“How the ultra-rich get even richer”

June 10, 2010 · by wciecon · in Inequality, Stephen Gordon · 31 Comments

That's the title of my latest column on high-income concentration at Canadian Business.

Notwithstanding the title, the article's main point is that we don't know how it's happening.

31 comments

Erin Weir · June 10, 2010 - 6:19 pm · Reply→

A few thoughts on an interesting column:
– While Mike Veall’s data are extremely useful, massive gains by the richest 1% (or fractions thereof) are hardly a new revelation. The extreme concentration of income and wealth at the very top should have put the lie to “skill-biased technical change” stories a long time ago.
– Although it is important to “come up with a better theory,” we should not allow the absence of a perfect theory to prevent us from advocating redistributive policies.
– We know, for example, that asset ownership is concentrated at the very top. Taxing the full (inflation-adjusted) value of capital gains would help reduce inequality.
– You note that the super-rich may have the bargaining power to raise their pre-tax incomes enough to cover any tax increase. But aren’t they already using their bargaining power to maximize their incomes? If so, higher taxes would reduce their incomes. If not, you need a theory of why the super-rich are leaving dollar bills on the sidewalk by not fully exercising their bargaining power (until taxes increase).
– Neoclassical economics promotes all manner of inequitable policies (e.g. no minimum wage) on efficiency grounds since we can remedy inequalities later with taxes and transfers. If we cannot tax the rich after all, then perhaps we should be less acceptant of pre-tax inequality.
Mike Moffatt · June 10, 2010 - 6:30 pm · Reply→

“If we cannot tax the rich after all”
How do you come to this conclusion? Even if we can’t use income taxes (which is debatable), there are certainly other policies, such as increased use of property taxes. For instance, we might want to start to look at the fact that property tax rates (as a percentage of income) are twice as high in London as they are in rich Toronto suburbs such as Rosedale.
Mike Moffatt · June 10, 2010 - 6:33 pm · Reply→

That should be: (as a percentage of property value).
Mike Moffatt · June 10, 2010 - 6:35 pm · Reply→

Source: http://ontariofairpropertytaxes.com/category/news/page/2/
Stephen Gordon · June 10, 2010 - 6:46 pm · Reply→

Erin – did you see this post? You don’t need perfectly inelastic demand for high-income earners in order to get the incidence story to work. The share of the tax burden that sticks to the top end may not be zero, but it would be very small.
I’d be more keen on pursuing the last point, and looking at the mechanics of just how someone signs off on a 7-figure salary (eta: or on doubling the bonus pool in the face of a surtax). Corporate governance issues are definitely something to look at.
Matt · June 10, 2010 - 7:37 pm · Reply→

I know that the plural of anecdote is not data, so I offer this with caution. I know many people who’s income is north of $250,000 a year. They’re earnings come either from business ownership or from a highly paid profession. Those who earn a regular paycheque are either lawyers or bankers. The rest own a business, or have sold a business for a substantial sum.
Is it possible that occupations that have always been highly rewarding are simply becoming more highly rewarded?
Stephen Gordon · June 10, 2010 - 7:45 pm · Reply→

Perhaps, but why?
J. Powers · June 10, 2010 - 7:50 pm · Reply→

Um, any title that requires a “notwithstanding” caveat is a terrible title. Shouldn’t a good title communicate what’s actually going to be covered in the column? Is this a good reason not to trust the editors of Canadian Business, who apparently have no issue using misleading titles to trap me into reading what I don’t want to read?
Jim Rootham · June 10, 2010 - 8:20 pm · Reply→

The first thing to do to figure this out is to identify the source of the income.
Are these corporate types? In which case John Kenneth Galbraith came up with the theory many years ago (they are capturing returns which should go to shareholders).
Are they workers whose work scales (the same work can supply many people), like entertainers and sports players? Software is in this category too. Things that scale lead to winner take all markets.
Stephen Gordon · June 10, 2010 - 8:57 pm · Reply→

Yep. This is very much an ongoing research agenda. And the story you’d tell for one group – and hence the policy remedy – is different from another.
Erin Weir · June 10, 2010 - 9:06 pm · Reply→

Mike: “How do you come to this conclusion?”
I don’t. I advocate taxing the rich more. But Stephen is suggesting that taxes on very high incomes could be shifted onto other segments of society.
Matt makes an important point that many of the rich are small-business owners or professionals who can incorporate their practices. Therefore, we should oppose further cuts to “small business” corporate tax rates.
Stephen Gordon · June 10, 2010 - 9:12 pm · Reply→

