Contrary to The Economist, the Tax Treatment of Businesses' Interest Expense is not a Danger to the Global Economy

My favorite news magazine, The Economist, has a cover article this week entitled "The Great Distortion" portraying "tax-free debt" as "the dangerous flaw at the heart of the world economy".  In their usage, "tax-free debt" refers to residential mortgage debt and business debt on which interest payments are deductible (not, as an American taxpayer might think, tax-free state and local government debt which is literally tax-free to the holder).

Unusually for this sophisticated magazine, the article seems to have a poor understanding of the underpinning of the tax deduction for interest expense incurred by businesses, so I am putting up this post to address that.

The characterization of mortgage and business debt as "tax-free" is a good example of their confusion.  Neither residential mortgage debt nor business debt is tax-free to the holder, as long as the holder is a taxable entity.  The beneficial holder of a mortgage / MBS or a loan / loan fund will have to treat the interest payments received as ordinary income under US tax law.  The payor is allowed to deduct those payments.  This is the principle of "matching" that is fundamental to income taxing systems and is not at all unique to either the US or debt setvice payments.  For example, if a retailer like Target buys 100 Wrangler jeans from VF Corp., the retailer deducts the cost of the jeans as an expense and VF Corp records the sale as gross income, against which it has its own deductions, resulting in the profit being taxable income.

If we change the jeans to interest on a loan, the treatment should be the same, at least in a business context.  The lender records the payment as gross income, against which it nets its own costs, and reports a profit that is taxed at ordinary income income tax rates (and there can be further taxation if the lender is a C corporation and remits any of its profits to its holders).  The business that borrowed the money records the interest payment as a deduction and that just mimics the tax treatment of the jeans.

There is no reason to treat a business's interest payments differently than  any other expenses it incurs.  A business may borrow to buy inventory or equipment. Its sellers may finance those purchases with an explicit interest charge.  Or they may give a discount for payment made within X days, which is just an interest charge stated in different words. For bigger-ticket items, there may be a multi-year installment payment schedule, with or without an explicit interest rate, and there are rules for figuring out the unstated interest and related tax issues.    The equipment may be leased instead of sold outright; the lease, as anyone who has leased a car understands, will embed an interest rate of some size.   So there are numerous conventional and uncontroversial ways in which the cost of money can enter into the sale of goods and other assets and it is more consistent and efficient to accord the finance cost the same treatment as the sale it pertains to, than to try to break it out and apply a radically different treatment.

The article argues that, as it is difficult to eliminate tax preferences, it would be systemically healthier for the global economy to afford a comparable tax break for payments to equity holders.  They note that, beyond equalizing owners' preferences for debt vs. equity, such a tax break would offset the problem of "double taxation" that burdens business owners with taxation of income at both the corporate and the owner level.  Although double taxation is certainly a flaw and distortion of economic activity, I disagree with the proposed solution, as I find it overly clumsy and distorting.

Interest on business debt is deductible because, as shown above, it is a cost of business incurred by the business owner, directly if the business is a sole proprietorship, or at a remove through a business entity in which the owner holds an interest.  An equity distribution is not a cost incurred by the business owner. It is net income, exactly the opposite.  Sometimes this proposal is rationalized by characterizing the equity distribution as a payment by the corporation for the funds provided to it by the equity owners and thus a classic business expense. That is a flaw, in my view.  A corporation in and of itself has no intrinsic reason to receive or disburse funds.  It is just a shell.  It is the owners who want the corporate entity to have funds and operate.  Business entities are better seen as proxies for the owners.  If they are taxed, it is justifiable only because it is more efficient than to tax the owners (e.g., because the owners are tax-exempt or reside somewhere beyond the taxing authority's jurisdiction, or because the records are all kept at the corporate level and are more easily processed there).   It is better analysis of economic substance to see all the expenses of a corporation as expenses of the owners through a proxy.  In that light, interest is deductible, while equity returns are not.

By the same logic, residential mortgage interest should not be deductible, because it is just funding a consumption purchase, not the income generation of a business that borrows.  It is an unfortunate relic of a politically motivated encouragement of postwar middle-class consumption.

Although there should not be double taxation of business income, giving a tax break for income distributions to equity is not the way to fix that.  The simplest way is to make all business entities pass-throughs, like REITs, partnerships, LLCs, S Corps, mutual funds, hedge funds, MLPs, etc., and eliminate tax-exempt treatment of  investment income received by not-for-profit organizations. The second best way, if one cannot accept eliminating the present disparate tax treatment of for-profit and not-for-profit corporations, is to give each business owner an income tax credit equal to his or her proportional ownership share of any income taxes paid by the corporation in which he or she has a stake.  The not-for-profit holders would not be able to use it, but neither do they pay income taxes on corporate distributions in the first place.  See this brief article for an overview of the problem and solutions.

Further, corporate debt is not a systemic problem.  This is because of (1) the operation of chapter 11, in particular the absolute priority rule, and (2) stiff margin requirements for private sector debt and equity holdings.  Chapter 11 enables business debt to be converted to business equity, minimizing losses to the debt holders, while shifting the losses to the pre-restructuring equity holders.  In turn, the stiff margin requirements (minimum 50%) for holding equity of public corporations ensures that, if and when losses hit the equity holders, they absorb it and do not pass them on to their lenders.  Also, the risk capital weightings are higher for private sector debt than for other types of debt so there is an additional layer of buffer in the financial system for the risk of private sector default.

The residential mortgage sector unfortunately has not had these protections. In particular the margin requirements, and the regulatory capital requirements, for holding mortgages and MBS were woefully inadequate, always less than 10% and often less than 5%, which left the financial system exposed to massive losses when housing prices fell more than the margin / capital buffer.

The real issue with debt is not its tax-free-ness but the risk of incurring too much. Tax deductibility is a small factor in increasing that risk, but the larger one is too liberal margin and capital requirements, and the residential mortgage sector is a particular source of that risk.

Nicholas Kristof and the Ecological Fallacy

On several recent Sundays,  the New York Times Sunday Review section has carried Op-Ed columns by Nicholas Kristof that assert, in his own words, that "unconscious bias remains widespread in ways that systematically benefit both whites and men. So white men get a double dividend, a payoff from both racial and gender biases."  Titles for these columns include strings of monosyllabic words like: "When Whites Just Don't Get It" and "Straight Talk for White Men".  These columns elicit more opposition from Times Nation than the typical editorial in the Times, which Kristof curiously and patronizingly responds to by continuing to tell his readers that they "Just Don't Get It". 

The purpose of this post is to explain that it is Kristof who doesn't get "it", that he doesn't understand how to read the studies he quotes nor does he understand basic logic. Specifically, his argument suffers from the "ecological fallacy", a fallacy common among journalists who have a educational background which, while it may have resulted in high marks that lead them to think they are highly intelligent, has usually omitted a rigorous investigation of statistics and logic, which leads them to consistently over-state the significance of studies in social science. 

The ecological fallacy is simply this: attributing to individual members of a sample population a characteristic demonstrated by a statistical analysis of the population as a whole.   It is well recognized in social science (yet sadly often committed in discourse  grouped under the rubric of "social justice").  When committed in the context of race, gender, etc., it is often just an intellectual version of stereotyping.  I have no difficulty agreeing with Kristof that unconscious bias exists and affects some proportion of the decisions made in the population.  But it doesn't mean that everyone shares it or that every white male's station in life can be attributed to it. Those are fallacious statements, and they are why his white male readers react angrily to his generalizations about them.

Simple, even crude, examples will serve to illustrate the ecological fallacy:  blacks tend to make less than whites, so it must be true that any given black member of a professional sports team makes less than any given white player on that team.   Or, women tend to make less than men, so any given female CEO must make less than any given male CEO.  Both those inferences are fallacious - the differences  within the populations studied are erased in the statistical analysis of the population, even though the statistical analysis is itself true about the whole population. The flaw lies in the generalization that the statistic describes every member of the group equally  -- if the reasoning were true, one would not need statistical analysis, ironically.  The reasoning is simply fallacious. 

