Home > income inequality, inequality > Some important limitations of income inequality data

Some important limitations of income inequality data

from Jonathan Nitzan

Blair Fix, a PhD student in the Faculty of Environmental Studies at York University in Toronto, points to some important limitations of income inequality data. In a recent posting on capitalaspower.com, Fix shows that, in the case of the U.S., the Top 1% income share correlates not with the share of capitalists in national income (profit and interest), but with the share of corporate dividends in national income. This difference means that income-inequality data of the sort reported by Thomas Piketty and others in the World Top Income Database give a very partial and potentially biased picture of ruling class power, power that is much better proxied by all income rather than dividends alone. Blair Fix’s article: http://www.capitalaspower.com/forum/viewtopic.php?t=427&p=1147#p1147

  1. Nell
    July 11, 2015 at 9:47 am

    Checked out the link. Nice graph and really interesting point. The last sentence is speculative but surely would be strengthened by another graph showing the relationship between the ratio of profits invested/profits to dividends compared to a measure of income inequality. This would remove the speculative element. As the blairfix states another possible reason for less profits going to dividends is tax on profits. It would be interesting to see also how this impacts the relationship between income inequality and profit.

    “When companies reinvest most of their profits, income inequality is low. Conversely when companies pay out most of their profits as dividends, income inequality is high.”

  2. July 11, 2015 at 10:38 am

    Yes, Blair Fix has an important point and Nell is right about eliminating investment in price speculation. My reaction is only nibbling round the edges, but shouldn’t banker/CEO bonuses and celebrity/director fees be counted as forms of dividend?

  3. July 11, 2015 at 4:44 pm

    Reblogged this on ihtis69.

  4. A.J. Sutter
    July 13, 2015 at 3:02 pm

    I’m sorry, I’m a lawyer and not an economist, but why is this surprising? How else did economists expect corporate profits to get into the hands of individuals, but by dividends?

    As for banker/CEO bonuses and “celebrity/director fees” (not sure what the “celebrity” is doing there), typically these would be accounted for as expenses, and therefore reduce bottom-line profits. They aren’t dividends. (More evidence for that: the bonuses aren’t given to all holders of a given class of shares, and aren’t based on the number of shares held.)

    Another element of executive compensation is stock options. In fact, the higher the level of executive and the larger the company, usually the higher the percentage of annual compensation comes from options. Assuming his or her timing is good, an individual can realize a profit through the sale of shares, or the exercise of stock appreciation rights. (An SAR means that instead of having to fork over the option exercise price and then sell your shares, you receive the spread between the exercise price and the market price at time of exercise, and the underlying options are extinguished. They’re quite typical in employee stock option plans.) Since both profits on sales of shares and gains through the exercise of SARs count as capital gains, note that these *wouldn’t* be included in national income.

    Piketty’s book assumes that in the long run — like a century or a big chunk thereof — capital gains and capital losses are a wash. (Source: personal correspondence with TP.) But over shorter time periods, including of over a few decades, this might not be the case. So capital gains can contribute to income inequality as well, in a way not clearly correlated to national income. Moreover, if capital gains aren’t reinvested in the stock market, they could earn returns at the (elevated, per Piketty) rate of return on capital, meaning that they can also contribute to wealth inequality.

    A more general observation: it would help for economists to learn something about basic company law.

    • July 14, 2015 at 9:29 am

      “As for banker/CEO bonuses and “celebrity/director fees” (not sure what the “celebrity” is doing there), typically these would be accounted for as expenses, and therefore reduce bottom-line profits. They aren’t dividends.”

      Didn’t I say FORM of dividend? So bottom-line profits and tax thereon are reduced, and individuals benefit more from corporate profits anyway, if perhaps people who have earned their keep more than gamblers and inheritors of wealth and privilege. Blair Fix started this discussion, so the celebrity I had in mind was probably Tony Blair, whose fees for giving a presentation I found truly astonishing. But really, celebrities don’t have to be individuals, they can be institutions like highly regarded rating agencies, accountancies and law firms, where “second sons” may reside as they often did in the medieval church. However, don’t mind me. I’m raising questions for discussion, not making accusations.

