Inequality and Economic Policy: Essays in Memory of Gary Becker, edited by Tom Church, Chris Miller,...

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Copyright © 2015 by the Board of Trustees of the Leland Stanford Junior University. All rights reserved.


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Inequality and

Economic PolicyEssays inMemory ofGary Becker



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Te Hoover Institution gratefully acknowledges

the following individuals and foundations

for their signicant support of theWorking Group on Economic Policy

and this publication:

Lynde and Harry Bradley Foundation

Preston and Carolyn Butcher

Stephen and Sarah Page Herrick

Michael and Rosalind Keiser

Koret Foundation

William E. Simon Foundation

John A. Gunn and Cynthia Fry Gunn



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Inequality andEconomic Policy

Essays in

Memory ofGary Becker

EDITED BY

Tom Church

Chris MillerJohn B. Taylor

CONTRIBUTING AUTHORS

John H. CochraneCharles I. Jones

Edward P. Lazear Casey B. MulliganKevin M. MurphyLee E. OhanianJames PieresonJoshua D. RauhEmmanuel SaezGeorge P. ShultzJörg L. Spenkuch

HOOVER INSTITUTION PRESSSTANFORD UNIVERSITY STANFORD, CALIFORNIA



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With its eminent scholars and world-renowned library and archives, the Hoover Institution

seeks to improve the human condition by advancing ideas that promote economic opportunity

and prosperity, while securing and safeguarding peace for America and all mankind. Te views

expressed in its publications are entirely those of the authors and do not necessarily reect the

views of the staff, offi cers, or Board of Overseers of the Hoover Institution.

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In Memoriam

Tis conference volume is dedicated tothe life and work of Gary Becker.



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Contents

List o ables and Figures ix

Acknowledgments xiii

Introduction xv

om Church, Chris Miller, and John B. aylor

ONE Background Facts 1

James Piereson

TWO The Broad-Based Rise in the Return to

Top Talent 17

Joshua D. Rauh

THREE The Economic Determinants of Top

Income Inequality 49

Charles I. Jones

FOUR Intergenerational Mobility and

Income Inequality 65

Jörg L. Spenkuch

FIVE The Effects of Redistribution Policies

on Growth and Employment 91

Casey B. Mulligan

SIX Income and Wealth in America 111

Kevin M. Murphy and Emmanuel Saez

SEVEN Conclusions and Solutions 147

John H. Cochrane, Lee E. Ohanian, and George P. Shultz



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viii Contents

EIGHT Remembering Gary Becker 181

Edward P. Lazear and George P. Shultz

Conerence Agenda 191

About the Contributors 193

About the Hoover Institution’s 197

Working Group on Economic Policy

Index 201



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Figure . Percentage o total income rom executives, managers, and

supervisors in top . percent

Figure . Average prot per partner at top US law rms, –(in millions o dollars)

Figure . Average prot/partner at top law rms relative to average

AGI o top ., –

Figure . Multiples o pay o top twenty-ve hedge-und managers to

total ex-ante pay o all S&P CEOs

Figure . Average top twenty-ve salaries in proessional baseball,

basketball, and ootball (in millions o dollars)

Figure . Generation o wealth-creating business in Forbes : more

sel-made, less inheritance

Figure . Did US Forbes grow up wealthy?

Figure . Higher education o Forbes

Figure . Outside the US: Sharpest difference between wealthiest

individuals in United States and around the world? Figure . op income inequality in the United States and France

Figure . op income inequality around the world

Figure . Te Pareto nature o labor income

Figure . Basic mechanism: random growth with death → Pareto

Figure . Te Great Gatsby Curve

Figure . Intergenerational persistence and the college earnings

premium Figure . Earnings deciles o sons born to bottom-decile athers

Figure . Earnings deciles o sons born to middle-two-decile

athers

Figure . Earnings deciles o sons born to top-decile athers

Figure . Enrichment expenditures per child in the US, by parental

income

Figure . Steady state analysis

Figure . Statutory marginal labor tax rates

Figure . Health insurance marketplaces

x List of Tables and Figures



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List of Tables and Figures xi

Figure . axes in Affordable Care Act

Figure . Saety net rules compared with work hours

Figure . Measures o wages Figure . Full-time wages or married and unmarried workers

Figure . Returns to college education, –

Figure . Growth in men’s and women’s log weekly wages by percentiles

o the wage distribution, – through –

Figure . Change in relative log wage or men rom –

Figure . Supply growth and relative wages

Figure . Returns and college attendance

Figure . op percent pre-tax income share in the US,

–

Figure . Decomposing top percent into three groups,

–

Figure . Change in top tax rate and top percent share, – to

– Figure . op percent income share (pre-tax) and top marginal

tax rate

Figure . op percent and bottom percent income growth

Figure . Bottom percent wealth share in the United States,

–

Figure . Real average wealth o bottom percent and top percent

amilies Figure . Savings rates by wealth class (decennial averages)



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Acknowledgments

We are grateul to many people or their help in putting together

both the conerence and this conerence volume, including

Barbara Arellano, Marshall Blanchard, Nick Brady, ess Evans

Clark, John Cogan, Barbara Egbert, Denise Elson, Scott Harri-

son, Linda Hernandez, Stephen Langlois, Guity Nashat, Jennier

Navarrette, John Raisian, Marie-Christine Slakey, Janet Smith, and

Ian Wright.



