The View From 1776

We can be confident that the New York Times will print the same story it regurgitates every year at this time.  But the statistical basis for the Times take is inaccurate.

A Forbes Magazine commentary by Hunter Lewis reveals the hodgepodge of omissions and misclassifications in Commerce Department statistics.

A New Robber Baron Era?
Hunter Lewis

11.08.07

The Commerce Department has released new data on the gap between rich and poor in America.

The gap was described by President Clinton’s Council of Economic Advisors in 1994 as “widening” and “alarming.” This was before the bumper crop of new multi-millionaires produced by the dot-com, housing, private equity and hedge fund bubbles of the past decade. James Lardner, co-editor of Inequality.org, describes the rise in American economic inequality as “relentless” and “extreme.”

What do the Commerce Department numbers actually tell us? They show the bottom fifth of households are currently collecting only 3.4% of all personal income. This is down from a high of 4.3% in 1978, but only down a bit from 3.5% in 2001. The top fifth of households has increased its share from 43.7% in 1978 to 50.5% today.

What do the Commerce Department numbers not tell us? Importantly, they do not tell us how much of the top fifth of all income is really business income that has been incorrectly lumped with personal income. More and more businesses are abandoning the corporate business form in favor of the LLC (limited liability company) and other alternatives. This means that business income is increasingly reported, not on corporate tax forms but on the personal tax returns (1040s) of the well-off.

What else do the Commerce Department economic inequality figures not tell us?

--The degree to which a large increase in new immigrants, most arriving very poor, is holding down the bottom fifth’s income share;

--How changes in household size (dramatically shrinking in the bottom quintile) and changes in average age of the population (people in prime working years make more) are affecting the numbers;

--How the figures would change if adjusted for hours worked (the top quintile seems to be working many more hours);

--How they would change if all income sources (earned income tax credits for instance) were included;

--How they would change if capital gains were excluded (these gains are actually asset exchanges, typically stock for cash and vice versa, not economic income).

--How many households seem to be stuck in the bottom fifth, not just passing through?

The truth is that U.S. income inequality statistics are a muddle. We can glean some information from them, but they obscure as much as they reveal.

Does this mean that the rich-poor gap has not grown in America? No, it simply means that we cannot presently measure it. It does seem reasonable to assume that, in an age of economic globalization, the gap between rich and poor countries would narrow, but the gap within rich countries would widen, at least temporarily, as some lower paid jobs move abroad.

Meanwhile, what about the question we started with? Are we in a new robber baron era? What does it mean for some hedge fund managers to be drawing not a million dollars a year, but a million dollars a week or more?

The first point to be made about this is that colossal private equity or hedge fund paychecks are not a market phenomenon, an example of markets running to excess and ultimately to destruction, without government correction. They are, instead, a direct result of government economic policies gone awry.

For over a decade, the U.S. Federal Reserve (along with other central banks) has “printed” larger and larger amounts of new currency, which is injected into the economy as cheap lendable funds. The money often flows through banks and prime brokers right into the hands of private equity and hedge funds. Many of them have been able to speculate aggressively with this money, not only because the rates are cheap but also because central banks are expected to make changes slowly, to keep currencies steady and to maintain a generally stable environment.

The kind of “easy money” policies that we have had, especially in recent years under Greenspan and now under Bernanke, are supposed to help the poor and middle class but rarely do. If this is a form of populism, it is populism for the rich, a seeming oxymoron. The rich, in particular members of the investor class, can both exploit these policies and protect themselves from the resulting inflation, whether the inflation turns up in the consumer price index, the price of homes or elsewhere.

The danger now is that there will be a backlash against the “rich,” leading to more mistakes, this time by Congress. Democrats have threatened to repeal the partial elimination of the double tax on dividends that was passed by President Bush. They see it as another loophole for the rich. What they do not understand is that the double tax on dividends makes equity financing more expensive than debt financing and thus fuels the over-borrowing behind all the recent economic bubbles.

This would not be the first time that Congress has blundered. At the beginning of the Clinton administration, it capped public company C.E.O. cash compensation at $1 million. When companies naturally turned to stock options as the principle form of C.E.O. compensation, the Senate then prevented the national accounting standards board from requiring that options be treated as a business expense. All this fed the late 1990s stock market bubble and accompanying corporate scandals. But no legislator has ever acknowledged the legacy of financial excess that Congress helped the Fed create.

Hunter Lewis is the co-founder of global investment firm Cambridge Associates and author of five books on economics and related subjects including “Are The Rich Necessary?: Great Economic Arguments and How They Reflect Our Personal Values."