Macro Roundup

CBO Staff, "The Distribution of Household Income, 2016," Congressional Budget Office, July 9, 2019, https://www.cbo.gov/publication/55413

though you would like this chart

"...Taken together, private-equity funds of $10 billion or more posted 14.4% five-year annualized returns net of fees as of the end of last September, barely edging past the 14.1% return for the S&P 500, according to data from investment firm Cambridge Associates. Buyout funds’ relative performance doesn’t improve much over a longer time frame. Over a span of 12.75 years—the longest period for which Cambridge has sufficient data on megafunds—returns for these large funds was 10.2%, the same as the broader index, its data show. The reasons behind the trend are simple: Bigger funds generally have to find bigger targets to invest their money, which means they have fewer options. It tends to be more difficult to broadly implement new operating strategies at larger companies than at smaller ones. Megafunds, as a result, are often buying the market. The smaller the fund is, the less its returns tend to be tied to the broader market. U.S. funds of less than $350 million had a correlation of 0.38 with the S&P 500, compared with 0.62 for funds $10 billion or more, according to Cambridge...."

Private-Equity Firms Are Raising Bigger and Bigger Funds. They Often Don’t Deliver.

Blackstone Group LP is in the final stretch of raising what would be the largest private-equity fund ever. Big funds, however, don’t necessarily translate into big returns.

The private-equity giant has capped its latest fund at around $25 billion amid strong demand, according to people familiar with the matter. Collecting that would take the fund past the $24.6 billion record set by Apollo Global Management LLC in 2017. Others also are raising big funds: Advent International said earlier this month it had raised a $17.5 billion fund, and software-focused Vista Equity Partners is raising a $16 billion vehicle.

The rise of megafunds reflects the growing demand for private equity from large investors such as sovereign-wealth funds with hundreds of millions of dollars to put to work. With interest rates still persistently low, the industry’s historical reputation for 20%-plus returns, is appealing—even if it means paying higher fees and having money locked up for long periods.

The problem is that the largest funds haven’t always lived up to the hype. Taken together, private-equity funds of $10 billion or more posted 14.4% five-year annualized returns net of fees as of the end of last September, barely edging past the 14.1% return for the S&P 500, according to data from investment firm Cambridge Associates.

Buyout funds’ relative performance doesn’t improve much over a longer time frame. Over a span of 12.75 years—the longest period for which Cambridge has sufficient data on megafunds—returns for these large funds was 10.2%, the same as the broader index, its data show.

The reasons behind the trend are simple: Bigger funds generally have to find bigger targets to invest their money, which means they have fewer options. It tends to be more difficult to broadly implement new operating strategies at larger companies than at smaller ones. Megafunds, as a result, are often buying the market.

The smaller the fund is, the less its returns tend to be tied to the broader market. U.S. funds of less than $350 million had a correlation of 0.38 with the S&P 500, compared with 0.62 for funds $10 billion or more, according to Cambridge.

Megafund managers say their main periods of outperformance tend to come when the market is down—not in a decadelong bull market like the current one. Megafunds also provide one of the few places for large pension and sovereign-wealth funds to invest massive amounts of cash all at once. That offers them a way for them to get exposure to the growing slice of the market that isn’t traded on major exchanges.

“They are definitely serving a role in your portfolio, but it may not be the role you think they are serving,” said Andrea Auerbach, head of the global private-investments group at Cambridge, in an interview. “Size is the frenemy of performance.”

Investors piling into Blackstone’s latest fund can look at its past performance for an indication of where returns may be heading. Its 2011 fund, a $15 billion pool, posted annualized returns of 15.2% net of fees as of last September, public pension data show. That is less than 2 percentage points above the annualized total return for the S&P 500 with dividends reinvested over the same period.

Blackstone’s $18 billion fund raised in 2016 returned a net 22.9% through last September versus about 16% for the S&P 500 over the same period. Some pension funds still consider that fund too young for those results to be meaningful.

