A tale of the top 1%

Consider the two countries portrayed below. In both cases, the lines represent the share of national income earned by the top 1%.

In both countries, inequality fell from the early part of the 20th Century through until about the 1980s. From 1990, inequality started increasing in both, with a much sharper increase in the country with the higher line.

Draw some conclusions about the policies in the country represented in the upper line. Would you say that:

1. The graph clearly shows that policy went wrong starting around 1994, allowing the rich to exploit the poor.
2. We cannot really tell whether the graph demonstrates generalised good things or bad things; we need to know why the shares changed before assessing anything.
3. The graph clearly shows that policy improvements in 1994 stopped the wage compression that was hurting economic growth; we should expect that overall outcomes have improved since then as well.

I, likely obviously, go for answer #2. Rising or falling income shares for the top 1% tell us nothing on their own. If it's a Wilt Chamberlain process, I'm cool with that, though Chamberlain isn't everything. If it's instead some crony deal where we tax everybody a dollar and give it all to one person, I'm not cool with that, unless the money goes to me.*

Now that everyone's had enough time to draw their conclusions, we can reveal that the top line belongs to South Africa. The end of apartheid brought a sharp increase in the income share of the top 1%, as pointed out in a new NBER working paper from Acemoglu and Robinson. The bottom line is Sweden.

Their abstract:

Thomas Piketty's (2014) book, Capital in the 21st Century, follows in the tradition of the great classical economists, like Marx and Ricardo, in formulating general laws of capitalism to diagnose and predict the dynamics of inequality. We argue that general economic laws are unhelpful as a guide to understand the past or predict the future, because they ignore the central role of political and economic institutions, as well as the endogenous evolution of technology, in shaping the distribution of resources in society. We use regression evidence to show that the main economic force emphasized in Piketty's book, the gap between the interest rate and the growth rate, does not appear to explain historical patterns of inequality (especially, the share of income accruing to the upper tail of the distribution). We then use the histories of inequality of South Africa and Sweden to illustrate that inequality dynamics cannot be understood without embedding economic factors in the context of economic and political institutions, and also that the focus on the share of top incomes can give a misleading characterization of the true nature of inequality.

On South Africa, they note:

No clear consensus has yet emerged on the causes of the post-apartheid increase in inequality, but one reason is related to the fact that after the end of apartheid, the artificially compressed income distribution of blacks started widening as some portion of the population started to benefit from new business opportunities, education, and aggressive affirmative action programs (Leibbrandt, Woolard, Finn, and Argent, 2010). Whatever the details of these explanations, it is hard to see the post-1994 rise in the top 1 percent share as representing the demise of a previously egalitarian South Africa.

And, across the OECD, skill-based technological change and increases in the size of the top firms explains much of the increase in earnings at the top. They caution that if a rising income share of the top 1% turns into entrenched political power, that can be disastrous; appropriate policy then should focus on institutional checks against power-grabs rather than wealth taxes.

* Gordon Tullock liked to give this example. The Tullock Tax would impose a small cost on each American but make Tullock about $300,000,000 richer. Despite that Tullock had a concentrated interest in such a tax, the tax never passed: the Logic of Collective Action isn't everything. 

Ship money

Acemoglu's latest paper, on institutions, tax revenue, and state capacity, has this bit on the history of England:

The British tax revenues increased by over three fold in the quarter of a century following the Glorious Revolution (while French revenues remained constant). Notably, these revenues were used very differently from how the marginal revenue was spent during the reign of the Stuarts before 1688: instead of financing the consumption or the retinue of the crown, they were spent to strengthen the Navy, which would then play an important role in defending the overseas interests of those in the Parliament (who in fact constituted the main checks against the power of the Hanoverian monarchs).

But wasn't the levying of ship-money one of the big complaints against Charles by Parliament just before the Long Parliament? If I remember my Hume correctly, Charles levied a tax (as prerogative rather than through Parliament) to kit out a first rate navy, and Parliament, who otherwise refused to grant him adequate supply for anything, got mighty ticked off about this imposition despite it being very well used indeed. Charles, seeing the writing on the wall, gave up ship money in the lead-up to the Long Parliament, but Hume suggests ship money nevertheless as one of the spurs for the Glorious Revolution: hardly an indication that the navy was neglected under all the Stuarts.

Or does Acemoglu count ship-money as inframarginal? The marginal dollar, I suppose, under Charles would have been used trying to defend against the incursions of crazy religious fanatics from Scotland: navy not much use there. Or is Acemoglu referring more to Charles' predecessors? If the latter, then does the comparison of revenues pre and post revolution make sense?

Hume's chapter on Charles is depressing.

None of this detracts from Acemoglu's overall point though:

This paper points out why this argument needs to be qualified and why caution is necessary before increasing the fiscal capacity of the state becomes a silver bullet policy recommendation. Because the availability of more efficient means of taxation increases the potential benefits of controlling state power, it also intensifies political conflict aimed at capturing the control of the state. This indirect effect counteracts the benefits from more efficient taxation and may dominate these direct benefits; as a consequence, the allocation of resources may deteriorate when the society and the state have access to additional fiscal instruments.

As Farrant and I have said before, the last thing you want is for Stalin to have more efficient means of taxation. And as I've said here before, I oppose Key making the NZ tax system more efficient (flattening out the income tax and imposing a land tax) because I don't trust Labour not to keep the land tax while re-implementing a 39% top marginal tax rate. The imposition of a new tax needs be accompanied by a commensurate increase in our ability to veto future growth in the overall size of the state. Acemoglu again:

The more general lesson is that while state capacity and states with sufficient economic strength to tax, regulate and provide public goods are essential for economic development, these benefits may not get realized by an autonomous increase in the strength of the state because this will also increase the value of controlling the state and thus induce increased political conflict and infighting. Therefore, the virtues of strong states emerge when the increase in the economic strength of the state is a consequence of, or at least happens simultaneously with, an increase in the political accountability of rulers and politicians. This underscores the need for future work investigating dynamic models of the endogenous emergence of state capacity and its relationship to political accountability.

Indeed. Couple the tax change with a requirement that any future tax increases be passed by supermajority referendum (or big structural decreases in the overall size of government), and I'm all for it.  Otherwise, not so much.