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Gregory Mankiw Discusses Equality of Opportunity

Gregory Mankiw discusses an argument I hear most often when considering the issue of income inequality – lower income kids are born into an adversarial circumstance.  I can agree with this assessment to a degree.  Money helps, but at the same time, our parents bank account on day one does not determine who we will be on day 16,756.  I would contend other factors more highly associated with lower income households are larger obstacles to overcome, of which many do – the most salient obstacle being education.  Dr. Mankiw discusses research from Raj Chetty’s “Recent Trends in Inter-generational Mobility“:

When people think about inequality of incomes, a key issue is inequality of opportunity. Some people are born to rich parents who can afford private schools, summer camp, SAT tutors, etc., while others have poorer parents who cannot easily afford such things. One might wonder how much of the income inequality we observe can be explained by differences in the resources that people get because of varying parental incomes.

Let me suggest a rough calculation that gives an approximate answer.

The recent paper by Chetty et al. finds that the regression of kids’ income rank on parents’ income rank has a coefficient of 0.3. (See Figure 1.) That implies an R2 for the regression of 0.09. In other words, 91 percent of the variance is unexplained by parents’ income.

I would be willing venture a guess, based on adoption studies, that a lot of that 9 percent is genetics rather than environment. That is, talented parents have talented kids partly because of good genes. Conservatively, let’s say half is genetics. That leaves only 4.5 percent of the variance attributed directly to parents’ income.

Now, if you let me play a bit fast and loose with the difference between income and income rank, these numbers suggest the following: If we had some perfect policy invention (such as universal super-duper pre-school) that completely neutralized the effect of parent’s income, we would reduce the variance of kids’ income to .955 of what it now is. This implies that the standard deviation of income would fall to 0.977 of what it now is.

The bottom line: Even a highly successful policy intervention that neutralized the effects of differing parental incomes would reduce the gap between rich and poor by only about 2 percent.

This conclusion does not mean such a policy intervention is not worth doing. Evaluating the policy would require a cost-benefit analysis. But the calculations above do suggest that all the money the affluent spend on private schools, etc., explains only a tiny fraction of the income inequality that we observe.
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Addendum: A few readers seem confused about how to infer an R2 from a coefficient.  The key is that the left and right hand side variables in the regression have the same variance.  In this case, the R2 is the square of the coefficient.  This conclusion is a standard result for AR(1) models, which is what we have here, as applied to generational data.  (Also, a few readers are confused when they look at the paper’s Figure 1. The points plotted are not the raw data but binned averages, so you cannot see the R2 in the plot.)

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Sluggish Economy? Not for these states!

Remember the recent Q1 GDP growth rate of -2.9%?  North Dakota’s economy is growing so fast it would make China blush.  Clocking in at a rate of 9.7%, North Dakota’s growth leads the nation followed by Wyoming, West Virginia, Oklahoma, and Idaho.  There is a common thread between this growth – MINING.  This includes natural gas, oil, and coal.

What comes with this growth?

  • $15/hr for serving tacos
  • $25/hr for waiting tables
  • $80k/year truck drivers

This boom is no secret but the economic growth in these areas is staggering AND steady.

USA Today published a piece on this growth:

The United States economy grew 1.9% in 2013, down from the 2.8% growth rate in 2012, as growth in the world’s largest economy remained inconsistent. The largest contributors to the national economy were nondurable goods manufacturing, real estate and leasing, as well as agriculture and related industries.

While the U.S. economy grew less than 2%, the output of a number of states grew well in excess of 3% last year. North Dakota continued its torrid growth pace, leading the nation with a state GDP growth rate of nearly 10%. This year, Wyoming and West Virginia were the second- and third-fastest growing states, respectively, rebounding from slow growth in 2012. Based on data released this week by the Bureau of Economic Analysis (BEA), these are the 10 states with the highest real GDP growth rates for 2013.

There were considerable differences in what drove national growth and what drove output in the fastest growing states, according to Cliff Woodruff, an economist at the BEA. “For the nation, it was nondurable goods manufacturing and agriculture, forestry, fishing and hunting [that] were the top two contributors to national growth,” Woodruff said.

On the other hand, in “five of the top states, [growth] was primarily a result of mining,” which includes oil, natural gas and coal production. Among these was Wyoming, the nation’s second-fastest growing state, where mining accounted for 6.1 percentage points of the state’s 7.6% growth rate.