California Public Employees’ Retirement System, the largest U.S. public pension fund, which aims to commit between $10 billion and $13 billion a year to private equity, is exploring a new model for investing in it. Under the current plan, the pension fund would become the sole backer of at least two limited-liability companies. These companies would be overseen by outside managers, who would invest directly in companies on Calpers’s behalf. The fund would also continue its regular investments in private-equity funds.

Other institutions whose size allows them to be more nimble have opted to invest mostly with smaller managers. Alaska Permanent Fund Corp., which has about $60 billion under management and commits around $1.6 billion a year to private equity, targets funds in the range of $500 million to $1 billion. It aims to be one of the larger investors in these funds by writing checks of $50 million to $100 million, a position that also gives it access to more co-investment opportunities.

Steve Moseley, Alaska Permanent Fund’s head of alternative investments, said the strategy requires more legwork because he has to oversee more investments and more relationships with general partners. But the state fund’s private-equity investments have posted five-year annualized returns of 22.6% as of the end of last year.

“We discovered that by having more robust relationships with mid-sized and smaller we could deliver better returns,” Mr. Moseley said. “I don’t envy the folks who are managing the giant public pension funds.”

“…According to the IRS from a previous report on the dynamics of the Top 400 earners (updated here with 2014 data), “The data reveal a mostly changing group of taxpayers over time. In fact, there were 4,584 different taxpayers represented in total for the 23-year period between 1992 and 2014. Of these, fewer than 17% appear more than once and only 3% were represented in 10 or more years. Nearly three out of four taxpayers (71.2%) were in the Top 400 in only a single year.”…”

Mark Perry, "Q: How much turnover is there among the richest Americans? A: A lot according to IRS data," American Enterprise Institute, July 9, 2019, https://www.aei.org/carpe-diem/q-how-much-turnover-is-there-among-the-richest-americans/

Q: How much turnover is there among the richest Americans? A: A lot according to IRS data

Of the 9,200 total tax returns filed in the 23 years from 1992 to 2014 for the 400 highest earners in each year, there were 4,584 unique, individual taxpayers in the Top 400 over those 23 years, since some taxpayers were in the Top 400 group in more than one year. The new IRS data show that:

1. Of the group of 4,584 unique top earners from 1992-2014, there were 3,262 individual taxpayers who made it into the “Fortunate 400” only one time during the 23-year period. Those 3,262 one-timers represent 71.2% of the total 4,584 taxpayers (see chart above), and therefore only 1,322 taxpayers that make up the rest of that elite group (28.8% of the 4,584 total, or about one in four) were able to make it into the Top 400 in more than one year between 1992 and 2014.

2. Moreover, since 3,262 earners made it into the Top 400 only once (71.2%) and another 558 taxpayers (12.2%) made it into the top group twice between 1992 and 2014 (see table above), that means that 83.3% of the top earners made it into the “Fortunate 400” only once or twice (3,820 out of 4,584), and only 16.7% (764 taxpayers out of 4,584) were able to make it into the top group in more than 2 years out of 23 years.

3. There were only 138 taxpayers out of the 4,584 total taxpayers in the top earner group (3%) who were in the Top 400 in 10 or more years out of 23 (see table).

4. Why is there such a high turnover among the Top 400 and why are most taxpayers in that group for only a single year? Data in Table 1 of the IRS report provide an answer. The combined salaries and wages of the Top 400 in 2014 were about $5.6 billion, which represented only 4.4% of those taxpayers’ combined Adjusted Gross Income (AGI) of about $127 billion. But those top taxpayers as a group had about $76.8 billion in income from sales of capital assets in 2014, which was more than 60% of their combined AGI of $127 billion. So while the Top 400 are certainly high earners (average salary of about $14 million in 2014), what puts them into the Top 400 in a given year isn’t their high salaries, but rather their large gains from the sale of capital assets (average capital gain for the Top 400 taxpayers in 2014 was $192 million) - which are often one-time sales of appreciated stock, or one-time gains from selling a business, partnership, farm, or real estate.

