Putting the magnifying glass on the one percent

By Chrystia Freeland
February 8, 2013

Academics can be dismissive of the concerns of the popular media. But when it comes to the growth of the super-rich, the tabloids may have gotten it right.

The numbers tell the story. According to a study by John Van Reenen of the London School of Economics and Brian Bell of Oxford University, the share of national income earned by the top 1 percent in the United States surged to 18.3 percent in 2007, from 8 percent in 1979. In Britain, the trend was almost identical: The top 1 percent received 15.4 percent of the national income in 2007 compared with 5.9 percent in 1979. And these figures exclude capital gains.

“A lot of the action has been at the very top end of the distribution, the top 1 percent or the top 0.1 percent,” Van Reenen, director of the Center for Economic Performance at the LSE, told me. “It shows you that the media’s focus on the very rich and on bankers’ bonuses wasn’t misplaced.”

But while much of the shift in income distribution has been at the apex of the pyramid, that is not where most academic research on rising income inequality has been focused. If anything, Van Reenen said, academics “have tended to focus on the bottom of the distribution, much more than the top.”

Van Reenen and some like-minded colleagues have been working to fill that gap. Their efforts made it to the economic major leagues in January when Van Reenen convened a panel discussion on extreme wage inequality at the prestigious annual get-together of the American Economic Association.

One of the most striking findings will probably give comfort to the plutocrats: In contrast to previous generations, the super-rich today tend to have earned their fortunes rather than inherited them.

Steven Kaplan of the University of Chicago and Joshua Rauh of Stanford University in California studied Forbes magazine’s annual list of the 400 richest Americans. They found that in 1982 just 40 percent of these plutocrats had built their own businesses. By 2011, the super-rich had gotten much richer — the combined wealth of the Forbes 400 was $92 billion in 1982 and had surged to $1.53 trillion by 2011 — and many more of them had, as the meme of the 2012 U.S. presidential election campaign had it, built it themselves: 69 percent.

“This isn’t the ‘Downton Abbey’ rentier class,” explained Van Reenen, who has found a similar trend in Britain. “These incomes come from the labor market. You can say it is a triumph of the human capitalists over the physical capitalists.”

Among economists who study the surge in pay at the top, it is pretty much a truth universally acknowledged that taxes should rise at the summit, too. “Economics would suggest that when you have big increases in inequality, the top tax rate should rise,” Van Reenen said. “That seems very right and very reasonable.”

The impact and the structure of higher taxes for the rich are a more complicated and controversial issue. Timothy Besley and Maitreesh Ghatak, both of the London School of Economics, make a robust case for higher taxes on bankers’ bonuses. Their work is theoretical, but beyond the campus green what may be particularly interesting is the way they frame the wider debate.

“Little undermines the case for a market economy more than the perception that there is injustice in the rewards that it generates,” they argue in a recent paper. “The greatest clamor for reform should come from those who support the market system.”

“We have shown that some form of bonus taxation in the financial sector is optimal above and beyond standard progressive income taxation,” they conclude. “We have identified a form of taxation that we believe makes the market system both fairer and more efficient.”

This robustly pro-market rationale for higher taxes on bankers, who like to think of themselves as the very embodiment of capitalism, is eye-catching, particularly for anyone who spends much time in the United States where higher taxes and more efficient markets are usually portrayed as being anathema to one another.

Emmanuel Saez, an economist at the University of California, Berkeley, who is one of the pioneering students of incomes at the very top, has offered an even more provocative suggestion. At the American Economic Association meeting, he argued that when tax rates at the top are low, “top earners extract more pay at the expense of the 99 percent.” Higher tax rates for the rich, he suggested, “reduce the pretax income gap without hurting economic growth.”

This is a truly radical idea: that higher taxes at the top can reduce pretax inequality and not weaken the economy as a whole.

Outside the seminar room, however, these elegant ideas may run into political opposition intensified by the trends within the 1 percent that these same economists have documented.

“It may have a political effect,” Van Reenen said of the shift from inherited fortunes to self-made ones. “You feel you’ve earned it. This does make people more strongly inclined to resist taxation.”

3 comments

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While Ms Freeland’s comments on the super rich are indeed interesting, like the Plutocrats, the key component regarding “why” this is happening is largely missing in her writings.

The world’s economy is increasingly become more “monopolized” and is a part of the process of globalization. It spells a danger for capitalism because it will be the challenge of this century to try and deal with it before “the 99 percent” explode in anger over this unjustified distribution of income and resulting wealth.

Some might say that envy is the mirror of greed but I think not.

Cheers

Posted by sandystone | Report as abusive

I rather liked the Venetian term you used La Serrata, or “The Closure,” in one of your New York Times articles to describe the increasing polarization between the Plutocracy and the Middle Class. “The Closure” seems to me a very apt term to describe the never ending task for human beings to discover balance between selfishness and selflessness being further “closed off” by an inadequate democracy that doesn’t prevent this plutocratic polarization. Clearly Nature is based upon seeking balance and it is now clearly in the process of seeking to destroy “The Closure.”

Posted by IfAtFirst | Report as abusive

History is littered with the heads of kings and the wealthy elite too greedy and arrogant to see the inequality and suffering of the proletariate.

Posted by Dj301 | Report as abusive