  5. Michael Kowalik
    July 13, 2015 at 11:43 pm

    Dividends are off course only part of the income stream for individuals. Every individual in or near the CEO position is likely to have some under the table, split-income arrangement with the company, whereby significant part of their income goes directly into a tax heaven, off the books.

    But the most significant income stream may be associated with corporate bonds and associated coupons, not with dividends on shares. For example, the top banks generally pay more in coupons to faceless wholesale-bond holders in low tax jurisdictions than to their ‘official’ shareholders. I invite you to examine the financial report of your bank of choice. These coupons are written off as costs (of funding!) by the banks, but may indeed be simply a way of offshoring profits to their own subsidiaries and evading taxation.

    • A.J. Sutter
      July 14, 2015 at 5:04 am

      1. Apropos of “Dividends are off course only part of the income stream for individuals. Every individual in or near the CEO position is likely to have some under the table, split-income arrangement with the company, whereby significant part of their income goes directly into a tax heaven, off the books”:

      I can’t speak to companies in Europe and elsewhere, but for a company trading publicly on a US stock market this would be a crime. That circumstance, coupled with the fact that the arrangement as described seems to benefit the individuals while putting the company at risk, makes such a scheme extremely unlikely, to speak with some understatement.

      US securities laws require disclosure of the compensation of the five most highly compensated individuals. They also require disclosure of transactions with related parties, a broad term that included directors, officers, and their family members. No public company is going to risk the severe penalties for fraud for the sake of benefiting individual officers or directors. Many countries have similar laws, though the US versions are among the most stringent and harshly enforced.

      In the past, companies such as Enron set up off-balance sheet investment vehicles, but this was for exactly the opposite purpose to the one suggested here: Enron’s idea was to hide *losses,* not to hide corporate income. The purpose of public company securities fraud is usually to make earnings look bigger, not smaller. (A fraud like this in the news recently is Toshiba.) In any case, Enron, WorldCom and other frauds around the turn of the century prompted further tightening of US securities laws.

      Note also that a tax haven may shield corporate income from a high rate of taxation, but it doesn’t shield it from disclosing the income if the company is subject to reporting requirements under the securities laws. And again, most big companies like Apple and Google use tax havens is to make the company’s bottom line *higher* than it would be otherwise. This is intended to boost the share price, which in turn would boost the value of stock options held by the executives.

      2. Apropos of “But the most significant income stream may be associated with corporate bonds and associated coupons, not with dividends on shares. For example, the top banks generally pay more in coupons to faceless wholesale-bond holders in low tax jurisdictions than to their ‘official’ shareholders. … These coupons are written off as costs (of funding!) by the banks, but may indeed be simply a way of offshoring profits to their own subsidiaries and evading taxation.”:

      This argument is a little confusing, since it begins by talking about “income streams,” which in context seems to refer to income of individuals, but ends by talking about subsidiaries. Individuals like to understate income so as to avoid tax. But as described in (1) above, publicly-traded companies would like to avoid tax in order to *increase* stated income.

      If subsidiaries are holders of the company’s own bonds, then interest income they earn would need to be reported, and would be included in the parent company’s reported income due to the principle of consolidated accounts. Moreover, the investment in the bonds would be an expense to the parent company. And since current coupon rates are quite low — about 2.2% for bonds issued by GE earlier this year — it would take a long time to recoup the expense of investing in the bond principal. It isn’t clear to me how this scheme would benefit the parent company.

      Possibly it’s correct that some individual executives hold bonds in their own companies, in which case income earned from such investments would be private, and not subject to reporting as compensation or as corporate revenue under the securities laws. A first point is that that wouldn’t have anything to do with subsidiaries.