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Robert Reich on How to Shrink Inequality

I rarely ever agree with Robert Reich but his first few sentences I agree with:

Some inequality of income and wealth is inevitable, if not necessary. If an economy is to function well, people need incentives to work hard and innovate.

The pertinent question is not whether income and wealth inequality is good or bad. It is at what point do these inequalities become so great as to pose a serious threat to our economy, our ideal of equal opportunity and our democracy.

But have we reached that point? He continues to express his opinion:

“We are near or have already reached that tipping point.”

He expresses some uncertainty here (I believe for dramatic purposes only – we know his position, right?). Then he expresses certainty when he says:

As French economist Thomas Piketty shows beyond doubt in his “Capital in the Twenty-First Century,” we are heading back to levels of inequality not seen since the Gilded Age of the late 19th century.

I don’t think Piketty’s position has demonstrated any absolutism on the issue. There is plenty to debate without Chris Giles Financial Times article. Tax data present many fallacies.  His colleagues compliment the quality and effort (as I do) while questioning the conclusions (as I do).  Yet there are the “worshippers” of this piece of work that will point to it as divine economic perfection to meet political ends – Krugman and Reich.

My conclusion is this: I appreciate Robert Reich’s passion, but he proposing extreme solutions to an issue that he (purportedly) is uncertain about. I believe he offers a few good suggestions:

  1. Infrastructure (Didn’t we propose that already?  I just wish we had done it!)
  2. Create high earnings brackets with higher rates. Up to 55% potentially on income greater than $10 million.  There would have to other concessions leading to simplification of the code, eliminated investment income tax (medicare surtax), broadening tax base, etc… But this could be valid under certain circumstances.
  3. “Get big money out of politics.”  My solution would be term limits. Term limits could go a long way to accomplishing this goal.
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Chris makes good points over on Tax Analysts’ blog, “Progressivity Does Not Equal Equality“:

There has been a lot of discussion about “income inequality” lately – clearly because the Obama administration thinks it’s a political winner. You can’t have a discussion of this topic without quickly getting to tax policy and our tax system.

I am a strong supporter of progressive tax systems. That’s why I don’t favor value added taxes. I also believe the income tax system is one of the better vehicles for progressivity. However, I don’t think of progressivity as a cure for income inequality; I actually believe in it because of the exact opposite. There is no such thing as income equality, even in a communist system. I like progressivity because I believe people with higher incomes should pay higher rates and make a larger contribution than those starting out – so that they can work to make more and pay more taxes.

When I was a young editor, my senior editors would say, “Sure, you like the progressive income tax now, but wait until you start making more money and have more responsibilities.” They would say it with great confidence. And it turns out they were wrong, because I still favor a progressive tax system.

Also when I was a young editor, it made total sense to me that the company president was paid a bigger salary than I was. I didn’t pay a high marginal rate. But as I moved along in my career, I began paying higher marginal rates. I was always fine with that deal. I paid a higher rate, and someone starting out was getting the break that I got.

I see nothing wrong with income inequality; it’s actually income reality. That isn’t to say that I am unconcerned by the accumulation of wealth in a small percentage of our population. That’s bad for society, and history teaches that it can end quite badly for the wealth accumulators (when that happens, the folks who sell pitchforks become the real wealth accumulators). But those are two different issues – income inequality and wealth concentration – that our politicians are marketing as the same.

This week’s Tax Notes has an interesting article by Lee Sheppard – “The Gatsby Effect and the Middle Class” – that examines some of the issues involved in the income inequality debate, including what’s causing the decline of the middle class in this country and how to deal with so-called income inequality (by now you have figured out that I don’t care for the term). It’s based on a recent conference that was sponsored by the University of Southern California Gould School of Law to explore the role of tax policy in inequality. While I don’t agree with everything in it, I think it’s an informative and enjoyable read for anyone interested in the topic. You can get it by clicking here.

One of the concepts discussed at the conference that I’m not sure I support was progressive spending as a way to get to a more progressive system. I still support a progressive tax system, just not as a method of addressing income inequality. Because as far as the debate about income inequality goes, I remain a skeptic – with an open mind.