5. Data from Table 1 also reveal that the Top 400 are a pretty generous group based on their reported charitable contributions. In 2014, the Top 400 combined gave nearly $14.5 billion to charity, at an average of more than $37 million per taxpayer. Even though that Top 400 group represented only about three one-thousandths of 1% of all 148.6 million taxpayers in 2014 (0.000269%), those 400 taxpayers accounted for nearly 7% of the $210 billion in total charitable contribution deductions in 2014.

According to the IRS from a previous report on the dynamics of the Top 400 earners (updated here with 2014 data), “The data reveal a mostly changing group of taxpayers over time. In fact, there were 4,584 different taxpayers represented in total for the 23-year period between 1992 and 2014. Of these, fewer than 17% appear more than once and only 3% were represented in 10 or more years. Nearly three out of four taxpayers (71.2%) were in the Top 400 in only a single year.”

MP: Whenever we hear commentary about the top or bottom income quintiles, or the top or bottom X% of Americans by income (or the Top 400 taxpayers), a common assumption is that those are static, closed, private clubs with very little dynamic turnover. That is, once you find yourself in a top or bottom quintile, or a certain income percentile, or the Top 400, you’ll likely stay there for decades or even for life. But economic reality is very different - people move up and down the income quintiles and percentile groups throughout their careers and lives. The top or bottom 1/5/10% by income, just like the top or bottom income quintiles, are never the same people from year to year, because there is constant, dynamic turnover as we move up and down the income categories.

It’s very likely that most of the members of the IRS’s Top 400 started in one of the lower-income quintiles early in their lives and careers, and advanced into the higher income quintile and eventually into the Top 400 as they become successful, and they may drop into a lower-income quintile later in life. As the new IRS data show, almost three out of every four members of the ever-changing “Fortunate 400” over the last 23 years were only “members” of that group for a single year, which reflects the dynamic nature of the US economy and the significant income mobility that exists for Americans — at all levels of income.

Note: The IRS discontinued the top 400 taxpayer data series after tax year 2014 and replaced it with data on taxpayers at the.001 percentile level, which in 2014 represented the top 1,396 returns. According to the IRS: “This is a more analytically useful tabulation compared to the top 400 tabulation in that it provides a longitudinally consistent data point relative to the entire percentile distribution. As the number of returns increases with the growth of the economy, the number of returns in the.001 percentile will increase proportionally as well thus allowing for a consistent high-income data series.”

This post (and title) was inspired by a report yesterday by Robert Bellafiore and Aida Vazquez-Soto at the Tax Foundation titled “How Much Turnover Is There Among the Richest Americans?” based on the same IRS data above for the Top 400 Taxpayers from 1992 to 2014. Here’s a big slice of that report:

Income inequality has been a prominent topic on the presidential campaign trail, leading to proposals for wealth taxes, higher marginal income tax rates, and other policies. As scholars and everyday taxpayers continue to debate this issue and the question of increasing taxes on the richest Americans, one observation to keep in mind is the high degree of turnover among the highest-income Americans.

Data from the Internal Revenue Service shows the frequency of those filing who make the top 400 individual income tax returns with the highest adjusted gross income from 1992 to 2014. Of the 4,584 people who made it into the top 400 at some point over that period, 3,262 qualified for only one year. In other words, 71.2% of those who were in the top 400 made it once and not again. Of that same overall group, 138 people did qualify for at least a decade.

These data illustrates another important point about how tax rates, or the share of the tax burden on an income group, have changed over time: We should not conclude without evidence that it is the same people in that income group the entire time. For example, it can be easy to look at data on the top 1 percent’s tax rates over time and assume that the same people belong to that group in every year. However, such data on its own often doesn’t tell us whether a given income group represents the same people year after year, experiences a complete turnover annually, or something in between.