I will use the studies Kristof cites in his last column to show his unwitting embrace of this fallacy.

He first cites a study that he describes as " a huge interactive exploration of 14 million reviews on RateMyProfessors.com that recently suggested that male professors are disproportionately likely to be described as a “star” or “genius.” Female professors are disproportionately described as “nasty,” “ugly,” “bossy” or “disorganized.” 

The interactive site does not lend itself to being quoted because it is principally visual; you plug in a word and get a graph of how often it was used in describing male or female professors.   I tried a couple of words Kristof quoted and they showed a 2:1 or 7:3 ratio in favor of males.  As Kristof noted, one possible inference might be that the descriptions are in fact accurate, although he sort of laughs that possibility aside (which I think is cavalier given that females represent a slight majority of college students and the sample size is remarkably large).  We also don't know the total number of male and female professors that were being rated, their experience, etc.  But for this purpose, I will assume the exercise demonstrates the unconscious bias he suggests.  Still, there were 30-33% of the population that did not demonstrate pro-male bias.  That is at least 4.2 million out of 14 million who don't fit his claim.  It's the ecological fallacy to suggest that everyone who rated a professor was biased.  And it's the ecological fallacy to suggest that every male professor was unfairly overrated or that every female professor was unfairly underrated. 

Another point about the 30-35% figure bears noting as well.  If we assume that in an unbiased world the breakdown would be 50/50, i.e., each word would be used as often to describe a male as well as a female professor, then how much bias does a 70/30 split show? I suggest that the right answer is 35% (50% total female population - 32.5% females receiving equal or better treatment) / 50% total female population.  That is, you would expect females and males to receive 50% each by random allocation, so only you need to quantify the deviation from 50% (there is an argument that the denominator should be 100%, because the range of possible distributions ranges from 100/0 male to 0/100 female in which case the % of bias would be only 17.5%, but I don't need to take that view given I make my point with the more conservative denominator).  

Significantly, this means a solid majority -- 65% roughly -- of the 14 million student ratings exhibit no bias at all, thus supporting my point that it is fallacious to claim everyone has it or that every white male benefits from it. In this case, 35% of the population had a different result due to bias, that's material but not a majority, let alone something universal. To even call it pervasive is a stretch, with all due respect.

The second study he cites says: "researchers at North Carolina State conducted an experiment in which they asked students to rate teachers of an online course (the students never saw the teachers). To some of the students, a male teacher claimed to be female and vice versa. When students were taking the class from someone they believed to be male, they rated the teacher more highly. The very same teacher, when believed to be female, was rated significantly lower."

I could not access the study itself, only an article about it that Kristof links to.  So it is difficult to say anything conclusive about it (that did not stop Kristof, of course).  The article indicates the sample size is small (43 students, gender distribution unspecified) and it is very unclear how "same"  the instruction was in the several classes, thus raising doubts as to how comparable the cross-class results are. Finally, this is a single-blind study (the teachers knew what the test was testing) and there is no way of knowing if the teachers themselves acted in a way that biased the ratings.  The only specific data point that the article mentions is that, although homework was returned at the same time in each class, the male teachers were rated as having done so faster.  However, the respective ratings they quote are clearly averages (4.35 & 3.55) meaning that there could well have been individual raters who did not display a pro-male bias at all, which is my point again. It's fallacious to imply that all students gave a biased rating of their teacher.

The third study he cites (which by the way is about a dozen years old) "sent out fictitious résumés in response to help-wanted ads. Each résumé was given a name that either sounded stereotypically African-American or one that sounded white, but the résumés were otherwise basically the same. The study found that a résumé with a name like Emily or Greg received 50 percent more callbacks than the same résumé with a name like Lakisha or Jamal. Having a white-sounding name was as beneficial as eight years’ work experience."

All  of which is true, but two things should be noted, as the study itself does: first, that callbacks only represented 1/8  of the responses; 7/8 of the responses did not involve callbacks and there the resumes received equal treatment.  That is, the complete distribution of responses was:

87.5%: No discrimination

9%: Favored White Applicant

3.7%: Favored Black Applicant

See page 11 of the study.  So the extent of bias was much lower than implied.  Kristof gives no credit to the existence of procedures that generate an unbiased result and counteract bias thereby.

Secondly, and more to my point, even if the 9:3.7 ratio were applied to all outcomes, the amount of biased decisions would not constitute a majority of the decisions: the study sent 1 "white" resume for every "black" resume, so to quantify the amount of bias - even among just the callback pool and ignoring the much larger "no discrimination" pool  - I convert the percentages to raw numbers - say 900 and 370 -- determine how many callbacks each race would have received in an unbiased world (635), and then calculate how much deviation occurred from that number: (635-370) / 635, or roughly 42%.  Again a sizable number, but still less than half of all decisions.  So again, more than half of the sampled population showed no bias at all.  (Again, I am not contending the population exhibited no bias, or that it was insignificant; I am saying no inference may reasonably be drawn about either the population as a whole, whites as a whole, or any individual white person, either as applicant or resume recipient, from the proportion of bias detected in the sample). 

The last study he cites involves asking "professors to evaluate the summary of a supposed applicant for a post as laboratory manager, but, in some cases, the applicant was named John and in others Jennifer. Everything else was the same. “John” was rated an average of 4.0 on a 7-point scale for competence, “Jennifer” a 3.3. When asked to propose an annual starting salary for the applicant, the professors suggested on average a salary for “John” almost $4,000 higher than for “Jennifer.”

Following the link he provided led me to the study but I could not find the underlying data, just the averages Kristof reports.  So unfortunately there was no way to determine the number or percentage of respondents who did not display a pro-male bias.  (Otherwise that study is a randomized double-blind study and thus the best one in his arsenal for his argument; also an interesting fact about the study is that, even carried out to two decimal places, there was not the slightest shred of difference between the average responses of female and male respondents -- each applicant was ranked virtually the same by each gender).

But from what he cites, we can see that, properly understood, a majority of the sampled populations show no bias at all in favor of whites or males.  We can also see from the ratemyprofessors exercise and the last study that there is no evidence of males favoring males or whites favoring whites in his examples.  For both of these reasons, and another one I will give at the end, there is no logic when he goes on to universalize these results as follows:

"It’s not that we white men are intentionally doing anything wrong, but we do have a penchant for obliviousness about the way we are beneficiaries of systematic unfairness. Maybe that’s because in a race, it’s easy not to notice a tailwind, and white men often go through life with a tailwind, while women and people of color must push against a headwind."

Those claims about "white men" just reiterate the ecological fallacy; they are pure stereotyping. There are individual white men who experience greater headwinds and lesser tailwinds than some women and people of color, not all of whom must push against an equally large headwind.  Clearly if you believe the studies he cites, a majority of whites and males receive no tailwind at all from being white or male.  Looking at averages or other statistical measures obscures this fact - and that's where the ecological fallacy does its harm: if the average ranking of males or whites is n more favorable than that of females or blacks, it doesn't mean that each white or male got the same n  boost from being white or male. To infer that is to commit the ecological fallacy.  

If we put these insights all together, a legitimate inference might be that the majority of whites or males receive no privilege whatsoever, while a minority receive a considerable boost, and the average is just what it is.  