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Introductionom Church, Chris Miller, and John B. aylor

Te inspiration or these essays is the lie and career o Gary

Becker. One o the leading economists o his generation and a win-

ner o the Nobel Prize, Becker was a senior ellow at the Hoover

Institution or over twenty years. Importantly or the purposes o

these essays, Becker was also a leading researcher on the subjects

o human capital and income inequality. Many o the questions

raised by Becker’s research continue to spark vigorous debateamong economists, none more so than the effect o inequalities o

human capital. Te diverse ways in which the essays bring data and

analysis to bear on the questions o human capital and inequality

are a tting demonstration o Gary Becker’s lasting inuence on

economics.

Te question o income inequality has risen to the oreront o

public debate in recent years. Has income inequality increased?I so, what actors are driving this shif? What is the relationship

between inequality o income, wealth, and consumption? Is there

persistence o inequality rom one generation to another? o what

extent should we consider higher income inequality a problem?

And what role, i any, should public policy play in addressing it?

In different ways, economists have always been interested in,

and have debated, these questions. Yet while the essays in this vol-

ume engage with these long-term debates, they are motivated by

two recent developments. Te rst is increased interest in inequal-

ity, both among the public at large and within the political process.



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I we are going to talk about inequality, we need a solid actual

and theoretical basis underlying our discussions. All o the essays

presented here are written in part with this goal in mind. A secondmotivation or the essays is the exceptional array o new empirical

work on inequality, especially on the incomes and wealth o top

earners. Understanding these new data requires careul study and

interpretation, and these essays all aim to address this issue.

For Gary Becker, economics and economic policy were insep-

arable. When he talked to a politician running or offi ce or to a

public offi cial already in offi ce, his policy recommendations would

be exactly the same as i he were speaking to a student or a col-

league. Gary Becker was diagnosing and looking or solutions to

income distribution problems decades ago. And some o his most

recent work at the Hoover Institution was on inequality across

generations.

In chapter , James Piereson outlines the existing debate oninequality, surveying the data collected by Tomas Piketty and

Emmanuel Saez that show a remarkable increase in top incomes.

From a public policy perspective, Piereson argues, inequality pre-

sents a serious intellectual challenge, because many policies that

could reduce inequality might also slow economic growth.

Joshua Rauh asks, in chapter , why top incomes have increased

rapidly in recent decades. Drawing on a wide array o data, Rauhshows that top incomes have increased across different sectors,

rom corporate managers to sports stars. Rauh concludes that this

suggests broad market orces such as globalization or technologi-

cal change caused top incomes to rise.

In chapter , Chad Jones proposes a model to explain why

inequality varies across different countries. He examines how the

processes o creative destruction and innovation interact to shape

the returns to entrepreneurship. Jones’s model suggests that a wide

range o variables—rom research subsidies to barriers to market

entry—affect inequality levels.

xvi Introduction



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Introduction xvii

Jorg Spenkuch develops a model o an equally important issue

in chapter , exploring the relationship between intergenerational

mobility and income inequality. Spenkuch argues that parentswith high human capital are likely to invest more effectively in

the development o human capital in their children. Spenkuch

argues that this act explains why children o parents at the top

o the income distribution are themselves likely to reach the top

o the income distribution. Another surprising conclusion is that

increasing education spending by an equal amount per student

might lead to an increase in inequality.

In chapter , Casey Mulligan explores the downsides to policies

which are ofen used to combat inequality. Mulligan shows how

policies such as changes to health insurance and anti-poverty pro-

grams raise implicit tax rates on employment. Arguing that higher

taxes on employment in recent years have caused lower employ-

ment levels, Mulligan cautions against ignoring the side effects opolicies intended to reduce inequality.

Emmanuel Saez and Kevin Murphy debate the causes o rising

top incomes in chapter . Murphy ocuses on human capital, argu-

ing that high demand and low supply o highly educated workers

have pushed up top wages. Helping lower-skilled workers increase

their human capital, he suggests, would reduce inequality while

promoting economic growth. By contrast, Saez suggests that rent-seeking explains much o the increase in top incomes and argues

that government needs to play a big role in reducing inequality.

In chapter , John Cochrane, Lee Ohanian, and George Shultz

examine the implications or public policy. Cochrane argues that

inequality is an unhelpul intellectual ramework and suggests that

ocusing on inequality distracts rom challenges such as promot-

ing economic growth and decreasing poverty. Ohanian argues that

improved education and increased immigration could boost wages

or low-income workers. George Shultz concludes by discussing



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two case studies o organizations that work to ght poverty and

related social ills.

In the nal chapter, Eddie Lazear and George Shultz reminisceabout the lie and career o Gary Becker. Becker’s work touched

a wide range o subjects, rom the economics o sports to am-

ily structures. Lazear and Shultz celebrate Becker’s path-breaking

research and share personal stories borne out o decades o

riendship.

ogether, the chapters illustrate the complexity o scholarly

debate about income inequality. Not only do economists disagree

about which orces are driving changes in the distribution o

income, they also continue to debate the relevance o inequality

itsel as a concept or public discussion and policymaking. Need-

less to say, given the complexity o the issue, income inequality is

a topic that economists will be debating or some time to come.