But that’s not how they’re becoming rich; look through Mike Veall’s data files I posted earlier. It’s all happening with earned income. The self-employed have dropped out of the ranks of the super-rich.
Stephen Gordon · June 10, 2010 - 9:22 pm · Reply→

Actually, the trend is more visible in the data for the AER paper. There’s a link to the data file in the 2007 post.
Determinant · June 10, 2010 - 11:17 pm · Reply→

At risk of piercing the confidentiality veil, we need more data.
Does the income of the super-rich come from their business interests? That is, is it from a corporation in which they have a significant or controlling interest? This is still fully consistent with “earned income” reporting. Remuneration may be taken in the form of a wage or other personal compensation rather than dividends. It all depends on how advantageous this is so an individual’s tax situation. Furthermore, such an arrangement doesn’t have to be shared if there are other shareholders, so this can easily turn into a corporate governance issue.
Accountants make this sort of analysis for the rich all the time. It’s what they do.
If these truly are employed persons without an interest in their employer, then we need to consider the nature of the work that they do. Is it of value? If it isn’t and we believe that the income concentration effect is of more concern than the value of their contributions to society, then we need to consider a double assault both on their received incomes, and the corporate earnings of the corporations than employ them. Perhaps incomes over a certain threshold could no longer be deducted as an expense for income tax purposes. That would certainly change the minds of those who make the compensation decisions.
Jon · June 11, 2010 - 12:01 am · Reply→

Compound interest
Inflation of domestically produced goods, leading to wage premiums in closed markets, e.g., doctors and lawyers must be locally licensed
Chinese mercantilism
Jim Rootham · June 11, 2010 - 12:26 am · Reply→

There is another point to this. Current evidence (Goldman Sachs et all) that having very high income earners is not a net social benefit. If we set high marginal rates and thereby discourage people from becoming investment bankers instead of what they are personally interested in we wind up with a socially useful result.
Jon · June 11, 2010 - 2:09 am · Reply→

Current evidence (Goldman Sachs et all) that having very high income earners is not a net social benefit.

Which evidence is that?
Andrew F · June 11, 2010 - 9:00 am · Reply→

It boggles the mind that people think investment banking has no social utility whatsoever.
Yvan St-Pierre · June 11, 2010 - 10:50 am · Reply→

I’d just like to make 2 brief points and then ask a question. First, I don’t find the moral case against income inequality over the full income distribution to be particularly convincing. I’m a lot more concerned about the ratio of lower percentiles to the median than about whatever goes on at the top end of the distribution. This could be related to my second point, though, and that’s is my own theory of what’s going on, for lack of a better one, which is that preference for being ultra-rich is simply a rare pathology requiring sacrifices no sane person would accept – a twisted sort of “natural” monopoly, in effect.
Oh, and my question, Stephen, is what is so damaging for democracy with this state of things? The ultra-rich is a pretty popular focus of public discussions, right? So at least we’re having some of those, as opposed to the sort of generalized navel-gazing that Tocqueville feared. Maybe I’m just being facetious here, but I’m not sure what would be improved by these people earning less money than they do (except maybe their own well-being).
Andrew F · June 11, 2010 - 2:09 pm · Reply→

“I’m a lot more concerned about the ratio of lower percentiles to the median than about whatever goes on at the top end of the distribution. ”
Think about N Korea or Myanmar. Very little income inequality between the bottom decile and the median. They’re all very, very poor.
Yvan St-Pierre · June 11, 2010 - 2:19 pm · Reply→

Andrew,
My point was that my moral concern for equality applied to the bottom part of the distribution as opposed to the top part, not as opposed to a moral concern for efficiency.
Patrick · June 11, 2010 - 3:02 pm · Reply→

“Corporate governance issues are definitely something to look at.”
Yeah. How in the world is it that owners aren’t demanding their money be paid to them?
“It boggles the mind that people think investment banking has no social utility whatsoever.”
I wouldn’t go so far as to say no social utility. But the cost of finance/banking is in some sense a tax; it’s money that is diverted away from productive use. Yes, finance/banking a vital service but it’s a means to an end, and if it fails to deliver or becomes too expensive, that’s a problem.
beezer · June 11, 2010 - 3:02 pm · Reply→