A final reason Kristof's generalizations about "we white men" are fallacious is fairly obvious but rarely recognized -- that every exceptionally successful white male has had to out-compete the rest of the white male population too.  If you recognize this, as well as the size of the white male population, it becomes clear that the most successful white males are the least likely to have benefited from being white or male, given that they out-competed the many other holders of these supposed privileges.  Conversely, the benefits of the supposed privileges probably are greater the closer the white male is to the median or average, because his unique accomplishments are smaller in proportion to the benefits he supposedly received.   Not to personalize this to much, but to illustrate the point,  I attended all-male institutions in both high school and college and finished at the top of the class in both.  The population that took the high school entrance test was all male, by definition and almost entirely white, and I had the highest score on it.  I took the allegedly white-male-biased SAT with hundreds of thousands of other white males and outscored 99% of them.  Then I attended a predominantly male elite law school and finished somewhere in the top third, entered a predominantly male class of associates at an elite law firm and made partner, which less than a quarter of all my white male competitors did.  I respectfully submit that. given the number of white males I out-competed, and the decades  over which I did so, the most reasonable inference is that, even in a beautifully unbiased world, I would have had a fairly similar level of success. 

These are the points that Kristof doesn't get, when he encounters pushback from readers in Times Nation.  It is not that he is wrong about the presence of unconscious bias in the world, but that he is wrong to portray it as universal, when it's not even a majority view (and may be a very small minority among his readers when you consider how left-leaning Times Nation is. relative to the population as a whole), and wrong to claim that every white male has benefited from it as much as he thinks they all have.  That is why his readers are mad, not because they're in denial about their bias, but because they're more likely than not right that they are in fact not biased.  The world, even the white male subset of it, is more diverse, and yet more fair, than the ecological fallacies on the Times OpEd page lead one to perceive.

Inequality Models are Not Facts

The New York Times ran an article --  not an opinion piece, but an article -- last week entitled "Study Finds Local Taxes Hit Lower Wage Earners Harder".  It is a superficial summary of a report that is published every few years by a progressive think tank, The Institute on Taxation and Economic Policy ("ITEP"), which the article laughably describes as "nonpartisan".  The institute's board of directors includes Robert Reich, former Clinton Administration Secretary of Labor and a Berkeley academic, Robert Kuttner of The American Prospect, a leading progressive periodical and website, and other well-known progressives or associates of other progressive organizations.  The ITEP staff bios show that, with few exceptions, they have spent their entire adult lives inside the beltway or in surrounding states, beginning, in the main, with getting a degree (in what is usually not specified), at Georgetown or GWU, or perhaps as far away as UVa or U of Md.  Their bios cite prior contributions to the New York Times and the New Republic, but not a single publication of a different ideological stripe.  The organization's recent other publications include "Undocumented Immigrants' State and Local Tax Contributions", "State Tax Codes as Poverty Fighting Tools", "The Sorry State of Corporate Taxes" and "Options for Progressive Tax Relief".  It states on its website that it partners frequently with Citizens for Tax Justice, another, better-known progressive think tank that endorses Bernie Sanders' legislative proposals.  So this report is obviously partisan, unless as a New York Times writer or reader you are so steeped in progressive ideology that you can't see the rest of the world clearly. 

The report "Who Pays?  A Distributional Analysis of the Tax Systems of all 50 States" is available on the ITEP website. The proposition of the report is, as one might expect, that any tax system other than income taxes with progressive rates is unfair.  Most of the report is devoted to state-by-state tables that layout ITEP's calculations of tax burdens by income quintile, with the predictable breakdown of the top quintile into three subsets - top 1%, top 5% and the rest.  The report ranks each state in a tax inequality index of ITEP's own devising, in which four states without income taxes - WA, FL, TX and SD--  get ranked most unequal while states with high top rates on income -- OR, CA and DE -- get ranked least unequal.  Because DE has no sales tax at all, that combines with its "modestly progressive" income tax to make it the least unequal in the eyes of the ITEP staff.

The naive reader might think such a "study" simply consists of researchers going through tax return data, pulling out data on state and local taxes paid, then measuring those payments against income and putting the resulting ratios into a table.  The facts are the facts and the author of this post is just upset that progressives have found them out.  Ah, but "fact", dear reader, in social science data crunching is often the creation of the data cruncher, and that is the point of this post.  I consider myself a proud member of the "reality-based community" among which I counted many fellow citizens of the left back during the Bush-Cheney regime.  Sadly, when a progressive President came into power due to the unprecedented incompetence of said regime, the "reality-based community" got a lot smaller and more conservative.  The myths these days are confected on the left.  In this post, I will show how the data is manipulated to achieve a counter-factual depiction of tax payment distribution that comports with the progressive mindset of the organization that did the study. I don't claim that the manipulation stems from an outright intent to deceive; it is equally possible that it stems from the simple cognitive bias that can build up when people of like minds and backgrounds talk only to people of like minds and backgrounds.

The report does not detail the methodology of the computations, except indirectly in passing references to different kinds of taxes.  Sources for data were only partly disclosed in the report.  References are made to an underlying model, and I hunted down a short methodological note about it on ITEP's website that answered some of my questions.  The model appears to be based on 1980s and 1990s era academic research, probably reflecting when ITEP opened for business, with ad hoc updates, mostly of data sets, since then.  From these sources, I was able to identify at least some of the allocational and methodological decisions they made to generate their results.

For example, they claim to exclude all persons over 65 from the report because, to paraphrase page 19 of the report, "they get too many tax breaks" and their inclusion would obscure the picture ITEP wants to present of "the majority".  By this logic, all inequality studies can exclude "the 1%" or even the 1% and the two lowest quintiles, because the study would still be presenting a picture of "the majority". So one example of a choice made to slice the data to get to the desired result.

Secondly, they don't count all taxes.  They admit to excluding severance taxes on oil and gas extraction, which exist in most states and are certainly a major factor in Alaska.  They also exclude at least a portion of tourism taxes (as I write, I cannot recall if it is part or all but it's not that large a number either way).  The argument for both of those exclusions is that they are "exported" out of the state that imposes them, i.e. paid by its non-residents.  Which is true but they have to land somewhere and the vast majority of them land within the rest of the United States.  The model does not appear to include that second-stage allocation. 

Third, and a much larger contribution toward reaching a depiction of inequality, they selectively define what is counted as income.  From an endnote, it likely comes from IRS data which is well-understood to exclude many items, such as employer-provided health coverage to middle and upper middle class workers. But even for people in the lower quintiles of income, there are significant government benefits they receive that are not counted as income by the IRS.  For example, when a Medicaid patient sees a doctor and does not pay the real cost of the visit, that subsidy does not show up as the patient's income. If one lives in a rent-controlled apartment, or an affordable-housing complex where the landlord has agreed to a certain rent, even though there is not a formal rent control, that is an economic benefit that does not show up in one's tax return. Mass-transit subsidies are not acknowledged as income, etc. 

Similarly, a low-income household that sends children to public school does not recognize income based on a per child share of the education expenditures made by their school district for the benefit of those children,  But educational expenses make up the vast bulk of local government spending, and are the main use of property taxes!  In my town, school taxes make up 2/3 of my property tax bill, even though I have no children still attending the public schools.   There is a net transfer, not captured in traditional income categories, from taxpayers with a high income-to-child ratio to those with a low income-to-child ratio.  Government's role as middleman, or post-office, obscures that transfer, and the sponsors of inequality arguments, always people on the left, are disinclined to pierce that obscuring. 

ITEP defends this exclusion by saying, in substance, "yeah, well, an educated workforce benefits employers too."  But given that business profit margins are well-documented, and education-to-salary correlations have been extensively studied, that objection seems weak and convenient.  Employers don't capture 100% of the benefit of educating the workforce, given that they pay that workforce, you know, wages.  They capture at most a small fraction of it in the portion of their profit margin that may be allocated to worker productivity.  Thus, the portion of education spending captured by the student vs the portion theoretically captured by a future employer is as estimable as anything else ITEP chooses to estimate. I suspect they dodge this challenge because, by itself, it would kill their conclusion, given the growth of public sector education expenditure that has occurred in recent decades. 

