Piketty and Saez (2003) Income inequality in the United States

Research question:
Is the change in inequality over time, proxied by the change in top income shares,
consistent with Kuznets inverted-U hypothesis that inequality increases as a
country begins to develop but decreases as more and more workers join the highproductive sectors?
Why this question is interesting:
Kuznets hypothesis, if correct, is comforting for us because it means that as society
develops, the fruits of our collective labour will be increasingly evenly distributed
across all income groups. This is important because people care about upholding
equality and social justice. Furthermore, there has been an accumulation of evidence
that high levels of inequality can be detrimental to growth.1 More importantly, if
Kuznets hypothesis is valid, it suggests that the state has a limited role in reducing
inequality because the free market will, by itself, get rid of inequality in the long-run.
Yet, a cursory glance in the developed world today paints a different picture
inequality has heightened; the opulent lives of the wealthiest are almost obscene.
In providing a homogenous time series for the top income shares, top capital-income
shares and top wage-income shares for the past century, Piketty and Saez debunk
Kuznets hypothesis. They provide some explanations for why inequality has evolved
in this manner but do not claim that these explanations are true. Rather, the main
purpose of their paper is to provide a description of the data that they have collected.
Data used:
Piketty and Saez authors get data on pre-tax income and wages primarily from tax
returns data published by the Internal Revenue Service (IRS). Tax returns are forms
filled by some citizens to disclose income/wealth information and to report how much
taxes they have to pay. To get rid of the volatility in income associated with capital
gains, the income that they use in their series includes all annual income items (e.g.
wages, interest, rent etc.) except capital gains.
Main findings:
Top income share
Income
Capital Income
Wage Income

Trend
U-shape (See Figure I)
Persistent decline (See Figure V)
U-shape (See Figure VIII)

1) The general trend in top income shares looks more like a U shape than an inverted
U. The changes can be divided into 3 main sections:
a. Drastic fall after WWII
b. Stagnation for 3 decades
c. Steady increase since 1970s
1

Thorbeck (2013). The Interrelationship Linking Growth, Inequality and Poverty in

Sub-Saharn Africa. Journal of African Economies 22, AERC Supplement 1: i15-i48

2) Among the top 10%, changes are heterogeneous (See Figure II). The decline in
income share of the top 1% was notably steep in the first half of the century. This
is in line with Piketty and Saezs argument that the fall in income share in the
period after the war was due primarily to a fall in capital share, because then it
would make sense for the top 1%, whose income is dominated by capital income,
to be hit the hardest.
3) Capital income has undergone a persistent decline.
4) The trend in wage income also follows a U shape
a. Drastic fall during the war due to war wage controls
b. Stagnation after the war
c. Significant increase since 1970s and are now higher than than pre-war
levels
5) This leads Piketty and Saez to the conclusion that the working rich have now
replaced the coupon-clipping rentiers i.e. the top 10% used to be the wealthiest
because they held a significant proportion of the capital-income pool. Now, they
are the wealthiest because they hold a significant proportion of the wage-income
pool.
Piketty and Saezs interpretation of their data:
1) Capital-income share fell sharply because of the war and was not able to recover
due to the introduction of the progressive tax system. US imposed very high top
tax rates and sharp progressive estate tax after WWI, creating a substantial burden
on the very top income groups and made it impossible from them to recover to
pre-war levels of capital income.
2) Wage-income share did not recover to pre-war levels despite the removal of war
controls because of progressive taxes and changed social norms. Piketty and Saez
argue that the high income tax rates discouraged corporations from increasing top
wages. They also suggest that the change in social norms (towards embracing
equality and redistribution) and labour-market institutions (the rise of
unionization) made it hard for the high wage earners to push their wages back to
pre-war levels.
3) The sharp increase in wages since 1970s cannot be due to technical change alone
because other developed countries that experienced the same technical change did
not experience as significant an increase in top wage share.
4) The sharp increase in wages since 1970s also cannot be fully accounted for by the
decline in progressivity of the tax system. Top wages have been increasing
dramatically since 1970s (especially if one looks at the wages of CEOs), even
before the large top marginal tax rate cuts of the Tax Reform Act of 1986.
5) Hence, Piketty and Saez suggest that there may be more inequality today partly
because people are more accepting of very high wages and higher levels of
inequality.
Conclusion:
The annual series allow Piketty and Saez to conclude that the sharp downturn and
upturn in top income shares were not driven by the development process or technical
changes. Instead, they were the result of fiscal manipulation, changes in social norms

and labour-market institutions. Thus, Kuznets hypothesis fails to hold up against the
empirical evidence.
Critique of the article:
There is nothing particularly meaningful for me to critique in this paper because
Piketty and Saez did not mean for it to be a paper that tests the causal relationship
between X and Y. In this paper, they are simply trying to present the data on income
inequality over the past century and to show that Kuznets hypothesis is not true.
However, it would be interesting to point out that the implications of this paper are
enormous. In Pikettys updated paper, he finds that the income share of the top 10% in
the US was 47% in 2010.2 I find that highly disturbing and am disgusted by comments
saying that there is nothing unfair about this outcome because it was fair play. Of
course, it should be noted that Piketty and Saez have presented data on pre-tax
income, which may overestimate the levels of inequality, since taxes and other
government transfers should have redistributed from the rich to the poor.
Nevertheless, this paper is concrete evidence of what we already know the rich are
getting richer and the poor are getting poorer and it doesnt seem like we are doing
enough to turn the tables for the poor

http://piketty.pse.ens.fr/files/capital21c/en/pdf/F0.I.1.pdf

Important figures: