New (old) paper on US income distribution and re-distributive policies.

The Review of Keynesian Economics just last month published a paper I wrote with Lance Taylor, Armon Rezai, Laura Carvalho and Nelson Barbosa. At the moment the paper is open-access (link). These results were put together a couple of years ago with the main features being (a) The US economy functions as a transfer union and (b) The disparities in income are too huge to be overcome by feasible tax-transfer policies.

In the construction of data, we developed a dis-aggregated social accounting matrix model which bins household incomes into percentiles of the income distribution and makes estimates of consumption/saving based on logarithmic interpolation.

Modi’s abolition of currency notes means the estate tax should be resumed

Outside the US presidential election, the other big news today is the abolition of Rs 500 and Rs 1000 currency notes just enacted by India’s PM Narendra Modi. By most measures, this is a watershed moment in the move to register undocumented assets held by a small proportion of Indian families – not necessarily in a good way since its effect will likely be regressive. However, not only does the holding of large volumes of cash feed un-reported asset prices cycles (especially real estate) but permits the transmission of wealth across generations with no record, further fueling unchecked wealth inequality. Most countries (including once India) have used the estate tax – a tax on the assets of the deceased, prior to inheritance – as a tool to curb endless wealth accumulation. Curbing cash based transfers for inheritance is important because such transactions between the dead and the living are easily hidden from authorities. Let me make a small simple example of how this proceeds.

Person A has a home worth Rs 1 crore as measured by the market and (say) Rs 0.8 crore as per the circle rate criteria enacted by the municipality. On selling this property for Rs 1 crore and reporting a ‘white’ price of Rs 0.8 crore for stamp duty, person A has made Rs 0.2 crore in unreported capital gains which escapes the tax authorities. This assumes the buyer has made a cash payment of Rs 1 – 0.8 = 0.2 crore to person A. Now suppose this person A does nothing with this cash (mostly large bills) and at death his/her progeny inherit this volume of cash. There is no estate taxation anymore in India (Estate Duty put in place in 1953, was abolished in 1985) so as it is this direct inheritance costs nothing to the inheritors although they will pay taxes should they sell any of their inherited property.  But Rs 0.2 crore is lying unchecked and can be used to make further undocumented real estate purchases, benefit from asset price appreciation, make further unreported capital gains and the cycle continues. The flow of inheritance is given by the formula:

b = m * d * \beta

where b is the flow of inheritance relative to GDP, m is the mortality rate, d is the average wealth of the decedents vs the wealth of the living and \beta is the ratio of private wealth to GDP. For the sake of rough approximations, let us assume that 50% of wealth is stored as cash (not entirely inaccurate) and as per the RBI’s calculations 86% of this cash was held as Rs 500, Rs 1000 notes. Given LIC’s mortality rates of approximately 2% for wealth holders let us further assume a 5:2 ratio of the dead-living wealth. The last measure assumes a 4% net of depreciation rate of accumulation over one lifecycle so that Rs 1 transforms to Rs 2.5 in 30 years. Based on the Harrod-Domar-Solow formula, at 5% economic growth and a 20% private rate of saving \beta = \frac{20}{5} = 4.


b = 0.02 * 2.5* 4*(0.5*0.86) = 0.086 or the flow of cash based inheritance is worth 8.6% of GDP – Rs 172 billion. This is essential un-earned (inherited) wealth which can continue to fuel parallel asset bubbles in the real estate market. By removing this channel and forcing registration of large sums in these denominations, the state at least can register unreported wealth. Now in the first place, the cycle of transmission is halted partially because so much wealth is brought under scrutiny, but suppose we now re-impose the estate tax at an average rate of 40%, this raises a possible tax revenue of Rs 68 billion annually or around 3.4% of GDP. This is no small figure compared to direct tax collection. Since India has scrapped the wealth tax, there is no other measure to restrict endless wealth concentration. Why not use this measure to curb black money also to re-introduce the estate tax – a one time tax on unearned wealth – to further strengthen arguments made by Pratap Bhanu Mehta here?

On a related note: this policy challenges our assumptions about liquidity preference due to the low carrying costs and fiat guarantees associated with cash. Storing Rs 1 crore in bills of 100 is hard, though the Rs 2000 note will offset this (it can be tracked apparently). During financial crashes, there is a retreat from illiquid assets towards cash – this policy reverses this outcome. With the abolition of these denominations, the retreat is the other way – into bank deposits and financial assets. Technically, it is not rational with inflation threats to store wealth as cash. I expect investments into legitimate capital assets with a guaranteed rate of return.


