Income Inequality IX

Tyler Cowen has a piece at The American Interest on income inequality that’s worth reading. Here’s the snippet that jumped out at me:

The use of micro-data now makes it possible to trace some high earners by income and thus construct a partial picture of what is going on among the upper echelons of the distribution. Steven N. Kaplan and Joshua Rauh have recently provided a detailed estimation of particular American incomes.6 Their data do not comprise the entire U.S. population, but from partial financial records they find a very strong role for the financial sector in driving the trend toward income concentration at the top. For instance, for 2004, nonfinancial executives of publicly traded companies accounted for less than 6 percent of the top 0.01 percent income bracket. In that same year, the top 25 hedge fund managers combined appear to have earned more than all of the CEOs from the entire S&P 500. The number of Wall Street investors earning more than $100 million a year was nine times higher than the public company executives earning that amount. The authors also relate that they shared their estimates with a former U.S. Secretary of the Treasury, one who also has a Wall Street background. He thought their estimates of earnings in the financial sector were, if anything, understated.

Many of the other high earners are also connected to finance. After Wall Street, Kaplan and Rauh identify the legal sector as a contributor to the growing spread in earnings at the top. Yet many high-earning lawyers are doing financial deals, so a lot of the income generated through legal activity is rooted in finance. Other lawyers are defending corporations against lawsuits, filing lawsuits or helping corporations deal with complex regulations. The returns to these activities are an artifact of the growing complexity of the law and government growth rather than a tale of markets per se. Finance aside, there isn’t much of a story of market failure here, even if we don’t find the results aesthetically appealing.

And, of course, over the period of the last two years we’ve been subsidizing the financial sector with all our mights.

The entire article is worth reading but be aware that Tyler does a bit of bait and switch. While his characterization of the problems posed by rising inequality highlights the top 1% of income earners:

The numbers are clear: Income inequality has been rising in the United States, especially at the very top. The data show a big difference between two quite separate issues, namely income growth at the very top of the distribution and greater inequality throughout the distribution. The first trend is much more pronounced than the second, although the two are often confused.

When it comes to the first trend, the share of pre-tax income earned by the richest 1 percent of earners has increased from about 8 percent in 1974 to more than 18 percent in 2007. Furthermore, the richest 0.01 percent (the 15,000 or so richest families) had a share of less than 1 percent in 1974 but more than 6 percent of national income in 2007.

his analysis is primarily of the top .01%. As I’ve documented here before, honing in on the top .01% is taking your eye off the ball. The next .99% of income earners pose as much of a threat to an equal society as that top .01% does and there are a heckuva lot of rent-seekers in that next .99%.

20 comments… add one
  • john personna Link

    Only tangentially related, but up your alley, Dave:

    http://www.futurepundit.com/archives/007742.html

  • I am reminded of a snippet from one of Thomas Jefferson’s letters regarding the banking crisis in 1814:

    “It is cruel that such revolutions in private fortunes should be at the mercy of avaricious adventurers, who, instead of employing their capital, if any they have, in manufactures, commerce, and other useful pursuits, make it an instrument to burden all the interchanges of property with their swindling profits, profits which are the price of no useful industry of theirs.”

  • The next .99% of income earners pose as much of a threat to an equal society as that top .01% does and there are a heckuva lot of rent-seekers in that next .99%.

    So which is the problem, the rentseekers or the inequality of wealth? I can see the negative effects for society that arise from wealth that is generated from rentseeking – this is a classic misallocation problem. I don’t see the problems from wealth that is generated by creating value in some novel way, that absent the innovation, creativity or productivity, of the person who has accumulated the wealth would see society with less aggregate wealth.

  • So which is the problem, the rentseekers or the inequality of wealth?

    Both to different degrees. I’m more concerned about the rent-seeking but other people seem to be more concerned about the inequality as such.

  • steve Link

    At some point, I dont know where, absolute inequality is a problem. It means that a tiny pat of the population makes the economic decisions, controls the media and runs our politics.

    “The next .99% of income earners pose as much of a threat to an equal society as that top .01% does and there are a heckuva lot of rent-seekers in that next .99%.”

    I disagree. That next 0.99% have little influence unless they combine into groups. That top 0.01% are forces unto themselves. If just a few of them make bad economic decisions, it is harmful for everyone.

    In general, I think Cowen here shows us that the growth in inequality came mostly in the financial sector. Money was mostly made by making bets on bets. Money was made by lawyers setting up these same deals or picking up the pieces later. These were not job creating. If we had increased inequality because some people created new businesses, made new innovations and we ended up with new jobs, this would not be as much of an issue.

    Steve

  • Drew Link

    Oh, please Alex. Spare us. That quotation dealt not with what would become the workings of modern capital markets, and their attendant compensation structures, but with his hatred of a central bank (and Hamilton, and central bank’s inflationary tendencies) and the view that the Rothchilds intended to enslave the US, among others.

    You might as well admonish us to “get a horse.”

  • If we had increased inequality because some people created new businesses, made new innovations and we ended up with new jobs, this would not be as much of an issue.

    How high are the barriers to entry in the money management game? Pass some finance industry exams and be properly capitalized and you can enter into the field. The field is quite results driven so I’m not sure what we can, and should, do about some people out-competing others in the game of putting together and managing investment pools. If the owners of the capital being managed don’t like the terms of the deal they have no restriction on their ability to pull their funds and turn them over to another manager, one who will charge lower fees.