Te essays presented here, however, not only represent the cur-rent state o economic thinking regarding inequality, they lay out a

rich agenda or uture research. In that sense, these essays not only

constitute a remembrance o Gary Becker, but also a continuation

o his scholarly work.

xviii Introduction



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CHAPTER ONE

Background Facts James Piereson

Our subject is the inequality crisis, so called. I somewhat regret the

title o my book, Te Inequality Hoax. I you’ve published anything

lately, you know that your publishers want an attention-drawing

title on your book or article. I could not call the book “Te Inequal-

ity Dilemma” or “Te Inequality Challenge”; those titles are too

equivocal. Tat’s more or less what it is: a challenge or a dilemma,

and one that will be diffi cult to address. My view is that inequalityis real, however you want to measure it. But the subject is being

used in ways that are not helpul and could do a great deal o harm

i we’re not careul. I’ll elaborate on that view.

We’ve experienced a series o crises over our lietimes. I think

back to the poverty crisis o the s, the urban crisis o the s,

the energy crisis o the s, the ination crisis, later the homeless

crisis, the health care crisis, and the global warming crisis today.Many people nd it helpul politically to talk in terms o crisis,

perhaps as a way o stampeding voters into doing things they

might not otherwise do. I we look back over these crises, it’s not

clear that we’ve responded to them in ways that have always been

helpul.

oday we have what some have called “the new inequality.” Te

old inequality was all about helping the poor move up into the

middle class: think about the poverty programs in the s or

I want to acknowledge the invaluable assistance o Carson Bruno in the preparation o

this paper.



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2 James Piereson

spending on education. Federal programs o all sorts were designed

to allow the poor to rise. Te inequality crisis today is rom the

other end. It’s about the top percent o the income distribu-tion, and nding ways to redistribute that income down through

the population to raise the living standards o the other per-

cent. We’ve been talking about this or a number o years, but it

surged into public consciousness last spring with the publication

o Tomas Piketty’s book, Capital in the wenty-First Century. It

was a monumental bestseller, and was widely read and reviewed.

Piketty became an overnight celebrity. It is a careully researched

and closely argued book. I encourage everybody to read it. It’s an

impressive work. It’s very insightul in a lot o ways and it makes

a case that puts inequality in a historical and intellectual context.

In a certain sense, he’s done or inequality what Marx did or capi-

talism. In the nineteenth century, intellectuals and radicals com-

plained about the actory system, the movement o people into thecities, the exploitation o labor, and other developments associated

with the rise o industry. But it was Marx who placed it into a theo-

retical and historical context.

In the s and s, many people were talking about public

spending and public works as a way to deal with unemployment. It

was John Maynard Keynes who put that into a broader theoretical

context to explain how public spending could be used to manipu-late or jumpstart the economy during the Depression. In a certain

sense, Piketty (along with his colleague, Emmanuel Saez) has done

something similar or inequality. Tey’ve placed it into a broad

intellectual context. It’s the strongest statement we have o what we

might call “the redistributionist thesis.” Tey have done an impres-

sive job o collecting a great deal o data on wealth and income

extending back into the s in the case o a ew countries. With

respect to the United States, they have collected data on wealth

and income going back to . Tese data are not perect in every



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Background Facts 3

respect. Te wealth data in particular were arrived at via some

sophisticated statistical estimation. Governments collect income

data because they tax income. Tey don’t collect data on wealth.For this reason, Piketty and his associates had to piece together the

data on wealth using estimation techniques rom estate tax lings.

People have criticized their data. I do not, because I expect that

they will improve the data over time. In addition, no one else, to

this point, has done a better job.

Piketty makes the theoretical case that inequality is built into

the abric o the capitalist order. It’s not accidental but undamen-

tal: inequality will inevitably explode unless it is counteracted

by active governmental measures. Teir remedy to redistribute

income is not complex; they call or a return to the high and con-

scatory tax rates on the wealthy that were in place in most coun-

tries rom the s into the s.

Te basic theory is that returns to capital always grow morequickly than output in the economy or returns to labor. I that pat-

tern persists over time, then those who own capital grow wealthier

over time. In Figure ., taken rom Piketty’s Capital in the st Cen-

tury, one sees that in the middle o the twentieth century returns to

capital declined and were overtaken by overall economic output.

For that reason, there was a rough equalization o incomes dur-

ing that period. Later in the century, afer about , inequalityincreased because capital accumulated aster than the output o

the world economy.

What we conclude rom this is that the modern age o capital-

ism can be divided up into three periods. Te rst period, run-

ning rom roughly to in the United States and rom

to in Europe, was the original gilded age o inequality. Te

middle period, running roughly rom to , might be called

the “golden age o social democracy,” marked by high marginal

tax rates, output growing more rapidly than returns to capital, and



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4 James Piereson

a greater equalization o incomes and wealth. Beginning in

and moving orward to the present time, we have lived through

a new gilded age o rising inequality and returns to growth going

disproportionately to the wealthy. Tat is the tripartite division o

the history o modern capitalism, which I more or less accept on

the basis o the data marshaled by Piketty and his associates.Figure . displays a set o data on afer-tax income rom the

Congressional Budget Offi ce. Te data cover the period rom

to . Te top dotted line displays the percentage growth in

income rom year to year or the top percent o the income distri-

bution; the bottom line displays the same variable or the bottom

percent. Te line displays the evolution o the median income

or the entire population, which tracks closely with the incomes

o the bottom percent o the distribution. Te basic problem is

that the income o the top percent is exploding and the income

or the rest is increasing much more slowly, though (importantly)

6

5

4

3

2

1

0

0 - 1 0 0 0

1 0 0 0

- 1 5 0

0

1 5 0 0

- 1 7 0

0

1 7 0 0

- 1 8 2

0

1 8 2 0

- 1 9 1

3

1 9 1 3

- 1 9 5

0

1 9 5 0

- 2 0 1

2

2 0 1 2

- 2 0 5

0

2 0 5 0

- 2 1 0 0

Growth Rate of World Output (g)

Pure Rate of Return to Capital, after Taxes (r)

FIGURE 1.1. Rate o return vs. world growth (antiquity to )

Source: Tomas Piketty, Capital in the st Century , gure ., p.