Income earned in the "informal economy" usually is not included as income in these studies, although it obviously exists and is heavily weighted toward the lower and middle quintiles.  ITEP claims to include an estimate for it, but I am very suspicious of it, since none of the examples they give of informal income -- farm income? seriously? -- include the kind of off-the-books wages or payments to independent contractors that is all I have ever seen and I have seen dozens of examples of it.  For example, one of my pro bono clients was a maintenance worker in a Manhattan office building.  He made about $30,000 - $40,000 in salary and his wife received a small amount of disability payments.  That is not usually enough to live on in NYC so I asked what other resources he was living on.  He told me they got by due to a sideline of his doing exterminations in the outer boroughs on off-hours and weekends,  He told me the business had generated roughly $30,000/year for several years -- which he had never declared to the IRS (which had never audited him).   As he was in no position to pay back taxes, interest or penalties, he chose not to proceed with the personal bankruptcy filing, in which he would have had to disclose the income or perjure himself, and tried to tough it out on his own.

Or there was the retired NYS teacher who tutored one of my kids for two years in math but demanded payment in cash (despite the fact that NYS public sector workers have their pensions  exempt from state and local taxation). Or the guy who gave music lessons, or the unlicensed child care provider, the small job home repairs contractor, etc.

There is academic research that attempts to quantify the distribution of non-compliance with the Internal Revenue Code that supports the idea that high earners cheat at least as much as low earners.  It has been observed that given higher marginal tax rates the high earner has a greater incentive to cheat..  That observation, however, tends to overlook that, due to the plethora of income-based subsidies provided by state and federal governments, which phase out as one earns more, the highest marginal tax rates in the economy are in the working class which then supports the proposition that the working class has the highest propensity to cheat.  Also, such studies, in addition to the inherent sampling error, have data collection questions:  how does one know the IRS caught everybody and every item of noncompliance?  It's harder to detect small amounts of cheating and the auditing and collection effort may not be worthwhile. An agent may buy a questionable explanation if the amount in dispute is small.  Whereas a bigger target justifies a bigger effort, although admittedly they may have greater resources to challenge the IRS.  Further the noncompliance studies contain their own sets of assumptions and judgments, so citing them to support a second generation of allocation propositions compounds the risk of error.

There are other types of income that don't make it into the IRS form usually -- debt that the creditor fails to collect, but also doesn't formally release being one category of billions of dollars a year that goes unrecognized. 

Fourth and also highly significant in terms of the ultimate re-distribution of tax payments by the study's authors, the ITEP study allocates a significant portion of business and property tax payments to persons who are not the owners of the property or business. The justification is stated that many of those taxes are passed through. This is the concept of "tax incidence".  I found a paper on their website that says (in a section titled "Incidence Assumptions") that 1/2 of property tax charged on rented residential real property was passed through by their model to tenants -- clearly an estimate and otherwise I did not see a detailed justification of the 50% number. 

This is perhaps the best example of how one can create facts in a model.  Obviously, the person who gets the bill and writes the check to discharge taxes on rental property is the owner.  So that is the "fact" that exists in the data sampled.  Further, in accounting, for centuries, expense and income are supposed to be matched to make for an accurate and not misleading presentation, so there too the recipient of rental property income would be required to show the property tax as an expense of renting that property.  So based on those objective facts, one would assign all the property tax to the owner of property which would depict a more progressive distribution.

The concept of tax incidence changes that.  It posits that, whatever the paperwork and money flows look like, economically, the burden of a tax may fall on a person different than the one paying it.  In this case, it may fall on the tenant, on the theory -- note that this is a theoretical allocation, not a reality-based allocation  -- that the landlord charges enough rent to cover its expenses which include the property tax, thus some portion of the property tax is included in the rent.

Tax incidence can also be invoked in the context of corporate income taxes (it is posited, for example, that workers may bear the burden of corporate income taxes, in the form of reduced wages, because the employer has to make enough money to stay in business and the tax is an expense that competes with other expenses, like wages) and even in the context of sales taxes (when you buy an item that costs $100 and the state adds 5%, you are obviously paying $105 total to take the item with you, so would you have paid $105 to the store for the item?  In that case, the store owner is bearing the burden of the tax, not the consumer).  The ITEP model does not seem to re-allocate any tax other than property tax on residential real property however. I am not sure intellectually how one selects that tax for a counter-factual reallocation, and not others.  A landlord pays income tax on rental income too -- by the logic used to reallocate property tax, one would reallocate the rental income too.  A logical explanation, however, is the progressive authors of the study have a desire to push states toward a more income-tax dependent regime and thus would not want to reallocate income taxes away from high earners, regardless of intellectual consistency.

Whether any particular claim of tax incidence is true is difficult to prove.  From a common-sense point of view, even a vacant building has a property tax, so there is no simple pass-through going on.  I happen to own two condos that I rent out to the extent I can.  The property tax is the same whether I rent them out or not; they are just taxed as residential units.  Am I passing that through when I elect to rent the units out?  Or is the tax simply eating into my profit, because the tenant would pay $X rent regardless of how much property tax I have to pay?  I know of no way to prove either proposition objectively. 

Then there are further distributional propositions one could make: perhaps in good school districts, with high property taxes, a landlord can pass taxes through, because tenants will sacrifice to get into such a district, but logically in worse school districts, with a poorer population, a landlord may succeed in passing less taxes through (you can't collect what they can't pay).  None of this is discussed in the ITEP papers available on its website.   Really the 50% is plucked out of the air.  It's no more a "fact" than 25% or 75% would have been.

In the main, the extent of tax incidence of any particular tax is a conjecture derived from theoretical models that rest on debatable assumptions (like full employment and efficient labor markets in the arguments that workers bear the burden of corporate income taxes). The authorities ITEP cites in support of their Incidence Assumptions are just theoretical arguments based on propositions about elasticity of inputs and so forth that themselves are partly conjectures.  There is no broad, accepted dataset that one goes to and says what the tax incidence of some tax is. There is just no way to prove the extent of tax incidence across every tax on every property in every state, but that doesn't stop people from asserting it when it suits their purposes.

The incidence of property taxes has been the subject of academic conjecture for at least 4 decades, yet there are virtually no empirical examinations.  The only two I can find in the last 25 years that I can commend are one from 1994 by Carroll and Yinger in Boston, who concluded that only 15% of any property tax is passed through to tenants, and a large 20-year study recently concluded in Germany where it was concluded that, in the short-run, landlords absorb all or substantially all of any property tax increase, and are only able, over the long term, to pass through to tenants some of it where and when rental housing demand exceeds rental housing supply.  So there is no support I can find for anything close to the allocation made to tenants in the ITEP study, which is obviously a very significant part of their portrayal of a picture of inequality. 

And as a closing point about the biased nature of the ITEP model, please note how its disparate allocation of property taxes vs its disregard of the services typically paid for with property tax revenue, i.e., education.  As pointed out above, the model allocates zero income to households for schooling children.  Yet it allocates to renters 50% of the landlord's property taxes.  That is a sure way to make the distribution look regressive: allocate costs but not benefits.  Unfortunately, that is at odds with the most basic principles of financial presentation: match the person's or entity's income and expenses.  Here, the organization deliberately chooses to separate them, which is a big driver of the portrait they create.

A fifth example of putting a thumb on the scale is the reduction of the tax burden for higher earners for the federal deductibility of state income and property taxes, without including a similar offset for the lowest quintiles by virtue of the standard deduction they can take on federal income taxes.  Some portion of the standard deduction should logically be viewed as a substitute for state and local tax deduction.  This is a relatively minor factor in the ultimate redistribution though.

A final observation about the choices made in the model is not about accuracy or bias but about values, as President Obama might say.  The model allocates excise taxes on gasoline, alcohol and tobacco primarily to lower-income quintiles, which forms a substantial part of their tax burden in many states.  The alcohol and gasoline allocations are debatable I think, as wealthier families may have more cars per household, and may imbibe more expensive alcohol.  But in any case, it's hard to see why taxes on these items shouldn't be maintained, if not increased.  Inequality is not the only issue in America, although sometimes it seems to be the only one to progressives. 