When the data do provide information on the people in a given group, as is the case here, the results can be surprising. At least among the top 400 such filers, there is more turnover than many might think. Policymakers and taxpayers should keep this in mind and be careful not to jump to unjustified conclusions as they consider the many changes to our tax code being debated today.

"...Effects of the $15 Option on Employment and Income. According to CBO’s median estimate, under the $15 option, 1.3 million workers who would otherwise be employed would be jobless in an average week in 2025. (That would equal a 0.8 percent reduction in the number of employed workers.) CBO estimates that there is about a two-thirds chance that the change in employment would lie between about zero and a reduction of 3.7 million workers (see Table 1). In addition, in an average week in 2025, the $15 option would increase the wages of 17 million workers whose wages would otherwise be below $15 per hour, CBO estimates. The wages of many of the 10 million workers whose wages would be slightly above the new federal minimum would also increase..... The $15 option would affect family income in a variety of ways. In CBO’s estimation, it would: Boost workers’ earnings through higher wages, though some of those higher earnings would be offset by higher rates of joblessness; Reduce business income and raise prices as higher labor costs were absorbed by business owners and then passed on to consumers; and Reduce the nation’s output slightly through the reduction in employment and a corresponding decline in the nation’s stock of capital (such as buildings, machines, and technologies). On the basis of those effects and CBO’s estimate of the median effect on employment, the $15 option would reduce total real (inflation-adjusted) family income in 2025 by $9 billion, or 0.1 percent...."

Nabeel Alsalam, David Burk, William Carrington, and Justin Falk, "The Effects on Employment and Family Income of Increasing the Federal Minimum Wage," Congressional Budget Office, July 8, 2019, https://www.cbo.gov/publication/55410

Jared Bernstein, "More evidence-this time from CBO-that higher (even much higher) minimum wages largely do what they’re supposed to do,"On The Economy, July 8, 2019, http://jaredbernsteinblog.com/more-evidence-this-time-from-cbo-that-higher-even-much-higher-minimum-wages-largely-do-what-theyre-supposed-to-do/

".... Raising the federal minimum wage to $15 per hour by 2025 would lift the pay of 27.3 million workers—17 percent of the workforce—according to a new report from the Congressional Budget Office. It would raise the incomes of poor families by 5 percent and thus reduce the number of people in poverty by 1.3 million. Since these low-end gains would be partially financed out of profits, the increase in the wage floor would reduce inequality. CBO also estimates that “1.3 million workers who would otherwise be employed would be jobless in an average week in 2025.” Because economists’ estimates of the job-loss effects from minimum wage increase are so wide-ranging—some studies find little-to-no job loss impacts; other find more—CBO estimates that there’s a two-thirds chance that the actual change in employment is between 0 and -3.7 million. Interestingly, -1.3 million is not the midpoint between 0 and -3.7, suggesting the budget office gave a bit more weight to studies finding less evidence of job-loss effects.The simple, classical model—raise pay by mandate and everyone affected gets hurt—is clearly wrong, as the CBO report shows. Just how wrong is it is something we’ll continue to argue about.But in the meantime, policy makers who want to improve the living standards of low-wage workers, reduce poverty, and push back on inequality can rest assured that, as the budget office’s new report shows, the evidence is on their side. The benefits of the increase—even a significant increase like this one—far outweigh the costs....."