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Background Facts 5

FIGURE 1.2. Average afer-tax income growth ( to )

Source: ravis Honeyeld, ed., “Distribution o Household Income & Federal axes,

–,” tables & (Washington, DC: Congressional Budget Offi ce)

it is not declining. Te mean afer-tax income or the top percentin was , and or the bottom it was ,. Te

gures are or afer-tax income; the distribution o pre-tax income

is slightly more skewed in avor o the wealthy, as there is a mildly

redistributive element to the ederal tax system.

Placing these gures within a longer historical rame, it is

apparent that the great increase in inequality since repre-

sented a departure rom the pattern o earlier decades. Figure .,taken rom an article by Saez, displays the share o pre-tax income

(with and without capital gains) received by the top percent and

. percent in the United States between and . Te data

begin in because that is the year the United States launched the

income tax. Te lines ollow a recognizable U-shaped pattern, with

the wealthy reaping higher shares o national income beore ,

then somewhat smaller shares between and , and once

again much higher shares during the three-decade period afer

. oday the top percent o the income distribution is receiv-

ing close to percent o national income, a gure close to what it

45%

95%

145%

195%

245%

295%

345%

–5%1979 1985 1991 1997 2003 2009

Average After Tax Income, 2010Bottom 99% = $66,500Top 1% = $953,000

Bottom 99% Adj. Median Income Top 1%



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6 James Piereson

5

10

15

20

25

0

1913 1922 1931 1940 1949 1958 1967 1976 1985 1994 2003 2012Top 1% (with capital gains)

Top 0.1% (with capital gains)

Top 1% (without capital gains)

Top 0.1% (without capital gains)

FIGURE 1.3. Share o pre-tax, pre-transer income or top and .

Source: Emmanuel Saez, “Income Inequality in the United States, –,” with Tomas

Piketty, Quarterly Journal of Economics, (), , –, updated to , September

, tables A and A

was in the s. In the intervening decades— to —those

shares dropped by hal to around percent o national income.

Tis chart more or less encapsulates Piketty’s historical narrative:

the original gilded age broken up by the stock market crash o

and the New Deal, the “golden age” o social democracy rom

to , and the return o the gilded age in recent decades.Piketty also points out that the wealthy in our era earn their

incomes rom different sources than was the case early in the

twentieth century. In the early decades o the century, the wealthy

received most o their income rom capital gains—that is, by earn-

ings rom stocks and bonds rather than rom salaries and wages.

In the parlance o the day, they were “coupon clippers,” passively

receiving income rom investments. In the contemporary era, the

wealthy are increasingly proessionals who earn generous salaries

rom executive positions. oday, more than hal o the total income



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Background Facts 7

o the top percent is received in the orm o salaries. Tese are

people who work or a living and depend upon salaries to pay their

bills and accumulate wealth.Piketty ocuses a good deal o attention on the so-called “new

salaried rich”—those who earn salaries o between , and

million per year as executives in businesses, nancial rms, col-

leges and universities, and not-or-prot organizations. He does

not believe that they genuinely earn these salaries on the basis o

their contributions to the protability or effi ciency o the organi-

zations they run; rather, he suggests, they set their own salaries,

or recruit board members who support generous compensation

packages, and in general receive high pay packages as members o

a “club” with wealthy associates and directors.

Te evidence or these claims is thin and impressionistic. Never-

theless, rom his point o view, they justiy much higher tax rates

on members o the new managerial class, particularly since hebelieves that the lower marginal tax rates o the post- decades

have created a permissive environment or boards o directors that

set salaries or executives. In the old days, with a percent mar-

ginal tax rate, it did not make a lot o sense or boards to approve

overly generous salaries, since most o the added increment went

to the ederal government in the orm o taxes. High marginal tax

rates thus tended to keep executive salaries down. oday, the logicis different: with low marginal rates, salaried proessionals can

keep most o their raises.

As one would expect rom these gures, there are now signi-

cant differences among different segments o the national economy

in mean household incomes and net worth. In , as depicted

in table ., the mean household income o the top percent was

. million while the bottom percent received on average about

,. Te disparities are even greater or household net worth,

measured in terms o ownership o real estate and nancial assets.



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8 James Piereson

TABLE 1.1. Income and net worth in the US by percentile ( dollars, averages)

Wealth orIncome Class Mean HouseholdIncome Mean HouseholdNet Worth

Mean Household

Financial (Non-Home) Wealth

Top 1% $1,318,200 $16,439,400 $15,171,600

80th to 99th% 107,000 1,295,600 1,010,800

60th to 80th% 72,000 216,900 100,700

40th to 60th% 41,700 61,000 12,200

Bottom 40% 17,300 (10,600) (14,800)

Note: Only mean gures are available, not medians. Note that income and wealth are

separate measures; so, or example, the top percent o income-earners is not exactly the

same group o people as the top percent o wealth-holders, although there is consider-able overlap.

Source: Edward Wolff, “Te Asset Price Meltdown and the Wealth o the Middle Class,”

August , , table

Data source: Survey on Consumer Finances

It is hard to quibble with Piketty and his associates in their claim

that inequalities in wealth and income are substantial and growingdecade by decade.

Piketty and Saez argue that these patterns justiy aggressive

national policies to redistribute income through higher taxes on

the wealthy. Tough the argument is logical, there are several

problems with it.

First, though the very wealthy have gained in terms o shares o

income and wealth, they have also been paying a larger share o theincome tax in the United States. From –, the tax liability

on the top percent has increased sharply, even as we have reduced

marginal tax rates. In , the highest earners paid ederal taxes at

a marginal rate o percent. Ronald Reagan (and a Democratic

Congress) reduced that rate to percent in and then later to

percent. Nevertheless, the share o ederal income taxes paid

by the top percent o the income distribution increased rom

percent in to percent by . Te top percent paid

percent o income taxes in but percent in .



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Background Facts 9

oday, then, the top percent o the income distribution pays

nearly the whole o our ederal income taxes. As we have reduced

marginal rates, we have also taken those below the median incomecompletely off the ederal income tax rolls (they are still hit with

payroll taxes). Tis, then, points to one o the diffi culties in redis-

tributive taxation: there is not a lot o room to raise taxes on “the

rich.” Tey are already paying the lion’s share o the income tax. It

also points to the political diffi culty in trying to cut taxes: any tax

cut will disproportionately avor the wealthy because they are the

ones already paying the taxes.

Second, it is not at all clear that we can reduce inequality very

much through the income tax system. In theory, taxpayers would

send money to Washington, DC, and rom there the political

authorities would allocate it to those who need it or the purpose

o equalizing incomes. But that is not the way the political system

actually operates. Money sent to Washington must pass through agantlet o interest groups seeking concentrated benets or their

members. In the struggle or unds, the politically inuential

groups usually win out over disorganized voters seeking small and

widely dispersed benets. In addition, the immediate beneciaries

o the national tax system appear to be those living in or around

the nation’s capital. Five o the six wealthiest counties in the United

States surround Washington. Te capital already has the highestper capita income o any metropolitan region in the country. Under

current circumstances, a tax increase on the wealthy would merely

redistribute income rom the top percent to the next percent or

percent o the income distribution.

It is true that there is some “real” money in the top income

groups. Te top percent paid about billion in ederal taxes

in , leaving them with about . trillion in afer-tax income.

It might be possible to gain another billion to billion by

raising their taxes by another percent or percent. Tat is not



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10 James Piereson

a large sum in relation to a ederal budget o close to trillion, but

it would represent a signicant proportion o the current ederal

decit o billion to billion. But, or reasons stated above,it is unlikely that those added revenues would eventually end up

where Piketty and his colleagues think they should.

An obvious limitation o the income tax is that it does not get at

the extraordinary accumulations o wealth held by individuals like

Warren Buffett, Bill Gates, and other members o the Forbes .

Governments tax incomes, but not wealth. Te very wealthy own

a disproportionate share o these assets. According to some esti-

mates, the wealthiest percent own close to hal o the trillion

to trillion value o the stock, bond, and residential real estate

markets.

As a remedy or this problem, Piketty advocates a global “wealth

tax” on the “super-wealthy,” with that tax levied against assets in

stocks, bonds, and real estate. He acknowledges that such a tax haslittle chance o being enacted, though he hopes that at some point

it might be enacted to cover the countries in the European Union.

Te United States has never had a wealth tax; and in act such a

tax may not be allowed under the Constitution (which authorizes

taxes on incomes). Several European countries—Germany, Fin-

land, and Sweden among them—have had such a tax in the past,

but have discontinued it. France currently has a wealth tax thattops out at a rate o . percent on assets in excess o ten million

Euros (or about million).

Wealth taxes are notoriously diffi cult to collect, and they

encourage capital ight, hiding o assets, and disputes over pric-

ing o assets. Tey require individuals to sell assets to pay taxes,

thereby causing asset values to all. Piketty thinks that a capital

tax would have to be global in nature to guard against both capital

ight and the hiding o assets in oreign accounts. It would also

require a new international banking regime under which major

banks would be required to disclose account inormation to



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Background Facts 11

national treasuries. Under his scheme, a tax would be imposed on

a sliding scale beginning at percent on modest ortunes (roughly

between . million and million) and perhaps reaching as highas percent on “super ortunes” in excess o billion annually.

Te purpose o the tax, it should be stressed, is to reduce inequal-

ity, not to spend the new revenues on benecial public purposes.

Proessor Piketty argues in the broader message o his book

that we are living through a new “gilded age” o extravagant wealth

and lavish expenditures enjoyed by a narrow elite at the expense

o everyone else. As with the original “gilded age” o the late nine-

teenth century, the wealth accruing to the ew gives the illusion o

progress and prosperity, but conceals growing hardships and eco-

nomic diffi culties endured by the rest o the population. Much o

his thesis rests upon this proposition: our era is one o aux pros-

perity, a claim that is maniestly untrue.

Tis argument makes sense only i one accepts the narrow prem-ise that these multiaceted regimes can be assessed on the basis o

the single criterion o wealth and income distribution or that the

essence o the capitalist order is ound solely in returns to capital

and in the distribution o wealth and incomes rather than in rising

living standards, innovation, and the spread o modern civiliza-

tion. In each o these three eras, there was much more going on

than simply the rearranging o wealth and incomes.No less an authority than John Maynard Keynes looked back

upon the pre-war era in Europe as a “golden age” o capitalism.

