Greg Mankiw, an economist who is head of the economics department at Harvard, is an economist that I regard highly.
He has published two items that I reproduce here. One is an analysis by the Brookings Institute, a liberal think tank, that shows that in the past several decades there has been an improvement in the income at every level of income in the U.S. Not a decline for those in the middle class and below. Here is a summary from that report.
“Some crucial findings of the new study may come as a surprise, especially to people who believe incomes of the poor and middle class have stagnated since the turn of the century while incomes at the top have soared. The CBO’s latest numbers show the opposite is true. Since 2000 pre-tax and after-tax incomes have improved among Americans in the bottom 90% of the income distribution. Among Americans in the top 1% of the distribution, real incomes sank”
The second item is a chart that shows an interesting change in the structure of American business.
Let me explain what is going on since I regularly recommend this change of business structure to my clients.
In the past I have often recommended the corporate form for a small business if there was any risk of lawsuit for any form of damages the business might incur. About two decades ago I started recommending the use of LLCs and partnerships in these cases along with the purchase of liability insurance. The reason is straightforward. If you have a corporation you will be paying corporate taxes to the state and federal governments. These can be trivial or significant depending on how rapidly the business grows and what industry the business is in. But the principals who own the business also pay income tax on the revenues they received within the corporation as salaries (or in the most extreme situation as dividends). By forming an LLC or a partnership (and getting liability insurance) the income from the business goes directly through to the owners or principals and they only pay personal income tax on that revenue without having to additionally pay the corporate tax.
You can see why more and more businesses are finding this an appealing approach. It effectively reduces the amount of tax an individual pays on a business they own and operate.
What is missing is a combination of the Brookings analysis of changes in income distribution in the past few decades and the changes in ownership of small businesses? We need an analysis of how these two effects are working together. Clearly if more business people are creating flow-through structures and avoiding the corporate tax, greater income is going directly to the individuals who are most likely in the top income brackets and increasing their incomes.
So what is the interaction of these two items that I have taken from Greg Mankiw’s blog?