CBO Study Undercuts Piketty’s Analysis

November 24, 2014

The Congressional Budget Office (CBO) has released its annual study on the distribution of household income and federal taxes. (See here.) The numbers are for 2011 (latest available data.) A valuable feature of the study is that CBO estimates the amounts and distributional effects of government transfers and federal taxes, in addition to looking at market income.

In CBO’s terminology, market income refers to labor, capital, and other income earned in markets. Before-tax income is market income plus federal, state, and local transfers. After-tax income is before-tax income minus federal taxes.

The CBO data confirm and quantify what most people know in general: the size and distributional impact of transfers and taxes are huge.

Dividing households into quintiles (fifths), CBO estimates that, on average, transfers and taxes increase household income by $8,600 for the bottom quintile, $12,500 for the second quintile, and $9,100 for the middle quintile. Meanwhile, transfers and taxes reduce household income by $700 for the fourth quintile and by $46,500 for the highest quintile. (See table.) In percentage terms, government transfers and taxes, on average, raise household income by 55 percent in the bottom quintile, by 42 percent in the second quintile, and by 18 percent in the middle quintile, but cut it by 1 percent in the fourth quintile, and by 20 percent in the top quintile.

Average Household Income, Transfers, and Taxes, by Before-Tax Income Group in Dollars, 2011

Lowest Quintile

Second Quintile

Middle Quintile

Fourth Quintile

Highest Quintile

Market Income

15,500

29,600

49,800

83,300

234,700

Government Transfers

9,100

15,700

16,500

14,100

11,000

Before-Tax Income

24,600

45,300

66,400

97,500

245,700

Federal Taxes

500

3,200

7,400

14,800

57,500

After-Tax Income

24,100

42,100

59,000

82,600

188,200

Source: Congressional Budget Office, The Distribution of Household Income and Federal Taxes, 2011

Government transfers are large in all quintiles because they include Social Security and Medicare as well as numerous means-tested programs. But they are greatest relative to income in the lower and middle quintiles. Federal taxes are likewise strongly redistributional. CBO’s computations include all major federal taxes (individual income, corporate income, payroll, and excises). CBO also reports the distribution of the individual income tax by itself, and that is even more progressive.

CBO also examines the distribution of income using a more sophisticated gauge known as the Gini index. The Gini index can vary from 1 to 0, with 1 indicating total inequality and 0 meaning complete uniformity.

As shown in the figure, inequality appears to have edged up over time, but it is always much lower after accounting for government transfers and taxes. According to the Gini index, income inequality after transfers and taxes is actually lower now than it was in 2000.

CBO’s analysis forcefully demonstrates that any distributional study which ignores how much the government already redistributes will be incomplete and potentially misleading.

This brings us to a distributional study that has received enormous attention in the last year: Thomas Piketty’s Capital in the Twenty-First Century. In his book Piketty draws a dark picture of soaring inequality. He insists radical tax increases are needed to correct the problem. However, unlike CBO, Piketty leaves out government transfers and taxes. Hence, when he declares that inequality is returning to levels last seen in the Belle Epoch of a century ago, he is omitting government income redistribution. Income redistribution was miniscule then, but it is massive today.

Many observers have faulted Piketty for failing to acknowledge how much redistribution currently takes place. (For example, see a recent critique by Gramm and Solon discussing this and other problems.) CBO’s findings confirm there is much less inequality than Piketty claims. (Piketty has also been faulted on numerous additional grounds. For two examples among many, see here and here.)

It is peculiar that someone who wants to sharply increase taxes and government spending to achieve greater income and wealth leveling omits all that the government is already doing. In any event, it is clear from the CBO study that Piketty’s before-transfers, before-taxes numbers do not reflect reality. While CBO does not directly criticize Piketty’s work, it does not need to. The numbers speak for themselves.


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