“What an extraordinary episode in the economic progress o man

that age was which came to an end in August, ,” he wrote in

in Te Economic Consequences of the Peace. He marveled at the

economic progress made across the continent afer ollowing

the unication o Germany. Industry and population grew steadily

as trade across the continent accelerated, widening the sphere o

prosperity and the reach o modern comorts. In the United States,

rapid growth, stable prices, and high real wages drew millions o



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12 James Piereson

immigrants rom Europe to build railroads, work in actories, and

industrialize the country. Far-reaching innovations—electricity,

the telegraph, mass-produced steel, and motorcars—drove theindustrial process orward and made a ew people very rich. It

was the rst era o globalization and open trade. Tese three ac-

tors— innovation, emigration toward emerging centers o wealth,

and widening circles o trade—have been key elements o “golden

ages” throughout history, and especially in the modern age o capi-

talism. Tis particular golden age ended in in Europe and in

in the United States.

Te so-called “golden age” o social democracy has much to

commend it; one should not gainsay the genuine economic and

social progress achieved in the United States and elsewhere dur-

ing the middle decades o the century. Nevertheless, the virtues o

that era can be overstated. As Piketty acknowledges, much o the

accumulated capital o the preceding era was wiped out by war anddepression. Te conscatory tax rates o that era, with marginal

rates as high as percent in the United States in the s and

s, may have equalized incomes to some degree but they also

discouraged effort and held back risk-taking and innovation. Te

impressive growth rates o the s and s developed rom a

depressed base and built out innovations rom the earlier period.

Labor unions grew and won impressive wage gains or members,but mainly because (in the United States) they were bargaining with

domestic oligopolies in the auto, steel, railroad, aluminum, and

other industries. Te structure o American industry was highly

concentrated which, in the opinion o some, impeded innovation.

Economist John Kenneth Galbraith wrote that cartelization was a

permanent eature o the US economy. Tere was little immigra-

tion into the United States and Western Europe between and

. Most importantly or the distribution o wealth, the US stock

market barely moved in real terms between and ; in ,



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Background Facts 13

the Dow Jones Industrial Average was at a lower level (adjusted or

ination) than at its peak in .

Te high tax regime o that era collapsed in the s, notbecause “the rich” dismantled it, but because government spend-

ing and regulation brought with them more crime, dependency,

and disorder, along with simultaneously growing rates o unem-

ployment and ination. It was Jimmy Carter who rst led the

charge to deregulate the airline, railroad, trucking, and commu-

nications industries. Democrats and Republicans alike agreed that

the US economy was suffering rom a shortage o capital—and

that tax rates should be reduced to promote capital ormation.

Tat approach succeeded, as we have seen. At the same time, US

leaders pushed successully or the elimination o trade barriers

and a more open international trading system.

One might echo Keynes’s comments about the pre-war era in

Europe in reecting upon the era through which we have livedrom the s to the present. Tis has been, as some have called

it, the “age o Reagan”—an era dened by the tax and regulatory

reorms he put in place during the s. Far rom being a gilded

age, it appears rom a broader perspective to have been a new

golden age o capitalism, marked by lie-changing innovations

in technology, globalized markets, and widening circles o trade,

unprecedented levels o immigration into centers o prosperity, theabsence o major wars, rising living standards around the world,

alling ination and interest rates, and a thirty-year bull market

in stocks, bonds, and real estate. At the same time, the boom in

nancial assets and real estate has also enriched the endowments

o colleges, universities, and oundations, along with pension and

retirement unds upon which millions o households depend.

Tese developments broke up the concentrated structure o the

US economy, making it more open, competitive, and innovative. At

the same time, corporate prots are ar higher now than in the age



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14 James Piereson

o industrial concentration and oligopoly. Te end o the Cold War

and the entrance o China into the world economy similarly broke

open the structure o world politics and nance that dominatedthe middle decades o the century. Meanwhile, levels o poverty

and inequality around the world have declined dramatically over

the past three decades. Tough some have won incredible riches

in this new age o capitalism, they have done so by developing new

products and technologies o benet to everyone, or by investing

in enterprises that earn prots by satisying customers.

Keynes once remarked that the challenge in such a situation is

to keep “the boom” going, not to bring it to a premature end out o

a superstition that those who have prospered must be punished by

high taxes and sel-deeating regulations. Tose errors have been

made in the past, most recently in the s. Our golden age is

going to end sooner or later, but much sooner i Proessor Piketty

and his supporters have their way.Tis is because our main challenge is not in the area o inequal-

ity but in sustaining the economic growth that is the real solu-

tion to stagnating middle-class incomes. Economic growth has

1

2

3

4

5

6

7

01950 1956 1962 1968 1974 1980 1986 1992 1998 2004 2010

FIGURE 1.4. Annual ve-year moving average real GDP growth () –

Source: Bureau o Economic Activity



35/42

Background Facts 15

been slowing decade by decade in the United States and across

the industrial world, and particularly since the year . Te

stock market boom o recent decades has sustained the wealth andincomes o the top percent, but it has done little or the living

standards o the middle and working classes.

Tis point is illustrated more clearly in gure ., which dis-

plays the pattern o real GDP per capita economic growth rom

through . Te pattern is displayed in ve-year moving

averages in order to remove the “noise” o year-to-year changes

so that the long-term trend can be seen more clearly. As the chart

suggests, the US economy has gone through three extended boom

periods over the past sixty-plus years: the rst in the s, the

second in the s, and a third in the s. Yet each recovery has

been less robust in GDP growth than its predecessor. In between,

the nation has gone through periods o sluggish growth, including

an extended one in the s that set the stage or the airly robustrecoveries o the Reagan and Clinton years. From the late s

onward, the pattern has been steadily downward, and much more

sharply and or much longer than in previous sluggish periods.