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Household Budgeting: Mint.com Infographic

Along with economics, studying personal finance is a passion of mine.  I actually believe Mint probably has some of the best information on American family finances – what I would do to get a hold of it.  You see, IRS data has flaws that Mint does not have.  For example, if every person loaded all of their information into Mint, you would have the ultimate picture of family finance.  Income, debt, spending by category, etc.  Unfortunately, not everyone is on Mint so I must wait…

The graphic I have posted below comes from Mintlife’s (Mint.com’s Blog) post “How Common is Budgeting for Americans?

How-Common-is-Budgeting-for-Americans

 

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Calvin from Consumerism Commentary’s series Naked With Cash is recently divorced earning $120,000/yr as an IT project manager.  He is in his early 40s and has shared his financial position below.  Get his planner’s analysis here and learn more about Calvin here.

Calvin-nov2013

Why have these posts?  I think these folks provide a great service to many of us.  The financial topic is a faux pas to discuss socially.  The  – “Hey John, how’s it going?  Oh and by the way, how much do you make, I need an excel file of your budget, and need to you net worth figures – thanks!” – conversation doesn’t work out well.

These posts provide insight into others’ finances and also can provide insight into your.  If you visit over there, please provide them some encouragement!

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Comments on the Downward Revision to Q1 GDP (-2.9%)

The beautiful thing about economics is that the data tell stories and as more data are available, we can add sentences and paint a clearer picture.  This recover has been abominable. And Q1 2014 was the worst since the recession.

Five years since the Great Recession, we are in constant search for signals of life in the economy.  There are many moving parts to this story.  The latest Bureau of Economic Analysis revision of Q1 GDP demonstrates the slacking economy.  GDP contracted at an annual growth rate of -2.9%.  Note that this does not mean we are in a recession.  It typically takes successive negative quarterly growth rates to be deemed a recession.  This contraction has been attributed to:

  1. A drop in consumer healthcare spending.
  2. Weakness in export activity.

From Mish’s Global Economic Analysis:

  • Exports (which add to GDP) were down 8.9%.
  • Imports (which subtract from GDP) were up 1.8%.
  • Durable goods were up 1.2%
  • Nonresidential fixed investment decreased 1.2%
  • Consumer prices rose 1.3%.
  • Federal spending was up 0.6%
  • Personal spending was up 1.0%

From House of Debt:

A month ago, we compared the recovery from the Great Recession to the recovery after every recession since 1950. It looked pretty bad.

Real GDP growth for 2014q1 was revised downward today to -3.0% on an annualized basis. Yes, our reading of Table 1.1.3 of NIPA shows -3.0%, not -2.9%.

Here is real GDP indexed to the quarter before each recession for all 10 recessions since 1950, taking into account this morning’s revision. Notice the significant bend downward in the last quarter for the 2007-2009 recession (solid red line). It makes the recent recovery look even  worse relative to previous recoveries.

houseofdebt_20140625_1

From Doug Short:

Click to View

From Sarah Portlock at WSJ’s Real Time Economics:

The U.S. economy contracted at a 2.9% annual pace in the first quarter this year, the Commerce Department said Wednesday. That is a sharply lower reading than earlier estimates and marked its sharpest pullback since the recession ended five years ago.  Economists weighed in on the third read, what it might mean for the economic recovery, and where activity stands in the second quarter.

Hindsight is 20/20, This Was Ugly/Ugly: I think we can all recognize the first quarter was ugly, and, not to be too trite about it, the degree of ugliness seems to have grown with time.  But the first quarter has been over for nearly three months now, so the more material question is: what does this number say about the second quarter?  The answer hinges largely on the technicals of how the Commerce Department plans to estimate healthcare spend when second-quarter GDP numbers are released at the end of July.  –Guy LeBas, Janney Montgomery

Rarely does one see the third iteration of a GDP number so large, and so far from consensus. … The first point is that this is simply a very ugly temperature check of activity in (the first quarter). To put this in context, the decline matched the average GDP print during the last recession, the worst since the Great Depression. The big miss relative to expectations centered on downward revisions to healthcare spending assumptions for Obamacare. What had been viewed as a 0.7% addition to GDP turned into a 0.2% drag. That accounts for most of the miss, but it doesn’t account for a disastrous quarter of growth or lack thereof. –Eric Green, TD Securities

Bottom Line: The first quarter was a complete write-off for the U.S. economy, but growth has rebounded smartly in the second quarter, in part, because companies are more willing to take out their checkbooks. –Sal Guatieri, BMO Capital Markets

