever, and we have been doing the online course for several years now, and have a great deal of experience. Here is a sampling of views about the online course which have been previously posted on Twitter:

Russell Roberts‏ @EconTalker: Great class. Great teacher. No charge. Get your basics right here.

Ike Brannon‏ @coachbuckethead: The most entertaining economist I know.

Brian Wesbury‏ @wesbury:  If you want to learn Economics from one of the best, click on this link!  What great news!

Juan Carlos Martinez‏ @juank700410: Educación gratuita y de calidad

Tom Church @TomVChurch Interested in economics? Take Econ-1 online. Pass the quizzes and get a statement of accomplishment! Plus, you’ll learn a thing or two.

Chris Pippin @ChrisPippin This is the class and the professor that made me an Econ major. Thanks to the generosity of @EconomicsOne and the miracle of the internet, now anyone can take it.

Nicolas Petit  @Competition Prof Great course by terrific teacher, comprehensive & more than all eye opening on real world problems like trade wars and monetary policy.

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The Need for a Monetary Strategy

Today the Federal Open Market Committee described its upcoming plans for the federal funds rate through 2023.  It is good, as I wrote last month on this blog that “Rules Are Back In The Fed’s Monetary Policy Report,” after a short absence, but it would more helpful if the Fed incorporated some of these rules or strategy ideas into its actual decisions.

Apparently this did not happen, as the chart below shows. The chart gives the FOMC’s projection of the federal funds rate and three different rules-based paths for the federal funds rate through 2023. This FOMC projection is the “value of the midpoint of the projected appropriate target range for the federal funds rate or the projected appropriate target level for the federal funds rate at the end of the specified calendar year,” as stated in Table 1 of the Fed’s Summary of Economic Projections.

The three other rate paths show the federal funds rates from three policy rules using the same parameters as those in the Taylor rule–discussed in the Monetary Policy Report–with the so-called equilibrium interest rate reduced from 2 percent to 1 percent, as has been suggested at the Fed. The three policy rules use the four-quarter inflation rates of the GDP price index, the PCE price index, or the core PCE price index, based on the most recent Congressional Budget Office (CBO) projections. They use the same percentage deviation of real GDP and from potential GDP as in the CBO report. Most other forecasters do not have inflation and real GDP much different from CBO.

Even with this smaller equilibrium interest rate, the Fed’s path for the federal funds rate is well below any of these policy rules. There is a difference now (in the first quarter of 2021), and the difference grows over time.

There is no mention of why the discrepancy exists between the Fed’s actual decisions and the rules. Does this mean that the Fed will actually keep the rate this low under these circumstances regarding real GDP and inflation?  Will it then raise the rate sharply in 2024? Taken literally, this is the implication because there is no indication that the Fed will do otherwise. I see no reason why the Fed could not be indicating now that its strategy is to raise policy interest rate as economic growth increases and inflation rises. Such an interest rate strategy would clarify the Fed’s monetary policy and facilitate the market adjustment when it takes place. So would a strategy for asset purchases and other aggregates.  

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Rules Are Back In The Fed’s Monetary Policy Report

The Federal Reserve’s latest Monetary Policy Report just released on February 19, 2021 has a whole section on monetary policy rules.  That policy rules are back in the Report is a very welcome development. It re-initiates a helpful reporting approach that began in the July 2017 Monetary Policy Report, as I discussed here, when Janet Yellen was Fed chair. The approach continued under Chair Jay Powell in 2018, 2019 and early 2020, but it was dropped in July of last year. The good news is that it is back.

Five rules are discussed in the February 2021 Monetary Policy Report, especially on pages 45 through 48. To quote the Report, these include “the well-known Taylor (1993) rule, the ‘balanced approach’ rule, the ‘adjusted Taylor (1993)’ rule, and the ‘first difference; rule.  In addition to these rules” and this is very important, there is a new “‘balanced approach (shortfalls) rule,’ which represents one simple way to illustrate the Committee’s focus on shortfalls from maximum employment.” Here is a table of rules from the Report:

There were also five rules on the earlier Reports, but one is out and a new one–the Balanced-approach (shortfalls) rule–is in. As stated in the document this modified simple rule “would not call for increasing the policy rate as employment moves higher and unemployment drops below its estimated longer-run level. This modified rule aims to illustrate, in a simple way, the Committee’s focus on shortfalls of employment from assessments of its maximum level.”

