Wednesday, September 11, 2019

Tax policy colloquium on Zwick et al, part 3

Here and here above, I discussed the Zwick et al paper on high-end wealth concentration from yesterday's colloquium session, as well as the relationship between a semantically correct measure and issues of particular interest (such as wealth tax revenues and negative externalities).

But while wealth's meaning seems semantically fixed if one is counting up the dollar bills in a strongbox (meant, of course, in a broader metaphorical sense), there are instances in which one's underlying normative or empirical concerns might more plausibly affect how one does and/or uses the computation. Here are three examples:

1) Human capital - As pretty much all the leading empirical researchers agree, even if one has an intellectual warm spot for Piketty-esque beliefs about "capital" and r > g as key drivers of rising high end inequality, one simply can't ignore, at least in the U.S. data, labor income's central role over the last few decades. Rising high-end wage inequality (defining "wage" to include, e.g., the economic gains of a Bezos or a Zuckerberg from their companies' outsize success) has been the drama's lead actor.

We can reasonably use the term "human capital" (though Piketty, as I recall, disparages it) to connote the present value of people's expected future earnings. Given the role of labor income at the top - not all of which has been formally converted into seeming "capital income" via the sale of shares to the general public - one simply can't ignore this component of rising high-end inequality. The really big players here can use their human capital to help them buy (and prudently rationalize to themselves buying), for example, big houses and political influence. So even if one semantically considers human capital to be outside the permissible meaning of "wealth," it needs to be added to the analysis of how much high-end inequality has increased. I would guess that it's a far greater factor in this regard in the U.S. in 2019 than in the 1960s, helping to explain how much things appear to have changed even if technical pure wealth measures don't show as much growth.

2) Vertically heterogeneous returns - Let's return now at last to vertically heterogeneous rates of return, which, as I noted in Post 1 of this 3-part series, is one of the main refinements to Piketty-Saez in the Zwick et al paper. Recall the hypothetical in which, if both the plutocrat and the peasant are earning $5 per year from a given financial instrument, we plausibly assume that the former has a $100 bond (based on a 5% assumed rate of return), while the latter has a $125 bond (based on a 4% assumed return). As I noted earlier, if the rich have "better money" (in that they earn higher rates of return), does that mean we should respond by lowering our estimate of high-end inequality?

As a purely technical matter, perhaps the answer is Yes. After all, if we think of the exercise (at least metaphorically) as asking what dollar amount we would see on the instrument of we could look inside the strongbox, $100 vs. $125 are indeed the amounts that follow from the analysis. Yet the fact that some are getting higher returns from such wealth as they have than others is surely relevant as well.

One takeaway might be that we should measure income inequality as well as wealth inequality, and regard them as complementary inputs to measuring the degree of high-end concentration. But even just within the wealth measure, it may be illuminating to ask how it could possibly be that the wealthy have higher returns (and also higher expected returns, if there are positive risk premia) on the same "thing," i.e., wealth. Here are a few possible explanations, with a few words regarding what one might make of each of them:

a) Segmented markets - Suppose that the peasants lack the minimum investment capital, contacts, or knowledge that are needed to buy higher-yielding assets. So they are stuck with low-interest bank accounts in lieu of bond funds with internal diversification and low per-dollar management fees. In this scenario, even among assets with equal risk they can't buy the high-yielding ones, and the plutocrats don't touch the low-yielding ones. I think of this scenario as pushing towards the view that one should use uniform capitalization rates, rather than vertically heterogeneous ones, to get a handle on retention (as distinct from sales) value.

b) Better connections, etc., as a distinct intangible asset - Say that you can earn 5 percent, while I only earn 4 percent, because you know people who will put you onto a good thing. That is in effect a distinct intangible asset that you have and I don't, which we might indirectly include in our balance sheets by using uniform, rather than vertically heterogeneous, capitalization rates.

c) Higher-risk assets - It's generally agreed that wealthier people tend to choose riskier investments than poorer ones. This need not reflect distinct utility functions regarding risk - a person with a very conventional utility function will be more risk-tolerant with a large cushion than a small one.

With this in mind, suppose we revise the earlier bond hypothetical to involve a pair of $100 bonds, the plutocrat's paying $5 and the peasant's $4 because it's riskier. And suppose we re-conceptualize the latter bond as equivalent to an $80 bond that likewise pays 5% (i.e., $4), plus a $20 insurance contract that pays zero if nothing bad happens (i.e., what it does is top off the $4 in bad states of the world, including those in which there'd otherwise be a huge negative return).

Suppose we further agree that both the plutocrat who buys the bond paying $5, and the peasant who buys the bond-insurance combo paying $4, are (i) choosing rationally, and (ii) getting $100 of value. We might still conclude that the plutocrat is better-off in a way not captured by crediting them with $100 of value each, via the application of vertically heterogeneous capitalization rates.

The point I have in mind here is that, while the insurance is worth $20 to the peasant, it's worth much less to the plutocrat (and again, this may be due to divergent circumstances, rather than diverse utility functions). Can this be analogized - I'm still thinking this through, which is why I'm formulating it as a question - to the case where you rationally buy $20 of health insurance, and I rationally don't, because my health is better? Might I be ($20?) better-off than you in this respect, because my circumstances meant I didn't need to incur this cost, while yours meant that you did?


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