So the overall point is this: models do not generate facts.  Models generate representations of reality. Representations have a tendency to reflect the predisposition of the person making them. Models usually contain assumptions and similar propositions that are not proven empirically and may be selective to suit a particular outcome, as real estate appraisals in the subprime crisis were.   Models may omit or manipulate data for a variety of reasons (my favorite "tell" is to search a paper containing an economic or similar model for variations on the word "simplify" which usually leads right to the things the model's author cut out of the data).  One need not debate whether the manipulation of data is in bad faith or reflects simple cognitive bias, but one must be aware of the risk that one or the other is present. 

Amend the Federal Rules of Bankruptcy Procedure to Combat Fraudulent Asbestos Claims

Reading today's "ABI Daily Headlines Delivered" email, I see another disclosure of fraudulent submissions in relation to asbestos claims against a manufacturer forced into bankruptcy by such claims.

The email links, after you get through the ABI paywall, to a Reuters story about the Garlock Sealing Technologies bankruptcy, presided over by USBJ George Hodges, who has done the country a great service by respecting the debtor's allegations of fraud and allowing them to be investigated, when many other judges prefer to see the parties reach a deal of any kind so that the pendency of the case does not forestall the receipt of compensation by the truly injured.

As the District Court to which his court is appended wrote last year, 

"After hearing evidence from fifteen settled cases, Judge Hodges found that Garlock’s [pre-petition] settlements were not a reliable predictor of liability because misrepresentation had infected them:

"'[T]he fact that each and every one of them contains such demonstrable misrepresentation is surprising and persuasive. More important is the fact that the pattern exposed in those cases appears to have been sufficiently widespread to have a significant impact on Garlock’s settlement practices and results.

Judge Hodges went on to describe the plaintiffs’ lawyers’ conduct in these cases as forming a 'startling pattern of misrepresentation.'”

Those quotes come from the published order and opinion estimating the debtor's liability on asbestos claims at $125 million, roughly 10% of the amount the plaintiffs' representatives contended, based on extrapolation of pre-petition settlement.  Judge Hodges's ruling is found at 504 BR 71 and online here, at the website of Bates White, the consulting firm hired by the debtor who crunched the data to support the debtor's case.  The findings of misconduct run from paragraphs 55-71, beginning with the remarkable finding that the "fifteen settled cases" referred to in the opinion as tainted by misrepresentation were the entire sample the debtor examined - i.e., every settlement in the sample was tainted by misrepresentations by the plaintiffs about their exposure claims.

Notwithstanding his contribution to justice, Judge Hodges is not perfect, and these disclosures only come about now because, in July 2013, he sealed his courtroom and excluded the press from coverage of the hearing at which the debtor's asbestos liability was estimated.

The sealing of proceedings, however, was appealed by a news organization, Legal Newsline, who contended that the public had a right of access, joined by numerous other parties -- insurers and co-defendants among them -- with litigation-defense and other economic reasons for access to the information being aired in the trial, which per Judge Hodges' estimation ruling, lasted 17 trial days, entailed 29 witnesses and hundreds of exhibits.  It should be noted that the debtor also urged Judge Hodges to make the hearing and related information publicly available.

In July of 2014, the District Court agreed with Legal Newsline that Judge Hodges had not fulfilled the federal courts' "gatekeeper role" on behalf of the public's right of access, reversed the sealing orders, and remanded for a more careful scrutiny of the litigants' claims for confidentiality.  It also withdrew the reference of the debtor's common law and RICO suits against the law firms alleged to have engaged in the fraudulent conduct.  U.S.District Court, W.D.N.C. Docket No. 3:13-cv-00464-MOC. The remanded issues apparently unfolded over the ensuing months and now the documents are beginning to come to light.

The purpose of this post is not to revisit the misconduct allegations in detail but to advocate a particular path of action towards federalizing the lessons learned in Garlock in order to eliminate the scandal of fraudulent pursuit of asbestos claims from all federal bankruptcy proceedings, including asbestos trusts established under confirmed "524G plans". 

For decades, defendants and other potential payors of asbestos liability have tried to get Congress to pass legislation to address this issue, but such legislation always fails; the reason usually given is the political pull of the plaintiffs' bar. When the late Fred Baron, a Dallas-area lawyer who made millions off being an early mover in representing asbestos plaintiffs beginning in the 1970s, was accused by the Wall Street Journal in 2002 of having "all but bought the U.S. Senate" with his campaign contributions, he objected to the accusation, "Particularly the 'all but'."  But also there is the general reluctance of politicians to pass laws that might lead to campaign ads being run showing gravely ill people and claiming they are being denied compensation because of the politician's vote in favor of a bill that benefits big business.  Even Elizabeth Warren was subject to attacks of that nature, absurdly enough, given her long advocacy of prioritizing tort claims in business bankruptcies.

There have been individual efforts at the state level, e.g., Wisconsin recently, implementing disclosure reform, but those efforts would not likely have any effect in federal bankruptcy proceedings

But our government has a channel in which justice is not so subject to shabby electoral calculations, and that of course is the judiciary, as exemplified by Judge Hodges.  But Garlock is only one case and Judge Hodges only one judge, so a case-by-case approach runs the risk of inconsistent results, and as well, very likely entails recurring huge expenses -- the Garlock battle has already generated over $40 million just in fees and expenses of the bankruptcy lawyers for the asbestos plaintiffs (in the relatively low-cost forum of Charlotte).  In addition to those expenses, as this article recounts, Garlock itself had to initiate collateral discovery proceedings in 12 other cases besides its own bankruptcy, and prosecute appeals of adverse rulings in them, to obtain documentary evidence of misconduct.

So the best approach is for the judiciary to formulate a national rule for review of claims in all asbestos bankruptcy cases, and the way to do that is to amend the Federal Rules of Bankruptcy Procedure to add a rule that adopts the lessons learned in the Garlock case for all pending and future asbestos claims in bankruptcy cases. 

The Advisory Committee on the Federal Rules of Bankruptcy Procedure, which is headed by Judge Sandra S Ikuta, of the Ninth Circuit (thanks to reader Gary Streeting for his comment below informing me of this), advises ultimately the Judicial Conference of the United States on advisable changes to the Federal Rules of Bankruptcy Procedure.  Many of its recent proposals have dealt with claims procedures.  

The Advisory Committee receives submissions from interested parties proposing, opposing or simply commenting on the topic. This link explains how to make those submissions.  Then, often in subcommittees, the Advisory Committee analyzes the proposals.  Once or twice a year, it holds an open session at which the topics under consideration receive a public hearing.  Ultimately, the Committee may craft its own recommendation; it is not limited to simply approving or rejecting the proposals submitted to it.  

What an intelligent proposal on asbestos claim disclosure should contain is a topic I am not going to write fully on at this time, but the general thrust should be to generate the kind of information reviewed by Judge Hodges in the estimation procedures: What other claims has the claimant made? Against whom, when and in what forum?  Plaintiffs should be obligated to turn over copies of the claims, pleadings and testimony, if any in support of all prior or pending claims. And what recovery has the plaintiff received on those claims?  Then too, it should be provided that, if any evidence of misrepresentation or nondisclosure of the required information comes to light after a claim is allowed against an estate or trust, the allowance is void.  Last, the rule should endorse the disregard of settlement evidence in calculating the debtor's aggregate liability, unless examination of a sufficiently large random sample of settlements by application of these methods shown them to have been untainted.  I would expect the judges on the Advisory Committee to treat with the utmost seriousness the issue of fraudulent claims being systematically presented in federal proceedings and the trusts set up by federal courts in those proceedings.