How much different would this shortfalls rule be compared with the regular balanced-approach rule? There is a helpful graph in the Report which answers this question. I have magnified a portion of that graph below so it is easier to see. Notice that the balanced-approach (shortfalls) rule is below the balanced-approach rule in 2017 through the start of the pandemic in 2020. This is the period when the actual unemployment rate in the United States is lower than the estimate of the long-run unemployment rate. Thus the shortfalls rule does not increase the interest rate as does the balanced approach rule without the shortfall. The rule in between these two in the graphs is the Taylor rule. The shortfalls and the non-shortfalls rule then move together during the start of the pandemic as the unemployment rate rises well above the long run rate. The adjusted Taylor rule stays above zero, but then will stay low for longer than the Taylor rule.

The important contribution of this new discussion is that one now has an explicit way to think about the Fed’s new “shortfalls from maximum employment” approach. One can see if the new rule performs better that the balanced approach or the modified Taylor rule, for example, by simulating models. A huge amount of research can take place both outside as well as inside the Fed. There is much work to do. So let’s get going!

While this is an excellent start, more could be done. It is a bit disappointing, for example, that, as the Report says, the aims “of having inflation average 2 percent over time to ensure that longer term inflation expectations remain well anchored, are not incorporated in the simple rules analyzed in this discussion.” This is a very important issue and may be the subject of future Fed Reports.

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Watch, Listen, and Enjoy a Film About Thomas Sowell

The new one-hour program “Thomas Sowell: Common Sense in a Senseless World,” is a must watch. Beautifully narrated by Jason Riley of the Wall Street Journal, it tells the amazing life story of Thomas Sowell, born in 1930 in North Carolina, raised by a great aunt after both his parents died, moved to Harlem at 8 years old, joined the Marines, went to Harvard for college and Chicago for a Ph.D., taught at Cornell and UCLA, finally settled at the Hoover Institution at Stanford University, and in the process became “one of the greatest minds,” as Riley puts it, “of the past half century.”  

Free to Choose Network just announced that they are releasing this fascinating documentary “for airing on public television stations across the country – and for streaming on Amazon Prime, YouTube, and at freetochoosenetwork.org.” The public TV airings begin this month, but already the response on YouTube is huge with over 2 million views in just one week.

There is so much to like about this film. Visuals stream across the screen with a perfect selection of background music, as we see photo after photo, including a 1940 vintage rotary telephone which young Tommy wished he had. And Jason Riley takes us on location to 720 St Nicholas Ave in Harlem where Sowell lived, and to the front of the Harlem Branch of the New York Public Library, where a slightly older friend, Eddie Mapp, told him about library cards and books, and changed his life forever.

We watch teachers in the classroom helping little kids learn, illustrating Sowell’s long-term interest in the value of education. We hear friend Walter Williams reminisce about the days when he and Sowell were the only two Black conservatives, so people would say that they should not travel on a plane together. Larry Elder speaks on how Sowell causes “people to rethink their assumptions,” Stephen Pinker on how Sowell will never compromise just to appear agreeable, Victor Davis Hanson on how “Tom is an empiricist,” and Peter Robinson on the many books Sowell published after turning 80. They all talk about what Thomas Sowell means to them and what he is like.

Tom’s special gift for explaining things and sharing with others is illustrated with Rapper Eric July and his Backwordz style of music. We hear Dave Rubin ask Sowell in a TV interview about why he changed course away from Marxism early in life: “So what was your wake up to what was wrong with that line of thinking?” asks Rubin, and Sowell simply answers “Facts,” with maybe the best one-word answer in history. And that sets the stage for much of Tom Sowell’s unique empirical, eye-opening approach to research and writing, whether about economics, race, history, discrimination, education or culture. Throughout the program Jason Riley shows time after time that Sowell is one of those very rare people: “an honest intellectual.”

Throughout the show we see quotes on the screen from Sowell: “My great fear is that a black child growing up in Harlem today will not have as good a chance to rise as people in my generation did, simply because they will not receive as solid an education.”  He talks of a turning point in the 1960s after which there was no longer a stigma from being on welfare, and urban schools went downhill. His latest book, Charter Schools and their Enemies, recounts the story of the Success Academy in New York City and holds out hope for the future.

Tom’s long held view is that there are no “solutions” to the difficult real world problems we face as a society; there are only “tradeoffs” where you try to get as close as possible to the optimal answer. Here the film develops a clever analogy with Tom Sowell’s avid hobby—photography—where one is always changing and adjusting the aperture or the focus to improve the image, but never reaching an all-encompassing solution.