      A second point is that it’s unlikely that this would be the most significant stream of income for executives of large, credit-worthy companies: Rates of compensation from stock options are typically much higher. E.g., suppose an executive receives 1/3 of the value of his compensation from stock options, and the rest in base salary. Now suppose his company’s bonds earn 3% interest.Then since his option-based compensation = 0.5 times his base salary, he’d have to invest (0.5/0.03) times his base salary in the bond principal, ~16.7 times his base, to earn a comparable amount of income from the coupon. Even if options were only 1/4 of his income and the company had worse credit, with a 5% coupon, he’d have to invest 5 times his base salary in the bonds to break even on the coupon.

      • Michael Kowalik
        July 14, 2015 at 7:09 am

        Thank you A.J. for extensive rebuttal. You may well be right, but on the other hand, your conviction that the taxation and financial authorities are both competent and genuinely dedicated to serve the interests of the people may be a stretch. I tend to think that authorities are often incompetent, and where they are competent they are generally sold to the highest corporate bidder. But putting speculations aside, here is a few remarks that may clarify my prior post.

        I was referring to suspicious bonds arrangements only with respect to the banking sector, I cannot comment on other industries in that regard. For example, a bank whose operations I have studied is currently paying coupons in excess of 6%. The total amount of coupons exceeds the total income payable to shareholders. It also appears that these were not market-traded bonds but wholesale arrangements, negotiated between parties in private. Specific details of the parties involved are not publicly reported and despite my best efforts to find out, the relevant bank, a publicly traded company, bluntly asserted that this information is not available for public disclosure. In any case, the very existence of these ($100 billion!) bonds seemed unnecessary and was certainly excessive. I could not substantiate a commercial case to issue more than few billion of those bonds for any other reason than to redistribute income away from shareholders to bond holders. Let’s not forget that a bank can generate M2/M3 funds to buy bonds, even it’s own bonds, with only a fraction of the nominal amount covered by M0 reserves, and considering the amount of M0 sloshing around the banking system post 2008 this could explain how this liquidity has been leveraged to redistribute assets.

        It is certainly not implausible that bonds, which may be otherwise unnecessary, can be used to incur costs in one jurisdiction and income in another, or to offer off the books payment arrangements that would be too difficult to decode by the authorities. After all, the banks have invented this game and can afford to bankroll both experts and politicians.

        While I suggested the beneficiary entities are subsidiaries, I meant that in an informal, de facto sense. Officially they may be unrelated but may nonetheless operate together to minimise taxable income in certain jurisdictions.

        I accept that more investigation is necessary with respect to the above.

        The only other thing I would like to stress at this time is that accounting of income with a single monetary metric does not account for difference between income retained in hard money (cash) or converted to real assets and income retained as a claim on hard money. Only cash is a fully realised income, while bank deposits are still only a promise of payment that has an element of insolvency attached to it. I would therefore suggest that the only adequate measure of realised income is the change in real assets retained or consumed, plus changes in cash holdings. Any financial assets other than cash, which incidentally constitute the bulk of income and dividends alike, ought to be factored down to the respective level of solvency or not counted at all.

  6. A.J. Sutter
    July 14, 2015 at 11:35 am

    Michael, thanks very much for your reply. You may be right that there’s something fishy about what that bank is doing. And more generally, I’m not so knowledgeable with banking regulations as to know whether there is an ostensibly legal way they could do whatever they are doing, even if I knew what that was and what jurisdiction that bank is in. So I don’t dispute your point that some coupon payments may be unduly huge (and in fact am intrigued by it).

    It seems harder to know, though, what portion of such huge coupon payments will go directly to individuals, rather than being filtered through various institutions, hedge funds and other investment funds. E.g., rather than investing in bonds directly, a wealthy individual might invest through an asset manager in a fund that receives the interest income along with income from other sources, which is then periodically distributed to him or her. Am I missing something?

    • Michael Kowalik
      July 14, 2015 at 1:04 pm

      My guess is that these arrangements are primarily between institutions, but institutions are established by individuals to benefit individuals. To determine how much is retained by a multinational corporate entity and how much disbursed to individual beneficiaries is indeed a monumental task, and one that from my point of view is rather futile. It seems more productive to pursue reforms that would structurally preclude any covert expropriation of wealth. I also believe that the present problems have much to do with generally poor understanding of secondary redistributive effects of financial products.

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