Tyron Smith, Ryan Howard and Income Inequality

Back in November, I read a pair of stories on sports websites about two young, black, highly paid professional athletes, and the legal battles that have erupted between them and their respective parents and siblings over the money the athletes are making.  The media have framed these stories in a variety of ways beyond just being two more clichéd made-for-reality-tv  tales of dysfunctional families, or professional athletes who go broke.   Philly.com's  story on Philadelphia Phillies first baseman Ryan Howard, right from the opening paragraph, is an exercise in sympathy that presents him as a man suffering great psychological torment, implying quietly that these struggles may have affected his play in recent years.  ESPN the Magazine's story on Dallas Cowboys' offensive tackle Tyron Smith includes a racial angle, positing that these family pressures and the narratives associated with them impinge much more frequently on black athletes than white. 

I have a slightly different take on them.  These athletes' stories are startlingly pure, dramatic distillations of an issue that progressive thought leaders and allied politicians have been harping on for the past several years, that of "income inequality". 

Some economists contend "income inequality" is bad for economic growth because, after a certain point, a well-to-do person saves incremental dollars, while a less-well-off person has a higher propensity to spend incremental dollars, and the latter shows up in measures of economic activity while savings do not.  (This is, I think, a half-truth when you recognize that most savings are not inertly stuffed under a mattress, but are loaned to banks or governments, or reinvested in businesses, each of which, in turn, tends to return the funds to the real economy where they get spent.) The athletes' stories will touch on this a bit, but it is not my main focus.

Some arguments about "income inequality" are coupled with observations that some people in a society lack certain goods and/or access to certain services that are considered essential, calling them entitlements or rights.  These arguments do not treat "income inequality" as a bad thing, as much as the phrase simply identifies where funds can be found to pay for the delivery of the desired goods and services.  These concerns about income distribution would theoretically vanish once the roster of goods and services was made available, regardless of how they were made available, and thus they are not true objections to income inequality, and therefore not my concern in this post. As we shall see, these athletes' families do not lack for basic necessities.  

More fundamentally, it is frequently contended that income inequality is bad, not because it causes something else bad (a smaller economy, or a violent reaction) but bad in and of itself, in the sense of violating social norms of some kind.  Simply put, it is posited that successful people can make "too much" money for the good of society.  (It is rarely explained cogently how the permissible level of earnings is established normatively, as numbers do not have a normative component.)  Nonetheless, this perspective is demonstrated when someone contends that a society in which everyone becomes better off is still not just, because the lot of some people, who were already better off, improves more than people in the lower half.  As Deidre McCloskey wrote in a brilliant review of "Capital" by Thomas Piketty, "What is worrying Piketty is that the rich might possibly get richer, even though the poor get richer, too. His worry,..is... about a vague feeling of envy raised to a theoretical and ethical proposition."  This perspective is at the root of progressive objections to income inequality in the US today.  

And that is what these athletes' stories frame perfectly.  Each family can stand as a microcosm of a larger society; each of the athletes likewise can serve as a proxy for that typically small proportion of such a society that has dramatically higher earnings than the other members -- the so-called "1%".  How you react to these stories, I suggest, should be consistent with or, if not, challenge, how you react to arguments about income inequality.  These family battles can serve as modern morality plays on the theme of income inequality.   Were I more creatively inclined, I might actually write a play drawing upon these accounts, but, lacking that capability, I write this blog post instead. 

In the rest of this post, any factual statements about the athletes are direct quotes or paraphrases from the ESPN and philly.com links above, unless otherwise indicated; for sake of brevity, I am not going to elongate this post by prefacing each one with leads like "The article goes on to say" or similar phrases. And I don't bother with quotation marks because then I have to do quotes within quotes and it takes too long.

1.         The Athletes and Their Salaries

a.         Tyron Smith

Tyron Smith, age 23, is a highly regarded offensive tackle for the Dallas Cowboys.  Smith began to play football in high school.  He was huge and nimble, eventually reaching 6-foot-5 and 310 pounds. He did well enough to earn a scholarship to football powerhouse USC, and his continued development enabled him to turn pro in 2011 during his junior year.  His first contract provided compensation of $12.5 million over four years.  In July 2014, he signed an 8-year extension that guarantees him $22.1 million; he could earn as much as $109 million before the contract expires in 2023. 

b.         Ryan Howard

Ryan Howard, age 35, has played first base for the Philadelphia Phillies since 2004.  He was named the National League's Rookie of the Year in 2005 and its Most Valuable Player in 2006. He batted cleanup for the team when it won the 2008 World Series, only the second World Series the franchise has won  in 110  years of World Series play.  Initially grossly underpaid due to the structure of Major League Baseball's collective bargaining agreement, Howard signed a contract extension in 2010 that runs through 2016.  Under it, he has received $65 million to date and has $60 million left in guaranteed money.  Sadly, despite his initial success, Howard's performance has deteriorated significantly ever since he signed that extension, and the contract has been labeled by a few analysts as one of the worst, if not the worst, of all time from a club's point of view.

2.         The Athletes' Family Backgrounds

a          Tyron Smith

Smith spent much of his elementary school years working for the family business. Pinkney's Cleaning Service specialized in cleaning new buildings after construction was complete but before tenants moved in. Family members would often climb into the company van, drive from their home in Moreno Valley, California, to Phoenix or Sacramento or anywhere in between, clean a building and then pile back into the van for a return drive that could last seven hours. They'd pull into the driveway at 4 or 5 a.m., and Tyron and his five siblings -- a mixture of half brothers, half sisters, stepbrothers and step­sisters -- would be at school by 8.

Smith says he always asked, "'Can I get my own job? Can I do my own thing?' I didn't want to work in the janitorial business my whole life."  He was excused from janitorial work if he had a practice, game or camp to attend. 

b.         Ryan Howard

According to a New York Times profile that calls him the "anti-Barry Bonds", Howard comes from a largely white suburb. He grew up in Wildwood, Mo., on the outer edge of St. Louis’s western sprawl. His mother, Cheryl, now retired, worked in marketing, and his father, Ron, is a manager for I.B.M. He has three siblings, including a fraternal twin, all of whom are college-educated professionals.

“If you talk to his parents, it will help you understand Ryan,” Howard’s high school coach told the Philadelphia Daily News. “They’re such supportive people, of their kids, of this school. It’s such a good family.”

As his parents describe it, their household was a mix of old-time Southern values and middle-class aspiration. “All our kids were taught to say ‘Yes, sir,’ ‘Yes, ma’am’ and so on,” Ron Howard says. “We valued hard work and taught them: believe in oneself, believe in each other and believe in the Almighty.”

In 2007, Howard spoke of his father's influence on him.

Bryant Gumbel: ‘You have said , ‘My dad set the bar high for all of us.’ What was expected?”
Ryan Howard: “He is very, very big on going out and earning your own keep. because nobody is ever going to give you anything, nothing is ever free.”
Ryan Howard: “When I was younger, I forget what age I was, my dad set the tone by graduating from Washington University here (in St. Louis). We got to see him graduate and I know for me that stuck with me, every day.”

When Ryan Howard was 2, his father walked into a room where a TV was showing a baseball game and saw his son intent on the action and swinging a little red bat. “It was such a natural swing,” Ron Howard says. “At that moment I knew he’d be some kind of baseball player. How far? I didn’t know. But that feeling came over me.”

Cheryl Howard added: “I’m from the pre-Title IX days, so I didn’t get a chance to play organized sports. But my father played sandlot baseball with Willie Mays in Birmingham, so we’ve decided Ryan’s baseball talent comes through my side.”

From all accounts, Howard and his twin brother,  Corey, were inseparable. During high school, they practiced trombone together after school. At Missouri State University, they roomed together.

3.         Payments for Family Benefit

a.         Tyron Smith

When Smith signed his initial $12.5 million contract, he bought his mom a Range Rover and vowed to pay off his parents' mortgage and retire the family's debts. "I didn't think I owed them anything," Smith says. "I just really wanted to help out. I know how hard the struggle is, and growing up we always had to worry about debt. That was my thing: Use this money to pay off your house, pay your debt and be free of all that stuff."

