Metrics
Economic Performance

America's Appalling Wealth Inequality: Worstall's Fallacy

Burgess COMMENTARY
Tim Worstall is touching on an issue about measurement in the field of economics, but does not complete the journey. There needs to be clarity about State and Flow. The idea of discounting future flows to a present value is a useful concept, but it should be used only with an understanding of what it really is. Accountants are quite rigorous about this ... analysts tend to game this to fit their prejudice. Convenient, but dangerously wrong.
Peter Burgess

America's Appalling Wealth Inequality: Worstall's Fallacy

Over in the Wall Street Journal, Marty Feldstein has a look at the claims about the appalling wealth inequality extant in the United States today. In doing so, he explains something that is known as “Worstall’s Fallacy”. Yes, my ego is gargantuan. Yes, I did first point out the fallacy, but I did not name it. And, of course, such is the gargantuanity of my ego, that I’m perfectly fine with pointing out that Feldstein hasn’t heard of it, nor indeed me, nor has any other economist of repute. The fallacy being that you cannot go around recommending a course of action to solve some perceived problem without considering the effects of what we already do to solve that perceived problem.

A very simple example: if we look at the wages that people receive, we will see that some of them don’t have any. Thus they must be starving to death, as they’ll have no food. But that is obviously ridiculous. Absent addiction or mental health problems, no one in the U.S. starves, for we already do things to try to get food to people with no money: food stamps for a start, soup kitchens and so on. What we actually want to know in order to decide upon public policy is how many people still can’t eat well after the impact of food stamps and those other things we do to provide food to those who otherwise would not have any.

Please note that this has nothing at all to do with whether there should be more welfare or less. It is an observation of the logical fallacy that all too many fall into when considering the earlier part of the problem: what is actually happening out there.

We can obviously make the same point about income inequality. If we consider only market incomes before tax and benefits, then we’re going to get a very skewed idea indeed of how much inequality there is. For example, Sweden would show up in such a measurement as having about the same income inequality as the U.S.–not an observation that’s going to be supported by real world experience. What we need to do is measure income inequality after taxes and benefits, because only then can we decide whether there’s too much, not enough or just the right Goldilocks amount and thus what we’re going to do–more tax, less tax or nothing.

And so it is with wealth inequality which is what Feldstein is commenting upon here:

The Federal Reserve recently estimated total household net worth in the U.S. to be about $80 trillion, including real estate and financial assets. And data from the Fed’s Survey of Consumer Finances imply that the top 10% of households by net worth hold about 75%—or $60 trillion—of this total. The bottom 90% of households therefore have a net worth of about $20 trillion.

These data seem to show a country whose wealth is highly concentrated. But the true picture is hardly as stark as critics of inequality claim, because it leaves out the large amount of wealth held in the form of future retirement benefits from Social Security and Medicare.

Quite so. And one of the reasons we have those programs is to lessen the effects of wealth inequality. So that, obviously, the poor elderly do not die horribly in the streets nor do their meat shopping in the cat food aisle. We should thus be considering such wealth as, well, wealth, for it’s a considerable amount too:

The Social Security trustees estimate that Social Security “wealth”—the present actuarial value of the future benefits that current workers and retirees are projected to receive—is $59 trillion. Excluding the top 10% of households reduces the amount to about $50 trillion.

However, to qualify for those benefits, current workers must pay future payroll taxes with a present actuarial value of about $25 trillion. So you have to subtract these taxes from the $50 trillion, leaving a net Social Security “wealth” of $25 trillion for the bottom 90% of households. Adding this to the $20 trillion of their conventionally measured net worth, and these households have total wealth of $45 trillion.

Medicare and Medicaid add a similar amount to Social Security by Feldstein’s numbers.

Do note that while we can all play with or carp about his numbers, his basic point is absolutely correct. The weakest point in the Saez and Zucman paper (and also in Thomas Piketty’s book) is on exactly this point:

Our definition of wealth includes all pension wealth—whether held on individual retirement accounts, or through pension funds and life insurance companies—with the exception of Social Security and unfunded defined benefit pensions. Although Social Security matters for saving decisions, the same is true for all promises of future government transfers. Including Social Security in wealth would thus call for including the present value of future Medicare benefits, future government education spending for one’s children, etc., net of future taxes. It is not clear where to stop, and such computations are inherently fragile because of the lack of observable market prices for this type of assets. Unfunded defined benefit pensions are promises of future payments which are not backed by actual wealth. The vast majority (94% in 2013) of unfunded pension entitlements are for Federal, State and local government employees, thus are conceptually similar to promises of future government transfers, and just like those are better excluded from wealth.

They are specifically excluding from their definitions of wealth the very things we have put in place to reduce wealth inequality. That really is Worstall’s Fallacy.

And if we’re going to go around shouting that wealth inequality must be reduced, we’ve got to start with a measurement of what wealth inequality actually is. Otherwise we’re going to end up in no end of trouble. Think of this for a moment: let’s imagine that we double Social Security payouts for low income seniors. That reduces income and wealth inequality quite a bit. And given that we generally do measure income inequality after such payments, then it would reduce the recorded amount of income inequality. But by not including that in our wealth calculations, we are mismeasuring the amount of wealth inequality there is, aren’t we?

We simply must include the effects of whatever we already do to try and solve a problem in our examinations of whatever else we might think of doing to solve that same problem. Currently, with wealth measurements, we don’t and we must.

Recommended by Forbes Wealth Inequality Boosts Power Of Oligarchs Branko Milanovic's Elegant Thought Experiment About Wealth Inequality FidelityVoice: The Pros' Guide To Diversification How Federal Reserve Quantitative Easing Expanded Wealth Inequality Oversimplification Keeps Wealth Inequality In Place MOST POPULAR Photos: The Most Expensive Home Listing in Every State 2016 +192,833 VIEWS 10 Interview Red Flags That Mean You Should Turn Down The Job MOST POPULAR Photos: The Richest Person In Every State MOST POPULAR How To Write Better Emails