Capital Gains and Inequality of Personal Income: Some Results from Survey Data

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  • Capital Gains and Inequality of Personal Income: Some Results from Survey DataAuthor(s): Kul B. BhatiaSource: Journal of the American Statistical Association, Vol. 71, No. 355 (Sep., 1976), pp. 575-580Published by: American Statistical AssociationStable URL: .Accessed: 15/06/2014 11:29

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  • Capital Gains and Inequality of Personal Income: Some Results from Survey Data


    This paper deals with income distribution of capital gains and their effect on measures of income inequality for 1962. Aggregate accrued gains are allocated to various income classes by using microdata from the Survey of Financial Characteristics of Consumers. The results show that accrued gains are distributed more unevenly than money income. The Gini coefficient drops from 0.41 to 0.35 when accrued losses for 1962 are subtracted from income, but it increases to 0.43 when average gains for 1960-64 are added to income. Variance of natural logarithms, the other measure of inequality used, also shows a similar pattern.


    The objective of this study is to estimate the income distribution of accrued capital gains and determine how the inclusion of capital gains in income will alter the distribution of personal income and the commonly used measures of income inequality in the United States. Be- tween 1948 and 1964, capital gains accrued at an average rate of over $40 billion a year on corporate stock, real estate, and farm assets owned by individuals, who, on an average, reported about $9 billion of realized gains every year for income tax purposes during this period. Data on gains realized by people in various income brackets published in Statistics of Income [17] were incorporated into personal income by Liebenberg and Fitzwilliams [10] for 1958, but little information is available on the distribution of accrued gains, although it is widely be- lieved that gains accrue mostly to upper income groups. Arena [2] and Granger and Mlorgenstern [8] even use this argument to explain why accrued gains will not affect aggregate consumption or other economic magnitudes.

    Whether capital gains are a component of income has been the subject of a longstanding controversy among income theorists. Most well-known studies of the size distribution of personal income, for example, by Gold- smith [7], Miller [12], and Schultz [16], do not include accrued capital gELins, nor are gains incorporated in national accounts or the official measures of personal in- come (compiled by BEA, the Bureau of Economic Analy- sis). Although there are several theoretical reasons for including accrued capital gains in national income, a case for including them in personal income can be based simply on the argument that accrued gains enhance the

    * Kul B. Bhatia is Assistant Professor, Department of Economics, University of Western Ontario, London, Ontario, Canada N6A 5C2. This research was supported by a grant from the Canada Council. The author wishes to thank Michael B. McElroy and Peter J. Kuch for helpful comments on an earlier draft, and I. Tapley and J. Johnson for their competent programming. He also would like to thank the referee for helpful suggestions.

    purchasing power of an individual. They can be spent or saved almost like any other type of income; therefore, an income concept broader than the OBE measure will be a better indicator of the true change in the economic posi- tion of the personal sector.'

    The failure to include capital gains in income has many implications for personal income, its size distribution, and the whole area of personal income taxation.

    1. Aggregate personal income as reported and saving estimated from it do not correctly represent the economic position of individuals or their saving.2

    2. By including only a portion of realized gains in the tax base, a very profitable loophole for converting income into capital gains, has been provided to those who can, and the profit- ability increases directly with the marginal tax rate.3

    3. Most important for the concerns of this paper, the existing knowledge about the inequality of the size distribution of income is probably incorrect.'

    The plan of the paper is as follows. Section 2 presents a brief review of the present state of knowledge about realized and accrued gains and their distribution by in- come brackets; accrued gains are allocated to income classes in Section 3; effects on measures of income in- equality for 1962 are discussed in Section 4; and Section 5 concludes with a critical summary of these results. Most of the results reported here have been derived from the original data collected for the Survey of Financial Charac- teristics of Consumers (SFCC).

    I For a discussion of the debate on including capital gains in national income, see [3, 11]. The inclusion of accrued gains in personal income is one step toward the all-inclusive Haig-Hicks-Simon concept of income which, roughly, defines in- come as the maximum amount that can be spent while keeping net worth constant.

    2 Bhatia [3] showed that when accrued gains were added to personal income, the official estimates of both personal income and saving changed considerably and showed much greater cyclical variability than before.

    IThere is no tax on accrued gains, and the maximum rate of tax on realized gains is one-half the marginal rate of tax, subject to an upper limit. Thus, anyone who can convert income into gains can reduce his tax liability considerably. Tax aspects of this problem, however, require different definitions and data from those employed here, e.g., adjusted gross income instead of money income, incomes of individuals and couples, not family income. These matters are dealt with in a separate paper (see [4]).

    4 For example, data reported by Schultz [16, p. 79] from Current Population Survey, shows that the Gini coefficient of income of families and unrelated individ- uals in the U.S. has varied between 0.4 and 0.43 during the period 1947-1965, except in 1955 when it was 0.45. Also, Brimmer [5, p. 41] states that the distribu- tion of personal income has continued to move toward greater equality in recent years. McElroy [11] found that the Gini coefficient for accrued gains varied be- tween 0.6 and 0.7 in some years during this period. Thus, if gains are included in income, the resulting distribution will be more unequal than the official statistics indicate, and the degree of inequality will also be more variable.

    O Journal of the American Statistical Association September 1976, Volume 71, Number 355

    Applications Section


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  • 576 Journal of the American Statistical Association, September 1976


    Liebenberg and Fitzwilliams [10], working with a sample of income tax returns, examined the effects of realized gains on income distribution at length for 1958. They found that capital gains were widely dispersed, and both average gains and the percent of units realizing gains rose with income level. They classified all units by money income and money income plus realized gains.' The latter classification caused an upward shift of units to higher income classes-the number increased by almost 7 percent in income brackets above $25,000-but realized gains, being only 24 percent of family personal income, were too small to alter the distribution of personal income radically.