Later, Smith discovered the money he provided wasn't used for those purposes. Asked how it was spent, Smith shrugged, betraying no emotion. "We don't know," he says.

Smith was besieged with requests.  He paid for airline tickets so strangers and near strangers could accompany his parents to games in Dallas. He paid for game tickets, parking and food. He paid for hotel rooms or let the guests stay in his home.  "The things that were asked for as gifts shocked me," he says. "All I could think to say was, 'Hey, that sounds really expensive.'"

Smith's lawyer, estimates that the family received roughly $1 million from Tyron's accounts over one year.   The demands took a personal toll on him as well.  He was no longer son or brother or friend. He began to feel like a human Santa list, robbed of his capacity to be generous.

Smith's breaking point came when he received a telephone call from his mother.  He had agreed to purchase a home in Southern California for his mother and stepfather. They would live in it; he would own it as an investment. The agreed-upon budget was roughly $300,000, but when his mother called him to let him know they had found a home to their liking, the asking price was more like $800,000. 

b.  Ryan Howard

Last year, Howard's twin brother, Corey, sued him in federal court in Missouri for millions of dollars, alleging breach of a 15-year consulting agreement under which Corey had been billing his brother $7975 (in other reports $8975) every two weeks since August 2008.  Ryan Howard's answer and counterclaim denied that Corey had ever provided compensable services under the contract but also revealed that the rest of his family had also been receiving regular, large payments at Ryan's expense for several years.  His father Ron acted as “Business Manager,” his mother Cheryl as “Chief Financial Officer,” his brother Chris as “General Counsel,” his sister Roni as "Executive Director" of the Ryan Howard Family Foundation, and Corey as his "Personal Assistant". All were paid through an automatic “Bill Pay” system set up by Cheryl Howard.  The answer and counterclaim provides the following table of payments to them:

Family Member	Period	Amount
Ron Howard (Father)	Jul. 30, 2007 - May 15, 2012	$1,314,097.47
Cheryl Howard (Mother)	Mar. 20, 2007 - May 6, 2013	373,000.00
Corey Howard (Twin brother)	Aug.19, 2008 - May 15, 2013	610,586.85
Chris Howard (Brother)	Jun. 24, 2008 - Dec. 28, 2012	235,300.00
Roni Cowley (Sister)	Jan. 16, 2009 - Dec. 31, 2012	262,353.86
TOTAL		$2,795,337.38

Those payments, spread among the 5 relatives over varying periods that range from 4 to 6 years average out to roughly $110,000 per relative per year, although they were weighted clearly in favor of his father,  whom Howard's legal papers call the "patriarch" of the family - he got about double the average.

In contrast, Ryan Howard, the athlete earning millions of dollars per year, lived on an unspecified allowance managed by his mother / so-called chief financial officer.

4.         Estimating Income Inequality in the Smith and Howard Families

Economists use a variety of different measures to base assertions about income inequality.  The most commonly invoked metric appears to be the "Gini coefficient".  That site links to a Wikipedia page that tells one how to do a simplified calculation of the Gini coefficient for a population, which is
"If the high income group is u % of the population and earns a fraction f % of all income, then the Gini coefficient is f − u. An actual more graded distribution with these same values u and f will always have a higher Gini coefficient than f − u.

"The proverbial case where the richest 20% have 80% of all income would lead to an income Gini coefficient of at least 60%."

The penultimate link above tells one that: "Worldwide, Gini coefficients for income range from approximately 0.23 (Sweden) to 0.70 (Namibia) although not every country has been assessed."

As Howard is making $20 million a year, and there are 5 other members in the nuclear family, even in the unlikely event that the rest of them earn an average of $200,000 / year from other sources, he still would earn more than 95% of the total income in that family (pre-tax).  As he is 1/6 of the population, the Gini coefficient for his family is around 0.78 (95 - 16.7) -- higher than has been calculated for any nation on the planet.

Although we can't tell how much exactly Smith is making per year, it appears to average out to be no less than $3 million and no greater than $10 million over the life of his two contracts. We also don't know precisely how many people there are in his nuclear family, but in the unlikely event that the rest of its members combine for as much as $1 million per year, he still earns over 75% of the total (pre-tax).  While we can't do a precise calculation, under most plausible assumptions about the size of his family, its Gini coefficient is over 0.65, making it too a population of relatively high income inequality.

5.         The Athletes Attempt to Assert Control Over Their Earnings

Smith

After his mother's request for the $800,000 home, Smith made a last-ditch effort. He placed a call to his family, saying, "I love you all, and you mean the world to me, but all this money stuff is stressing me out. Can we just have a great relationship?"

Howard

According to his answer and counterclaim, in late 2011, Howard had become concerned with whether his family members were attempting to enrich themselves at his expense.  He told his parents he wanted to take control of his own affairs and keep his family relations separate from them.  In July 2012, he asked his twin brother to agree to terminate the consulting agreement under which the brother received at least $7975 every two weeks.  The brother declined.  Howard continued to pay him for another year, explaining that it was to maintain his brother's income for a time sufficient to find replacement work.

6.         The Families Respond Indignantly

a.         Smith

"We kept getting voice mails and emails threatening all kinds of things," his girlfriend says. Smith and his girlfriend hired a lawyer and a new financial adviser.  

In June 2012, Smith's mother and stepfather confronted him publicly while he was working at a youth football camp at his old high school in central California. According to a regional newspaper, the confrontation was verbal but involved threats to Smith and / or his girlfriend.  In response, Smith obtained a protective order placed against Smith's parents and siblings, prohibiting them from having contact with him.

Despite the restraining order, on October 27, 2012, with Smith at a hotel on the eve of a home game, two of his sisters showed up uninvited at the home he shared with his girlfriend in North Dallas.

"You need to let us in this house," one of them said. "Why?" his girlfriend answered. "You've made threats against my life. I don't know what you have on you right now, and your brother's not here." She called the police after the women repeatedly said, "We're not leaving until you let us in." 

Three days later, on Tuesday afternoon, two of Smith's sisters were among three people who returned to the house. This time, Smith called 911 and police cited the women for disorderly conduct. A Dallas police report noted that Smith's sisters were there to "harass and torment ... in the pursuit of collecting financial gain."

b.         Howard

When  Howard sought to take control of his financial affairs and “have his family just be family,” his father's  response was allegedly that “if Ryan wanted him to walk away from Ryan’s business affairs, [his father]  should receive $5 million himself and [his mother] should receive another $5 million.”  His mother told him he couldn't separate business from family because the LLC  -- into which evidently his salary was being paid -- had entered into long-term contracts with his siblings (allegedly drafted by his sibling who was a lawyer ...).  It was only then, in July 2012, that Howard claimed to have learned about them.   The term of at least his twin brother's contract ran through 2026.  His parents allegedly refused to turn over the LLC's books and records to him. 

After Ryan cut off payments to his twin brother in July 2013, the brother sued him in U.S. District Court for the Eastern Division of Missouri for breach of contract and sought $2.8 million in damages for the remaining payments in the contract.  Ryan defended alleging constructive fraud in the inception of the contract, and counterclaimed for breach as well, alleging failure to render services.  The case (4:13-cv-02518-CEJ) was settled on undisclosed terms in 2014.

7.         Justifying the Athletes' Perspective

Howard

Ryan Howard has not spoken out, AFAICT, about his family strife so I don't know with certainty what he would say to justify his perspective.  But if we take the allegations in his pleadings in the lawsuit with his twin brother as good faith reflections of his perspective, it is clear that he feels he was defrauded by his family into signing the long-term -- 15 years (!) -- "consulting agreements" and that there was a lack of good faith in the performance, if any, rendered under those agreements, that he got nothing from the agreements under which he was paying large sums semiweekly .  Also, he appears to believe that, as a grown man, he had earned the right to manage his own financial affairs independent of his parents.

