The problem with measuring inequality.

by w3woody

Reports Of Extreme Income Inequality Are Exaggerated Due To Shift In S-Coproration Income Among The Very Wealthiest

Since 2000, different measures of top income inequality have exhibited very different trends. Top income shares based on measures of total income show a continued rise, whereas top income shares based on wage and salary income show no increase in inequality post-2000. The most important difference between these two measures of income is the income that accrues to S-corporations. Moreover, the majority of the recent increase in top income shares is due to an increase in average earnings at very high income levels, much higher than that assumed in typical discussions of top income inequality. Once incomes above the 99.99th percentile are excluded (around $7 million in 2012), we see that little continued growth in top income shares has taken place in the last 20 years. Put simply, so far in the 21st century, all the action in top income shares has been S-corporation income at very, very high income levels.

Basically reports of the rich getting richer and the poor getting poorer has been–at least in part–exaggerated by the increasing use of S-corporations by small business holders.

As more and more small corporations register as S corporations (where profits flow to the owner(s) of the corporation as household income) instead of C corporations (where profits are reported as corporate profits), we see a shift in reported income away from corporations to individuals.

Which makes sense.

In my case, if I had organized as a C corporation, about half my reported income would instead be reported as corporate profit instead of personal income. That’s because C corporations (the traditional thing we think of as a corporation, like Apple or Google) can make a year-over-year profit, and tax-wise, there are advantages to having the corporation hold the profits rather than paying them out in bonuses. (There are also advantages to the C corporation owning my car or my house instead of me: by declaring those items as owned by the C corporation I don’t have to pay taxes on that money. Today that’s rarely done–but two decades ago that was extremely common.)

S-corporations, on the other hand, operate more like partnerships or sole-proprietorships when it comes to income: the S corporation does not make a profit but instead flows all that profit to the owners of the corporation.

Which means in the land of S corporations, while the top-line profits remain the same, my income doubles–and my corporation makes no profit.

The idea that we were seeing a growing divide between the rich and poor is a useful one to demagogues and progressives who seek to strip wealth from the rich and pay it out to the poor (with their cronies keeping a cut of the transaction). At the extremis, the idea we are living in a world of growing extremes is an argument for Socialism–for State ownership of the means of production, and greater regulation of the economy by the State.

And just because it failed in Venezuela doesn’t mean it won’t work here, supporters of the various flavors of Socialism argue.

But it seems to me that–beyond housing prices causing distortions in wealth (as home owners get ahead while renters fall behind in most markets)–most of the distortions in wealth we are seeing today are artifacts of how we measure the data, rather than representative of reality.

Just look at the long-term trend:

Five hundred years ago, wealth (and power) was concentrated in an aristocracy, with a very thin merchant class (the “middle class”), and the vast majority being poor peasants working the land.

Two hundred years ago, wealth (and power) was concentrated in an aristocracy–even in the fledgling United States, where suffrage was restricted to white male land-owners, representing less than 10% of the total population. The merchant class had grown enough that it permitted many in the United States to join the landed gentry–which caused disapproval amongst people like Napoleon (“nation of shopkeepers”) and Marx (“petit bourgeoisie”), who saw the rise of an uncouth class of nouveau-riche as undermining all that was right in the world.

A hundred and forty years ago, wealth (and power) was concentrated in the wealthy “robber-barons”, men who were so rich they could command the United States military to intervene against worker strikes. Men who were so wealthy (relative the rest of us) that when the United States suffered a 20-year long recession in the late 1800’s which lead to a panic in 1893 and a huge depression, the United States had to go, hat in hand, to J.P. Morgan for a bailout.

(The fact that the United States had to go to J.P. Morgan and a cadre of the very rich for a bailout was the impetus for the United States to create the Federal Reserve. Without the Federal Reserve, modern recessions would need the assistance of people like Warren Buffet and Bill Gates to keep the government afloat–and in today’s polarized world, such bailouts would undoubtedly come with more political strings than Mr. Morgan’s bailout.)

Today, the trend of history is definitely away from an aristocratic few having all the wealth and power, and the vast majority having no power at all. This long-term trend has had short-term setbacks, but by and large the trend of history is definitely towards economic equality and economic opportunity for the majority.

The trend is not as fast as we would like: major shifts in consciousness never come overnight. But the trend is there.

And where we see massive setbacks in this growing opportunism, we see it as the result of governments imposing itself on the economy to tip the scales supposedly towards the poor. Venezuela was started with the best intentions of using the wealth of that petro-state to create economic equality amongst the poor. Even in the United States we see members of both parties fighting the trend by passing laws that favor corporations as modern-day royal estates who are responsible for their peasant-employees–despite the fact that 50% of us are self-employed or work for small businesses. (Meaning the model used by most government administrators of the United States being a sort of corporate-feudal state–such as was used when crafting Obamacare–simply does not fit reality.)

So take heart. The shift of income from C-corporations to S-corporations does not represent the rich getting richer. It represents a restatement of income, and to an extent it represents a rise in the tax base and a decline in take-home pay (as tax avoidance strategies that worked with 1970 C corporations don’t work today).

If you want something to worry about, worry about this:

In San Francisco, a family of four with an income as high as $105,000 per year qualifies for Section 8 housing.

Which means the vast majority of the wealth being created in Silicon Valley does not come from new technologies being created to better our lives. It is instead coming from the “bootlegger/baptist” relationship between home owners, land developers and environmentalists who are getting rich on skyrocketing housing prices, as even the best paid developers in the region cannot afford a place to live.

When you consider that a home owner effectively lives in his house for free–most homes generally sell for more than they are bought for, meaning if you can pay cash for your house you are only out the opportunity cost of investing that cash elsewhere–if you want to become part of the “rich,” buy a house.