The film squeezes in meaningful interludes, such as his common sense book about Late-Talking Children based on a very personal story, or the saga of Steinway pianos where freedom to set up a new firm in America and try out new ideas was essential.

The film includes his time at the Hoover Institution where instead of teaching thousands in classrooms he reaches millions with his books and his welcome emphasis on free markets and personal responsibility.  He was drawn there in part by his teacher when at Chicago, Milton Freidman.

Lucky for us, Jason Riley is about to publish a new book about Thomas Sowell. It is a biography called Maverick. I have had a chance to take a peak, and it is wonderful, a perfect book to read after the movie. Indeed, it is a must read.

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Ideas and Actions for a Free Society: Still Relevant After a Year

Exactly one year ago, on January 15-17, 2020, a special meeting of the Mont Pelerin Society was held at the Hoover Institution at Stanford University. The Mont Pelerin Society was founded in 1947 for the “preservation and improvement of the free society,” and the 2020 meeting was the 40th anniversary of the meeting held at Stanford in 1980.

It is difficult to even think about all that has happened in the year since that meeting. The Coronavirus—not even mentioned at that meeting a year ago—has wreaked havoc around the world, and changed government policy in major ways. Nevertheless, the presentations at the meeting are still quite relevant, perhaps more relent than ever before, as a host of speakers presented new ideas and actions for a free society, looking at the past as prologue to the future. Fortunately, all have been documented in this volume https://www.mpshoover.org/papers

In describing the theme of that meeting, the introduction to the volume notes that “the challenges to the free society are again mounting and threatening economic growth and rising prosperity. We hear calls for a return to socialism, for restrictions on trade, for regulations on firms and individuals that go well beyond cost-benefit calculations.” These challenges and calls have clearly accelerated, but the appropriate responses and the case for preserving and improving freedom are still the much same.

The meeting, and the volume, begins with my interview of George Shultz on Choosing Economic Freedom and ends with Peter Robinson’s interview of Peter Theil on China, Globalization, Capitalism, Silicon Valley, Political Correctness, and Exceptionalism. Throughout the meeting and the volume there are extraordinary presentations about freedom by Robert Chitester, Robert Chatfield, Eamonn Butler, Jennifer Burns, Bruce Caldwell, Alberto Mingardi, Peter Boettke, David Henderson, Condoleezza Rice, Victor Davis Hanson, Amity Shlaes, Robert Skidelsky, Niall Ferguson, Jesús Fernández-Villaverde, Douglas Ginsburg, Jeff Bennett, John Cochrane, Lars Peder Nordbakken, Paulo Guedes, Anthony Kim, Fred McMahon, Valeria Perotti, John Cogan, Susan Dudley, Lars Feld, Ayaan Hirsi Ali, Samuel Gregg, Bridgett Wagner, Axel Kaiser, Ernesto Silva, Arnold Harberger, Terry Anderson, Lee Ohanian, Russell Roberts, Jamie Borwick, Thomas Gilligan, Edwin Feulner, Gabriel Calzada, Henry Butler,  Benjamin Powell, Nicolás Cachanosky, Inchul Kim, Annelise Anderson, Jeff Sandefer, Tyler Goodspeed, Ruth Richardson, Dominique Lazanski, Joe Lonsdale, and Sally Pipes. There were many more who enthusiastically participated in the discussions.

Take a look, and you will find much that is relevant today.

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Electronic-Commerce, Non-Store Sales and the Pandemic

Last week at the American Economic Association meetings, held online, many papers focused on Covid-19. A good example was the session organized by Dominick Salvatore which included Jan Eberly, Raghu Rajan, Carmen Reinhart, Joe Stiglitz, Larry Summers, and me. Most papers focused on the economic policy impact of the Coronavirus. I focused the “supply side” policies rather than on the “demand side” policies. Using a simple model, key facts naturally emerge if one simply divides retail sales into store-sales versus non-store-sales or electronic sales. To see this, take a look at these three figures. 

The first figure shows that the onslaught of the pandemic in the second quarter of 2020 immediately caused a sharp decline in retail sales less non-store sales in the United States. This was followed by rebound in the second third quarter of 2020.  Note that the rebound, while very sharp, left total retail sales in stores no greater than they were before the pandemic.