Smith

Smith was more forthcoming in his interview with ESPN.  Here are some excerpts that present his rationale:

"I'm not trying to be hurtful, but I'm not making this money so other people can live off it," Smith says. "You have to understand: This game doesn't last long at all."

HIs lawyer has a standard answer when questioned about Smith's financial responsibility to his family. "I am certain none of them ever took a hit for him," the attorney said. "None of them had to get a shot so they could get up and go to work. And they're not entitled to share in this. No matter what they did, they're not taking the risk."

That risk, short- and long-term, is significant. In his fourth year as a pro, Smith has already had a career longer than the NFL average according to the NFL Players Association.

"I know the amount of money I make in the NFL could be over any day," Smith said. "It has to be put aside for me later down the line or for when I have a family."

Smith repeatedly uses the word "work" to describe what he does. He suits up for the Cowboys not because he loves football necessarily, loves slamming into another massive body as a way of making a living. It's exactly what Smith says it is -- work -- and he speculates that half the players in any NFL locker room would walk away from the game if they were offered the same pay to do something else.

When he finishes playing, Smith wants to travel the country telling top college players --prospective fellow members of "the 1%" -- that it's OK to stand up to the pressures from family and friends. "It's so personal, and nobody really talks about it," Smith says. "'Hey, this sibling or family member is screwing me over.' You won't hear that, but it's a real issue. I'm not trying to bash my family at all, but it's hard to talk about this without doing that. And a lot of people aren't willing to tell their story."  He wants them to take control of their money and understand how long it has to last.  "It's OK to say no."

b.         Justifying the Other Family Members' Perspective

The athletes' family members did not give interviews in connection with the ESPN or Philly.com stories.  So I have tried to imagine how they would justify their perspectives.

The parents' argument is relatively easy to imagine:

(1) your success, athlete-son, is due in large part to genetic factors, and those genes come from us;

(2) a contributing factor in your success is the environment in which you were raised, and we were responsible for that; and

(3) we devoted countless hours to raising you and were never compensated for them; while we would not impoverish any of our children to obtain compensation for those services, you make enough money that we can demand compensation for our services from you without depriving you of a decent life.

The siblings' justifications are a little harder to see, but here I will draw upon some of the arguments that are offered up by proponents of redistribution in society as a whole and put those arguments in a family context: 

Athlete-brother, that you are so wildly successful, and we are merely middle class, is a stroke of luck and therefore it's not something you have a moral claim to.  We all grew up in the same environment, We all came from the same genetic stock.  It's just that, in the luck of the sperm-and-egg roulette, you got a package of genes that made your body an extremely good fit for a job that people will pay a lot of money for, and we didn't. Sure, you work hard at your job, but we work hard at our job, too, and it is not within our control that people pay less for our skill set than the one nature endowed you with. 

An Imagined Reply by the Athletes

It's customary for there to be a reply brief in litigation so this is what the athletes might respond to their parents and siblings:

(1) No one is smart enough to know how much of my success is due to genes, environment, luck and my own agency.  You've simply chosen to assign it a weight that supports the outcome you want.  But there is no scientific basis for that argument or for any particular allocation.  Your claim of luck has no more foundation than my claim of agency.

(2) Biological determinism has been raised time and time again throughout the last two centuries and debunked. It has often been used to justify unequal status, by those with higher status, and often to justify lower status for blacks.  How ironic that you would offer it up to demean the success of a fellow African-American.

(3) It is true that my genes are a large part of who I am, as is true for each of us. To deny me the benefits of my body's composition is to deny me as a person. If there is no "me" separate from my genes, then there is no "me" to be judged separately from them either.   In other words, my moral claim to my genes is identical to my moral claim to be a person. You cannot reject one without rejecting the other.

(4) However weak you may say my moral claim to the benefits of my genes is, it is stronger than anyone else's moral claim to those benefits!  No one else possesses them.  If I wasn't playing my position as a pro, someone else would be and you would have no claim to their income.  Your claim to my income is as much the result of luck as you say my claim is.  Your sole basis for claiming to share in my income is the luck of being in the same family as me.  

(5) You are not suffering or wanting anything important.  Your own labors have been sufficient to give you a decent life irrespective of my contribution.  In addition, I have given you a good deal already, and a good deal of the expenses I have paid for were mere entertainment and luxuries, not entitled to any moral standing vis a vis my claim to the fruits of my labor.

(6) But for the way I have been treated by you, you would have been able to count on the savings I have been prudently been accumulating to backstop you against many of the vicissitudes of life. 

(7) My success has not deprived you of anything.  You are no worse off for my success. And as I have shared some of it with you voluntarily, you are better off.  The issue is one of control over the fruits of my labor.

(8)  Relying on transfers from my bank account has made you more dependent, and less productive and self-sufficient, not to mention leading you to make threats to me and my girlfriend, which are clearly beyond any social norms you might invoke.  The aggregate welfare of society would be enhanced if instead you tried harder to succeed.

(9) As for parenting, it is true that you were not compensated for the labor you expended for my benefit in raising me.  Neither were your parents compensated for raising you so I see no moral standing on your part. When I have children I will care for them without expecting reimbursement.  That is the norm of parenting -- it's you who are violating a norm, not me. I have honored you, as any good son should, and, but for the way you have treated me, would have expected to do so for the rest of our time together.  And let's face it, you would not be interviewed by Bryant Gumbel or the New York Times, nor would you able to treat your friends to expensive weekend trips to see me play, if not for my success.  I have given you gifts of considerable worth, and I feel it is enough for now. 

I am sure there are other arguments on both sides but these seem like enough for now.

Closing Observations

What makes these stories perfect parables about income inequality is that there are no complicating factors to obscure the question.  The athletes come from families that were at least working class, in the case of the Smiths, and probably upper middle class in the case of the Howards. So there are no fundamental needs going unmet in the lives of the athletes' family members.  There is no dependency on the athlete;  rather, money is being sought for parties, travel and high-end homes - discretionary expenditures, not basic needs. 

There were two involved parents / stepparents present in each of the athletes'  upbringing, in contrast with the father-who-left-the-kids, parent-in-prison or parent-on-drugs paradigms that recur frequently in stories about professional athletes overcoming adversity.  

In addition, the athletes appear to be living their own lives in a conservative, prudent, non-self-indulgent manner.  There are no accounts of six-figure bling buys, "making it rain" money at strip clubs, no posses, no portfolios of children being fathered with different women.  

And the athletes appear to have voluntarily made large expenditures and gifts to family members, to pay off debt for instance, separate from what the family members requested or extracted.

In short, until there arose a disparity in income and the consequences thereof within each family, there is no factor in any of these stories that might lead the reader to form a negative judgment about any particular participant in these twin morality plays.

And in the Howard story, we can find additional parallels to a larger society.  When his mom collects his salary and disburses it as she and the rest of the family see fit, that resembles very much the tax-and-transfer mechanism of progressive government.  His mom is not really his CFO, she is his IRS.  If the family were a republic, it might have voted the redistribution of Ryan's income and might also have the monopoly of force needed to enforce it -- legitimate correlates to the threats of violence that Smith's sisters allegedly made to him and his girlfriend --  and Ryan would not have been able to escape the regime to establish a different outcome for himself. 

As I was finishing this up, I came across a WaPo report of the latest redistribution proposal of the Democratic minority in Congress (hat tip Hot Air website).  They propose that the federal  government give money, through tax credits, to people making under $200,000 and increase the tax take, yet again, on the top "1%."  No justification is offered that people making under $200,000 in America are lacking basic necessities.  It is simply observed that they have not been getting richer to the same extent as the so-called top 1% have been.  To redress that lack of relative enrichment, the Democrats propose to shift, to an even greater extent, the cost of government onto the top 1% of the country than it already pays.  When they advocate that, they're just playing the role of Ryan Howard's mother, taking from Ryan and giving to the rest of the family.  I submit that it is difficult to react differently to this proposal than one has to the accounts I have just laid out of these two athletes and their families.