In short, GDP was recession-like in Q1, although most other data clearly signal that the decline is an outlier. If anything, labor market indicators and business surveys are suggesting a net pick-up in the trend so far this year.  We expect at least partial payback with a strong 4% rate of growth in Q2. –Jim O’Sullivan, High Frequency Economics

It is amazing that the initial estimate of healthcare spending’s contribution to Q1 growth went from an initial estimate of +1.10 percentage points (representing a 9.9% quarter-to-quarter annualized growth rate in the sector) to -0.16pp (-1.4% q/q annualized). This is a crazy-sized revision, and speaks very loudly to the fact that nobody has a real handle on how the introduction of Obamacare has affected these data, nor for how long the distortions may last until things settle down. –Joshua Shapiro, MFR, Inc.

A number of factors were behind the contraction in the economy in the first quarter. The big drag was the difficult winter, which caused consumers to postpone spending, disrupted production, led businesses to hold off on investment, and caused construction delays. Consumer spending growth was weak. … But the contraction in the first quarter is old news, and things are looking much better for the rest of this year. Most importantly the labor market remains solid. –Gus Faucher, PNC Financial Services Group

More up-to-date data show that activity is rebounding in the second quarter. Indeed, May’s durables goods orders suggest that business investment is growing again. … In short, the larger contraction in GDP in the first quarter is not a sign that the US is suffering from a fundamental slowdown – it was still largely due to the extreme weather. The latest data are consistent with growth in the second quarter rebounding to at least 3.0%. –Paul Dales, Capital Economics

 

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Nate Silver on Piketty and His Skeptics

Nate Silver has said it very well, “Be skeptical of both Piketty and his skeptics.”

Data never has a virgin birth. It can be tempting to assume that the information contained in a spreadsheet or a database is pure or clean or beyond reproach. But this is almost never the case. All data is collected and compiled by someone — either an individual researcher or a government agency or a scientific laboratory or a news organization or someone or something else. Sometimes, the data collection process is automated or programmatic. But that automation process is initiated by human beings who write code or programs or algorithms; those programs can have bugs, which will be faithfully replicated by the computers.

This is another way of saying that almost all data is subject to human error. It’s important both to reduce the error rate and to develop methods that are more robust to the presence of error.1 And it’s important to keep expectations in check when a controversy like the one surrounding the French economist Thomas Piketty arises.

 

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NY Times: A Top-Heavy Focus on Income Inequality

I’m not of the opinion that economic well being is a zero-sum game.  By this, I mean that I do not believe that those working today as part of the labor force are in effect depriving another of doing the same – i.e. those out of the labor force.  Surprisingly, educated people often perceive it to be this way.  I choose to consider ways in which can uplift those referred to as the bottom 20%.  I like Sendhil Mullainathan’s perspective in his NY Times piece “A Top-Heavy Focus on Income Inequality“:

I worry about growing income inequality. But I worry even more that the discussion is too narrowly focused. I worry that our outrage at the top 1 percent is distracting us from the problem that we should really care about: how to create opportunities and ensure a reasonable standard of living for the bottom 20 percent.

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This should not come as any surprise but annual income varies by educational attainment.  I remember earning my degree and getting my first “real” job.  I was making $10 an hour and thought I was big time.  I had a one-bedroom apartment to myself and could go on dates.  I was set!  I remember after the “trial” period was over and I went on salary – WOW!  I was already saving at $10 an hour!  If I didn’t get complaints from my friends and family about my apartment’s location, I may have never moved.  It didn’t bother me so much when the strange guy would come “dumpster-diving” every day or when my bike would get stolen.

Back to the topic at hand, I earned an undergraduate degree and then chose to pursue a graduate degree.  I still wasn’t earning much, but I was earning more nevertheless.  The thought of bringing someone up higher than were I began with my four-year degree via artificial methods such as a minimum wage hike – without regard to any performance, effort, or achievement – is mildly offensive to me.  I have pride in my accomplishments and to think I could have done nothing and ended up in a similar place is outrageous.

With that, I present the Tax Foundation’s post regarding incomes and education:

One of the biggest contributors to rising inequality in America today is the growing earnings gulf between workers with college degrees and those without. Indeed, the median income for all households was $51,244 in 2011. By contrast, the median income for a household headed by a worker with a four-year college degree was $78,251, more than 50 percent above the typical household. Those with professional degrees earn more than twice the median household income.

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