Te United States may have an inequality problem, but more

undamentally it has a “growth” problem. A stagnant America,

lacking growth and broad opportunities or advancement and

achievement, would represent something new and dangerous or anation whose ideals and institutions have been built upon a oun-

dation o growth and prosperity. Te emphasis on inequality and

redistribution, while not wrong, is nevertheless misplaced, or it

may lead us to adopt policies that will disrupt the progress we have

made while doing nothing to promote the kind o growth that is

essential to national progress.



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About the Contributors

TOM CHURCH is a research ellow at the Hoover Institution. He studiesincome inequality, poverty, health care policy, entitlement reorm, andimmigration reorm. He has conducted research on developing supple-mental statistics to better measure income, poverty, and health insurancecoverage in the United States. He also contributes to the Hoover Institu-tion’s immigration reorm initiative. He received his master’s degree inpublic policy with honors rom Pepperdine University, specializing ineconomics and international relations.

JOHN H. COCHRANE is the AQR Capital Management DistinguishedService Proessor o Finance at the University o Chicago’s Booth Schoolo Business, a senior ellow at the Hoover Institution, a research associateo the National Bureau o Economic Research, and an adjunct scholar othe Cato Institute. His academic publications ocus on nance, macro-economics, and monetary economics, with orays into health insuranceand time-series econometrics. He also writes op-eds or the Wall Street

Journal and blogs as Te Grumpy Economist.

CHARLES I. JONES is the SANCO Proessor o Economics at the Stan-ord Graduate School o Business and a research associate o the NationalBureau o Economic Research. He has been honored as a national ellowat the Hoover Institution, a John M. Olin Foundation aculty ellow, andan Alred P. Sloan Foundation research ellow. His research has been sup-ported by a series o grants rom the National Science Foundation. He is

the author o numerous research papers as well as two textbooks, Intro-duction to Economic Growth () and Macroeconomics ().

EDWARD P. LAZEAR is the Morris Arnold and Nona Jean Cox SeniorFellow at the Hoover Institution and the Jack Steele Parker Proessor o



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194 About the Contributors

Human Resources, Management and Economics at Stanord University’sGraduate School o Business. He served at the White House rom to , where he was chairman o the President’s Council o Economic

Advisers. Beore coming to Stanord, he taught at the University o Chi-cago. He has written or edited a dozen books and has published morethan one hundred papers in leading proessional journals

CHRISTOPHER MILLER is the associate director o the Program in GrandStrategy at Yale University as well as a ellow at the Foreign Policy ResearchInstitute in Philadelphia. He recently nished a book, Collapse: Te Strug- gle to Save the Soviet Economy, and is currently writing Putinomics: Te

Price of Power in Russia. Miller’s other research interests include politi-cal economy, economic history, and nancial history. He has served as aresearch ellow at Stanord’s Hoover Institution, a research associate atthe Brookings Institution, and a lecturer at the New Economic School inMoscow. He received his doctorate rom Yale University and his bach-elor’s degree rom Harvard.

CASEY B. MULLIGAN, a proessor o economics at the University o

Chicago, has served as a visiting proessor teaching public economics atHarvard University, Clemson University, and the Irving B. Harris Gradu-ate School o Public Policy Studies at the University o Chicago. He isaffi liated with the National Bureau o Economic Research, the GeorgeJ. Stigler Center or the Study o the Economy and the State, and the Pop-ulation Research Center. His research covers capital and labor taxation,the gender wage gap, health economics, Social Security, voting, and theeconomics o aging.

KEVIN M. MURPHY is the George J. Stigler Distinguished Service Proes-sor o Economics in the Booth School o Business and the Departmento Economics at the University o Chicago. He is a senior ellow at theHoover Institution, a ellow o the Econometric Society, an elected mem-ber o the American Academy o Arts and Sciences, and a MacArthurellow. He won the John Bates Clark Medal in or his work on wageinequality and unemployment.

LEE E. OHANIAN is a senior ellow at the Hoover Institution and aproessor o economics and director o the Ettinger Family Program inMacroeconomic Research at UCLA. His research ocuses on economiccrises, technological change and inequality, and the impact o taxation



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About the Contributors 195

on economic activity. He is an adviser to the Federal Reserve Bank oMinneapolis and has previously advised other ederal reserve banks. Hepreviously served on the aculties o the Universities o Minnesota and

Pennsylvania. He is co-director o the research initiative Macroeconomicsacross ime and Space at the National Bureau o Economic Research.

JAMES PIERESON is president o the William E. Simon Foundation anda senior ellow at the Manhattan Institute. He is a requent contributor to

various journals and newspapers, including Commentary, New Criterion, American Political Science Review, Public Interest, Philanthropy, Ameri-can Spectator, Wall Street Journal, Weekly Standard, National Review,

and Washington Post. He is also the author o Camelot and the CulturalRevolution: How the Assassination of John F. Kennedy Shattered AmericanLiberalism.

JOSHUA D. RAUH is a senior ellow at the Hoover Institution and a pro-essor o nance at the Stanord Graduate School o Business. He ormerlytaught at the University o Chicago’s Booth School o Business (–)and the Kellogg School o Management (–). His research covers a

range o topics, including corporate investment and nancial structure,public pension liabilities, and the determinants o the distribution ohousehold incomes. His research has received national media coverage inoutlets such as the Wall Street Journal, the New York imes, the Financialimes, and Te Economist.