I didn’t read the article so forgive me if you already covered this.
There’s a theory that after a period of strong capital investment there can be a “lull” where the existing capital continues to churn out nice amounts of profits, more and more of which end up at the top of the wealth pyramid because there’s no need to continue capital investment, to hire more labor, or to increase labor wages.
Hence a growing income gap. Something like this happened in the 1920s where a growing income disparity preceeded the Great Depression. Don’t know if it had anything to do with causing the Depression, just that it preceeded the Depression.
This time around, the capital investment may have been made outside the US, but might be having the same result with US incomes.
At any rate, no matter what is causing the growing disparity this time around, the policy response should include the main one of fiat income redistribution via steeply progressive taxes on income/wealth.
Andrew F · June 11, 2010 - 3:57 pm · Reply→

Another question: is concentration of income really a problem if the rich are just saving it? I think I’d be more concerned with concentration of consumption.
Yves: I agree that I don’t get particularly upset by income concentration at the top. My only concern perhaps is that if they wealth were spread more evenly, it could raise quality of life for those at the bottom. I guess it’s not clear to me that the second is the counterfactual of the first. Clipping the tall daisies is of no obvious use to me.
Yvan St-Pierre · June 11, 2010 - 4:48 pm · Reply→

Andrew: “if the wealth was spread more evenly, it could raise quality of life at the bottom” – isn’t this close to being a tautology, assuming more wealth at the bottom implies higher QoL? Yet I think we actually agree that it’s a pretty darn big “if” in the first place – can a fixed amount of wealth be spread more evenly, or will the spreading itself just decrease the total amount, and plausibly have a negative effect at the lower end?
I would also suggest, as an entirely different point, that QoL probably depends a lot more on social norms defined by reference to some average schmo, than on the actual amount of material wealth, and certainly not by comparison to the lifestyles of the rich and famous, which most sane people I know do not really want to emulate. I think a pretty good case can be made that most people, including those at the bottom, want a worthwhile existence, not an extravagant one. Again, what I’m questioning is the moral value of equality across the board, not so much the possibility of implementing it, nor the benefit of something that may or may not be consequent to it, i.e. making people at the bottom better off.
Jim Rootham · June 11, 2010 - 5:12 pm · Reply→

Let’s see now. We have just been through a period where the activities of investment banks caused an economic shock greater than what triggered the Great Depression. I can’t really imagine the logic that says that was a net social benefit.
On a slightly larger time scale, if you look at what actually happens inside corporations you will find that the leveraged buy outs and other merchant banking activities damage the productive capacity of those organizations. I’d be hard pressed to identify logic that says that’s a net social benefit.
Andrew F · June 11, 2010 - 5:13 pm · Reply→

Less concentration at the top doesn’t mean there is a transfer of wealth to the bottom, necessarily. It could go to the middle class or even to the 80th percentile and still count as a significant reduction in concentration in the top 1% or 0.1%. That is leaving aside the possibility that attempts to spread the wealth end up shrinking the pie.
pointbite · June 11, 2010 - 11:11 pm · Reply→

My guess – The rich know how to avoid taxes. That small competitive advantage simply compounds year after year.
David · June 12, 2010 - 12:44 pm · Reply→

Couldn’t it just be simple supply-demand economics? If this is happening through earned income, perhaps the following three conditions are true:
1. The “ultra-rich” tend to be older, experienced workers who provide excellent leadership to their companies.
2. The demand for their leadership is quite inelastic, since it has a very big effect on the success of a firm. Putting someone in charge who is not experienced or does not provide strong leadership could turn a successful firm into a highly unsuccessful one.
3. The supply of such leadership is dwindling due to population aging. The experienced workers who provide excellent leadership are dying or retiring faster than they are being replaced.
Without an intimate knowledge of the subject, it seems to me the above three conditions are plausible, and if true, would result in what Mike Veall’s data shows.
Alex · June 14, 2010 - 12:32 am · Reply→

I agree with pointbite, the rich know how to avoid taxes. Or, more specifically, they have more marginal benefit as well as the resources to do so. Given time, it compounds. Our tax system is supposed to be progressive, but I wonder if there are studies that show how progressive it really is, or how that study would be structured.
Greg · June 14, 2010 - 3:40 pm · Reply→

Maybe the system is rigged. Maybe the ultra-rich are the big casino, and the rest of us are playing against the house.