The second figure shows that non-store sales increased from the time the pandemic began, just as in-stores sales were collapsing.  Without non-store sales, total retail sales would have declined.

 

And the third figure shows an alternative measure: electronic-commerce. It is only available on a quarterly basis but tells the same story as the in-store versus non-store story—a large increase starting at the time of the pandemic.

In sum, the pandemic had a big economic impact on in-person store sales, measured by total sales less non-store sales. But there is a countervailing positive effect through non-store sales or e-commerce.

As of this writing, the increase in non-store or e-commence sales is not abating, but rather continues to rise, even after in-store sales have rebounded. Regulatory policy, tax policy, monetary policy and even international policy must encourage this supply-side growth, not thwart it, if the economy is to continue to grow and create jobs.

 

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Stampede Out, Stampede In

Today I published an article in Project Syndicate called “The Stampede from Silicon Valley.” The fact-based message of the article is clear: Tax, regulatory, and other economic burdens that firms face in California are creating a stampede to other parts of the country—especially Texas. There are many examples–Hewlett Packard Enterprise, Oracle, Tesla, and even venture-capital firms like 8VC, who announced the exodus with an WSJ op-ed.  State and local policymakers, who want to prevent an even larger outbound stampede, need get to work.  There are some positive signs to build on, such as the California voters’ approval of Proposition 22, which frees up gig workers, and the voters’ rejection of Proposition 15, which would raise taxes on business. As one of the recent departures from Silicon Valley recently told me, “I still love California and hope to help fix it.” Well, now is the time. 

In fact, also published today was a front page story in the Wall Street Journal telling the same stampede story from the perspective of Austin, one of the go-to cities in Texas. Headlined, ‘Startup City’: Breakneck Growth Strains Austin,” the article tells the story of the arrival of the same firms: Hewlett Packard Enterprise, Oracle, Tesla, and other firms such as venture capital firms like Atomic.  The concern from the Texas side is to keep economics competitive while preventing some of the crowding effects of higher growth and land use regulations with added problems like homelessness and forest fires.

Let us hope that good competition leads to better economic performance both in and out of Silicon Valley and Austin. Indeed, some of the reaction I am getting to my Project Syndicate article warns of the failure to reduce economic burdens in the United States as a whole versus other countries, which may make the United States less attractive for business and income growth going forward. And to be sure, there are even a bigger problem globally if less emphasis is paid to economic freedom. There is work to be done in all parts of the world.

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The Best Part of the Coronavirus Relief Bill

As the Wall Street Journal reported and I tweeted yesterday, Senators Chuck Schumer and Patrick Toomey made important news when they agreed that with the new Coronavirus relief legislation, “the $429 billion would be revoked and the Fed wouldn’t be able to replicate identical emergency lending programs next year without congressional approval”

This is a welcome development because it is a start on the best monetary road back to a stronger economy. With the vaccines on the way and with markets functioning again, this is the time for the Fed to get back to a more rules-based monetary policy that it was moving toward before the pandemic struck.  

This favorable development owes much to the outspoken insistence and careful reasoning of Senator Toomey. He argued that the Fed’s new direct lending programs enacted earlier this year were not needed going forward, and that their very existence blurred in dangerous ways the operation of fiscal and monetary policy. As Toomey explained on Squawk Box this morning in an interview with Becky Quick, “These facilities were always intended to be temporary…. Their purpose was to restore normal functioning in the private capital and lending markets.”

He then explained that questionable interpretations of the legislation had been recently put forward raising doubts about this temporary status. So he took action, and he drafted legislative language to clarify the situation in the coronavirus relief bill. The concern was that monetary policy would become an instrument of fiscal policy to the severe detriment to good economic policy and thereby threaten a return to a strong, low-unemployment, low-inflation economy. With new legislative language, he said, “The good news is these programs will be the temporary facilities they were intended to be.”

 As an editorial in the Wall Street Journal said today: “The best provision in the bill is the limit on potential abuse by the Biden Treasury and Federal Reserve. Credit here to Pennsylvania Sen. Pat Toomey, who held firm on limiting the Fed’s maneuvering room without a new act of Congress.”

I hope this action is an important down payment on a return to a more strategic monetary policy going forward. As far as we can tell, the impetus for this change did not come from the Fed. But it is good news for the Fed that members of congress are supporting a more rules-based monetary policy, and they may even have some help next year from the Administration over at the Treasury.

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