Noah Smith on Mirowski on Noah Smith on Mirowski on……..and related thoughts

I just came across Noah Smith’s post on Mirowski’s social physics thesis (this is the second I believe) where Smith tries to address concerns raised by Mirowski on the ‘casual nature’ of the blog-writer’s understanding of physics envy.

To start with, I quote Noah Smith – “…For more specifics on exactly how ideas crossed from physics to econ, and on which of those ideas remain to this day, one should probably check out Mirowski’s book(though I hope it’s written in a different tone than this interview) …”

The last sentence in bold tells me that Noah Smith has not really read Philip Mirowski, till date, and so probably does not really do justice to one of the best historians of economics in the profession today. I suggest Mr Smith, who often brings out important issues about the discipline with great clarity, take the time to read a brief summary of More Heat Than Light here.

Getting back to the point now, I think Noah Smith is inaccurate on how he is approaching the issue and this is deeply related to ‘citing without reading’…..Yes a lot of this has to do with appropriation of mathematical methods and constrained optimization but the point that Mirowski tried to make is the path dependency of historical events such as the ousting of pre-neoclassical economics from the British scientific academy in the 1870s which perhaps ignited the movement towards scientific legitimacy by constrained optimization in the first place. This is followed by a series of coupling-decoupling episodes because having adopted a methodology which was itself losing credibility in its native profession, it was (in econspeak) less ‘costly’ to continue to mathematize and re-engineer the mode of analysis in existence rather than completely detach from the energetics analogy – a reminder that it isn’t just methods like calculus of variations (there’s also addition and subtraction!) which Mr Smith mentions but in fact the resemblance between entropy maximization and utility maximization. I don’t want to go in detail about the Cowles financing and the migration of physicists into economics after the 1930s depression….

As long as the concept of utility remains in our micro-foundations or as the payoff to action sets (yes game theory too — and ironically, Smith quotes the physicist Von Neumann in his post), we retain that legacy which originated in almost QWERTY like events back in the day. I don’t really have an opinion on whether this is good or bad right now. The real positive to takeaway is that regardless of physics envy, the literature on the history of economics is perhaps better than work on the history of physics. To add one more arrow to the economists’ quiver, lets not forget how the sciences drew inspiration from double-entry book keeping in the first place.

On whether physics envy is relevant today, yes economists make more money and don’t want to be physicists necessarily but the profession as a whole is surely starting to move towards publishing in the ‘style’ of the natural sciences – shorter papers, less technical stuff in the body (online appendices ahoy), team and lab models or research and the recent re-appearance of entropy in the rational inattention literature. Sometimes I read papers in the AER and find it more similar to Nature or Science, than Econometrica/JET. At the same time I find many contributions by economists in Nature or Science. Is it still Physics Envy then? Will applied/empirical work finally liberate us? Lets speak in another 30 years.

Mobility and segregation in the United States: John Oliver’s take is quite interesting..

John Oliver’s latest episode does an analysis of segregation at the schooling level in the US. Besides his usual ‘goblinesque’ humor, Oliver does a pretty good job of capturing some important stylized facts. I was pretty startled by the fact that New York City has the highest rate of segregation – my preliminary thought was that it would be the South. The link to his video is here:

New thoughts on US wealth inequality: Not simply asset price inflation but high savings and the capitalist spirit

My latest paper in the International Journal of Political Economy (Taylor & Francis)  is now up. This link leads to gated access. Amongst other things, I have developed a simple accounting formula to capture synthetic savings within fractiles. The abstract is summarized below:

Personal savings from top incomes and wealth accumulation in the United States: Results from disaggregated national accounts

This article explores the determinants and distribution of household wealth. Looking at U.S. data since 1980, it finds convincing evidence that top incomes were saved at high rates and contributed to the steady increase in the household wealth–income ratio. First, I rule out counterclaims regarding the role of housing and real estate prices finding little evidence of their influence on the trends and magnitudes of household net worth relative to disposable income. With savings as the remaining explanation, I present an accounting decomposition formula that captures savings rates for any reference group using the dynamics of intergroup accumulation rates. This methodology is applied to data from national accounts, balance sheets, and income distribution statistics in order to compute saving rates for the top 1 percent of households in the U.S. income distribution. The estimates also support the idea that top income earners have outsaved other households, thereby capturing an increasing share of wealth.

Upcoming talks in New York City

Tomorrow (10/25) I will be delivering a talk on wealth concentration in India at the NSSR Macro Lunch at The New School.

Location: Room D1008, 6 E 16th Street, New York from 12:30-2PM

November 3rd, I will be speaking as part of the Inequality Lecture Series at the City University of New York (CUNY) Stone Center/Luxembourg Income Study.

Location: Room 9204, CUNY Graduate Center from 3:30 – 5PM