    Although no similar information is available about the income distribution of accrued gains, it is usually assumed that such gains will be distributed more or less like the assets on which they accrue. Beliefs about income dis- tribution of accrued gains, therefore, are generally based on facts about the income distribution of wealth. Cor- porate stock is the most important source of accrued gains, followed by nonfarm real estate. Estimates re- ported by Bhatia [3] show that during 1947-64, more than 60 percent of all gains had accrued on corporate stock and about 27 percent on nonfarm real estate. In- come distribution of holdings of these assets, derived from SFCC data, is reported in Table 1.

    1. Distribution of Holdings of Corporate Stock, Survey Population, Money Income, and Nonfarm Real

    Estate by Money Income Class, 1962a

    Percent of Money Corporate Nonfarm real Income population income stock estate

  • Capital Gains and Income-inequality 577

    2. Income Distribution of Money Income and Accrued Capital Gains, 1962

    Money income Accrued Gains I Accrued Gains I1 Income ($000) Percent Mean Percent Mean Percent Mean Percent

    of amount of amount of amount of popu- totala ($000)b totalc ($000)d totale ($000), lation

  • 578 Journal of the American Statistical Association, September 1976

    3. Percentage of Population, Money Income, and Accrued Gains in Various Categories a

    Income & Money income Population Accrued gains I Accrued gains It accrued -_-_-

    gain.s Wi (jJ) fi (i)()(i)()Wi Lowest three 39.6 36.0 68.8 65.5 12.9 6.3 26.6 16.7 Top four 9.4 10.9 1.4 1.9 55.9 70.9 39.4 50.7

    a Classifying variable is income plus accrued gains. NOTE: All columns marked (i) are from Table 2, and use money income as classifying variable. Columns marked (ii) are based on money income plusaccrued gainsas classifying variable. The lowest three categories include people with income plus accrued gains of $7,500 or less, and the top four, those with income plus accrued gains of $25,000 or more.

    close for income levels between $10,000 and $100,000. The shares of the two lowest AGI classes were slightly understated, and there were nearly offsetting discrepan- cies in the two highest income classes: the share of the income class $100-200,000 was understated by about four percentage points and that of the highest, open-ended class was overstated by a similar amount. However, the mean percentage error for all income classes taken to- gether was less than half a percentage point. The results thus roughly confirm the allocation based only on wealth. Given the data difficulties and virtually no information on the distribution of accrued gains in the population, not much else can be said about alternative methods of allocating gains.9

    Since the principal results relate to 1962, it should be noted that it was an abnormal year for capital gains. During the first four months of 1962, stock prices fell sharply, real estate prices also declined, and although these movements were reversed toward the end of the year, there was an accrued loss of $52.95 billion on corporate stock, and $6.75 billion on nonfarm real estate. Farm assets, however, recorded an accrued gain of $6.64 billion; so the accrued loss on all assets together was $53.1 billion. Such large amounts of losses are not typical of the time period covered by this study. During the period 1947-64 for which accrued gains were computed in [3], there were accrued losses in only three other years, 1949, 1953, and 1957, and the amounts in all cases were much smaller than the accrued loss in 1962. In fact, the total loss for these three years together amounted to less than 70 percent of the figure for 1962. In Tables 2-5, we present two sets of figures, one using the estimated accrued loss for 1962 (called accrued gains I), and the other based on an average of accrued gains for the years 1960 to 1964 (called accrued gains II), to somewhat smooth the abnormality of 1962. All these data are from [3].

    It is apparent from Table 2 that gains are more un- evenly distributed than income: people with money in- come of $7,500 or less-about 69 percent of the SFCC population-had 39.6 percent of all money income, but

    9 The results based on taxation data were extended to years other than 1962. It was found that the estimates were not very sensitive to lower and upper bounds of the confidence intervals for various regression parameters. The conclusions based on taxation data should be regarded as no more than a rough confirmation of the wealth approach. Apart from the data difficulties discussed previously, the results are not entirely independent of the SFCC wealth data. For a detailed description of this and other alternative methods of allocation, see Bhatia [4, Sec. II].

    only 12.9 percent of 1962 gains, and 26.6 percent of average gains for 1960-64. At the other end of the in- come scale, 1.4 percent of the population with an income of $25,000 or more accounted for 9.4 percent of total money income, 56 percent of gains for 1962, and 39 per- cent of accrued gains II. These results are also reflected in the Gini coefficients for the three variables (presented in Table 5): 0.41 for money income, 0.78 for 1962 gains, and 0.58 for average gains for 1960-64. The effects of including accrued gains in income are illustrated in Table 3, where the classifying variable now is money income plus accrued gains II. The proportions of population, money income, and gains decline in the lowest three categories, and those in the top four classes increase when we divide the sFcc population according to money in- come plus accrued gains, instead of money income alone.


    Before examining the effects of capital gains on mea- sures of income inequality, we should point out that results on the distribution of money income derived here tally with those in earlier studies. For example, the dis- tributions of money income-by income class in Table 2, and by population deciles in Table 4-are exactly the same as those reported by Projector, Weiss, and Thoresen [15, Table 4, p. 128]; and the Gini coefficient of 0.41 for money income is also reported by Schultz [16] for BEA data on income of families and unrelated individuals in 1962. This corroboratory evidence confirms the accuracy of our data and also adds to our confidence in the com- putations about the distribution of capital gains,...


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