Bernstein on CBO report

"... CBO estimates thatthe ACA will reduce the total number of hours worked, on net, by about 1.5 percent to 2.0 percent during the period from 2017 to 2024, almost entirely because workers will choose to supply less labor—given the new taxes and other incentives they will face and the financial benefits some will receive. Because the largest declines in labor supply will probably occur among lower-wage workers, the reduction in aggregate compensation (wages, salaries, and fringe benefits) and the impact on the overall economy will be proportionally smaller than the reduction in hours worked. Specifically, CBO estimates that the ACA will cause a reduction of roughly 1 percent in aggregate labor compensation over the 2017-2024 period, compared with what it would have been otherwise. Although such effects are likely to continue after 2024 (the end of the current 10-year budget window), CBO has not estimated their magnitude or duration over a longer period. The reduction in CBO’s projections of hours worked represents a decline in the number of full-time-equivalent workers of about 2.0 million in 2017, rising to about 2.5 million in 2024.Although CBO projects that total employment (and compensation) will increase over the coming decade, that increase will be smaller than it would have been in the absence of the ACA. The decline in fulltime-equivalent employment stemming from the ACA will consist of some people not being employed at all and other people working fewer hours; however, CBO has not tried to quantify those two components of the overall effect. The estimated reduction stems almost entirely from a net decline in the amount of labor that workers choose to supply, rather than from a net drop in businesses’ demand for labor, so it will appear almost entirely as a reduction in labor force participation and in hours worked relative to what would have occurred otherwise rather than as an increase in unemployment (that is, more workers seeking but not finding jobs) or underemployment (such as part-time workers who would prefer to work more hours per week).

CBO Staff, "The Budget and Economic Outlook: 2014 to 2024," Congressional Budget Office, February 2014, http://www.cbo.gov/sites/default/files/cbofiles/attachments/45010-Outlook2014_Feb.pdf

CBO's 2014 tack on minimum wage employment elasticities

".....Once fully implemented in the second half of 2016, the $10.10 option would reduce total employment by about 500,000 workers, or 0.3 percent, CBO projects. As with any such estimates, however, the actual losses could be smaller or larger; in CBO’s assessment, there is about a two-thirds chance that the effect would be in the range between a very slight reduction in employment and a reduction in employment of 1.0 million workers... Elasticities for Directly Affected Teenagers......CBO calculated those conversion factors using CPS data from 1979 through 2009. The CPS data indicate that past increases in the minimum wage typically affected about a third of employed teenagers and were typically about 50 percent higher than the average of the wage changes necessary for compliance with the new minimum. Thus, elasticities for directly affected teenagers are about 4.5 times higher, CBO estimates, than the teen-employment elasticities with respect to the change in the applicable minimum wage discussed in the previous section.....Elasticities for Directly Affected Adults.....Much less research has been conducted on the responsiveness of adult employment to minimum-wage increases than on the responsiveness of teenage employment. Using the available information,CBO concluded that the elasticity for directly affected adults was about one-third of the elasticity for directly affected teenagers, and the agency applied that proportional adjustment to the central estimates and likely ranges of elasticities for teens discussed above. Some studies have found large elasticities for particular groups of adults, such as high school dropouts or African Americans in their 20s, but most of the adults who would be affected by the $9.00 and $10.10 options would not fall into those categories. A study that tracked directly affected adults regardless of their education, age, or race suggests that their employment is less sensitive to increases in the minimum wage than that of directly affected teenagers. One explanation for that lower degree of responsiveness is that employers facing an excess of workers or of job applicants tend to favor adults over teenagers. Supporting that explanation is research suggesting that encouraging employment among low-wage parents reduces employment among younger, childless adults...... How CBO Estimated the Total Effects of the Options on Employment.....CBO’s central estimates that the $10.10 and $9.00 options would reduce employment by roughly 500,000 and 100,000 workers, respectively, were based on four main factors. Two were discussed above: the number of low-wage workers directly affected by the options and the responsiveness of the employment of low-wage workers to increases in minimum wages. The remaining two factors were the change in the wages of directly affected workers and the increase in demand for goods and services caused by each option. To calculate the total effect on employment, CBO multiplied estimates of the first three factors together for teenagers; did the same for adults; added the results; and then added an amount to account for the fourth factor. To reflect the considerable uncertainty in estimating the total employment effect, CBO also reported a range within which, in the agency’s assessment, there was about a two-thirds chance that the actual effect would lie...."

CBO Staff, "The Effects of a Minimum-Wage Increase on Employment and Family Income," Congressional Budget Office, February 2014, https://www.cbo.gov/sites/default/files/113th-congress-2013-2014/reports/44995-MinimumWage_OneColumn.pdf