EMMANUEL SAEZ is a proessor o economics and director o the Cen-ter or Equitable Growth at the University o Caliornia, Berkeley. His

research ocuses on tax policy and inequality rom both theoretical andempirical perspectives. Jointly with Tomas Piketty, he has constructedlong-run historical series o income inequality in the United States thathave been widely discussed in the public debate. He was awarded theJohn Bates Clark medal o the American Economic Association in and a MacArthur Fellowship in .

GEORGE P. SHULTZ is the Tomas W. and Susan B. Ford Distin-guished Fellow at the Hoover Institution. He served as secretary o labor(–); director, Offi ce o Management and Budget (–); secre-tary o the reasury (–); and secretary o state (–). In ,he became the Jack Steele Parker Proessor o International Economicsat the Stanord Graduate School o Business and a distinguished ellow



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196 About the Contributors

at the Hoover Institution. He is the Advisory Council chair o Stanord’sPrecourt Institute or Energy Effi ciency, chair o the MI Energy Initia-tive External Advisory Board, and chair o the Hoover Institution ask

Force on Energy Policy.

JÖRG L. SPENKUCH is an assistant proessor o managerial econom-ics and decision sciences at Northwestern University’s Kellogg School oManagement. He joined the Kellogg aculty in afer receiving hisdoctorate rom the University o Chicago, where he studied under thesupervision o Gary Becker and Steven Levitt. His research interestsinclude political economy, labor economics, and applied microeconom-

ics more generally. He is currently working on issues related to inequal-ity, strategic behavior in nonmarket environments, and the interactionbetween religion and political extremism.

JOHN B. TAYLOR is the Mary and Robert Raymond Proessor o Eco-nomics at Stanord University and the George P. Shultz Senior Fellowin Economics at Stanord’s Hoover Institution. He is also the director oStanord’s Introductory Economics Center. He has served on the Presi-

dent’s Council o Economic Advisers and as undersecretary o the trea-sury or international affairs. He received the Alexander Hamilton Awardand the reasury Distinguished Service Award or his policy contribu-tions at the US reasury and the Medal o the Republic o Uruguay or hiswork in resolving its nancial crisis.



40/42

About the Hoover Institution’sWorking Group on Economic Policy

Te Working Group on Economic Policy brings together experts on eco-

nomic and nancial policy at the Hoover Institution to study key devel-opments in the US and global economies, examine their interactions, anddevelop specic policy proposals.

For twenty-ve years starting in the early s, the United Stateseconomy experienced an unprecedented economic boom. Economicexpansions were stronger and longer than in the past. Recessions wereshorter, shallower, and less requent. GDP doubled and household networth increased by percent in real terms. Forty-seven million jobs

were created.Tis quarter-century boom strengthened as its length increased.

Productivity growth surged by one ull percentage point per year in theUnited States, creating an additional trillion o goods and services thatwould never have existed. And the long boom went global with emerg-ing market countries rom Asia to Latin America to Arica experiencingthe enormous improvements in both economic growth and economicstability.

Economic policies that place greater reliance on the principles o reemarkets, price stability, and exibility have been the key to these successes.Recently, however, several powerul new economic orces have begun tochange the economic landscape, and these principles are being challengedwith ar reaching implications or US economic policy, both domesticand international. A nancial crisis ared up in and turned into asevere panic in leading to the Great Recession. How we interpretand react to these orces—and in particular whether proven policy prin-ciples prevail going orward—will determine whether strong economicgrowth and stability returns and again continues to spread and improvemore people’s lives or whether the economy stalls and stagnates.

Our Working Group organizes seminars and conerences, preparespolicy papers and other publications, and serves as a resource or policy-makers and interested members o the public.



41/42

Working Group on Economic Policy—Associated Publications

Many of the writings associated with this working group will be

published by the Hoover Institution Press or other publishers. Materi-

als published to date, or in production, are listed below. Books that are part of the Working Group on Economic Policy’s Resolution Project are

marked with an asterisk.

Inequality and Economic Policy: Essays in Honor of Gary Becker

Edited by om Church, Chris Miller, and John B. aylor

Making Failure Feasible: How Bankruptcy Reform Can End

“oo Big to Fail”*

Edited by Kenneth E. Scott, Tomas H. Jackson, and John B. aylor Across the Great Divide: New Perspectives on the Financial Crisis

Edited by Martin Neil Baily and John B. aylor

Bankruptcy Not Bailout: A Special Chapter *

Edited by Kenneth E. Scott and John B. aylor

Government Policies and the Delayed Economic Recovery

Edited by Lee E. Ohanian, John B. aylor, and Ian J. Wright

Why Capitalism? Allan H. Meltzer

First Principles: Five Keys to Restoring America’s Prosperity

John B. aylor

Ending Government Bailouts as We Know Tem*

Edited by Kenneth E. Scott, George P. Shultz, and John B. aylor

How Big Banks Fail: And What to Do about It*

Darrell Duffi eTe Squam Lake Report: Fixing the Financial System

Darrell Duffi e et al.

Getting Off rack: How Government Actions and Interventions

Caused, Prolonged, and Worsened the Financial Crisis

John B. aylor

Te Road Ahead for the Fed

Edited by John B. aylor and John D. Ciorciari

Putting Our House in Order: A Guide to Social Security and

Health Care Reform

George P. Shultz and John B. Shoven



42/42

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