    If someone wants to convince me that inequality in the finance sector is driven mostly by rentseeking then I’d like some evidence in support of that claim. If these finance guys are fleecing the capital owners in freely transacted dealings, where the capital owners have the freedom to find new money managers, then I don’t see why this is any of our business to regulate. Note that I’m talking of arrangements which don’t require federal bail-outs. If these money managers are actually creating better returns, then how exactly is society better by restricting their income and promoting investment allocation decision which yield suboptimal results?

  • Drew Link

    I suppose I have a soft spot for the problem of income inequality, but I’ll be damned if I know what to do about it. Dave’s point is as close as I can come: don’t subsidize industries where it is occuring. But that’s it. Period, full stop.

    But think about it: this isn’t a business issue only. I just read that a .198 hitting baseball player is going to get paid $10MM a year. Kanye West sings crap……….but gets paid what a year? Numerous TV and movie actors make the most vapid and inane “entertainment”………and get paid a fortune. That’s income inequality as well.

    But what to do? Just because my, or your, value judgments are different, do we take away private property based upon those relative judgments? Not in a free society.

    Owners pay dud ballplayers. Fans fork over their hard earned money to see them. People crowd the theatres and advertisers pay the money to fund the salaries of cretans like Charlie Sheen. So be it. I don’t like it. But in a free society its not my decision to make. So let’s not selectively castigate businessmen. Those who do are just showing their own brand of greed and envy. And it shows when they fail to include all manner of “inequality” examples.

  • Drew Link

    Tangoman –

    “How high are the barriers to entry in the money management game? Pass some finance industry exams and be properly capitalized and you can enter into the field.”

    You have no idea how naive that statement is. However, after that your post is spot on. This is is a private, arm’s lenght transaction between LP’s and GP’s, as long as nobody asks to get bailed out.

  • Drew,

    I don’t doubt that some financial services are valuable, but after having devoted quite a bit of study to the industry I’m hard-pressed to understand how the bulk of the industry, as presently situated, is producing real economic value in proportion to its share of the economy.

    Owners pay dud ballplayers. Fans fork over their hard earned money to see them.

    In stadiums funded by local governments often located on property that isn’t taxed in order to entice the team to come there. And the owners are, of course, in an industry that is one of the few legal monopolies…

    People crowd the theatres

    … to see movies filmed in places where governments grant sweetheart tax deals or sometimes outright subsidies.

    advertisers pay the money to

    …owners of TV stations and cable companies, who are often the beneficiaries of limited monopolies (over the airwaves or local cable system) or, if not part of a monopoly, an artificially created (by government operation) limited cabal of 2 or 3 companies.

  • Alex has already given the responses I would have to your examples, Drew. Both professional athletics and the music industry are examples of rent-seeking on steroids (literally and figuratively, I suppose).

    The horizontal monopolies in the music biz are particularly egregious. IMO they should be broken up.

    What would the salaries in professional athletics or music be without the rent-seeking? Who knows?

  • sam Link

    I’ll cross comment from what I said at OTB (and clean it up a bit).

    For me, the interesting part was this:

    [L]arge numbers of Americans oppose the idea of an estate tax even though the current form of the tax, slated to return in 2011, is very unlikely to affect them or their estates. In narrowly self-interested terms, that view may be irrational, but most Americans are unwilling to frame national issues in terms of rich versus poor. There’s a great deal of hostility toward various government bailouts, but the idea of “undeserving” recipients is the key factor in those feelings. Resentment against Wall Street gamesters hasn’t spilled over much into resentment against the wealthy more generally. The bailout for General Motors’ labor unions wasn’t so popular either—again, obviously not because of any bias against the wealthy but because a basic sense of fairness was violated.

    It’s a basically Rawlsian point. Most of us do not think the income distribution is unfair because we don’t have the sense that the really (really, really) wealthy are getting even more wealthy at our expense. We would think it unfair if it were shown that increasing wealth at the top is leading to increasing impoverishment of those below in the income distribution, especially at lower end. But, as I said, we don’t have that sense. (This is partly because of our progressive taxation system and social safety net.) This, I think, accounts for the near-universal almost-hatred of the Wall Street “gamesters”. Given events of the last few years, most of us think those folks did in fact get wealthier at our expense, and this sense of unfairness was heightened by the financial bailouts. Our sense of fairness is profoundly implicated when we make economic, political, or social judgments.

  • PD Shaw Link

    sam, I have no problem with the estate tax, I’m not at all sure why my countrymen feel differently. The notion that double-taxation is unfair runs aground against the corporate tax. I think there is some sense that one is an elite tax and the other is against family business.

  • sam Link

    “sam, I have no problem with the estate tax, I’m not at all sure why my countrymen feel differently.”

    PD, Tyler says most–well, “large numbers of” — Americans don’t have a problem with the estate tax (I know I don’t):

    “[L]arge numbers of Americans oppose the idea of an estate tax even though the current form of the tax, slated to return in 2011, is very unlikely to affect them or their estates.”

  • sam Link

    Sorry, PD, I completely botched that reply. I meant to agree with you about the feelings folks have about the estate tax as being against a family business. And I meant to say that large numbers of Americans don’t have a problem with estates not being taxed. I don’t really have a problem with that, either.

    Sorry for cocked-up first reply, hope this one is clearer.

  • It’s a basically Rawlsian point. Most of us do not think the income distribution is unfair because we don’t have the sense that the really (really, really) wealthy are getting even more wealthy at our expense. We would think it unfair if it were shown that increasing wealth at the top is leading to increasing impoverishment of those below in the income distribution, especially at lower end. But, as I said, we don’t have that sense.

    Probably because it is a highly dubious claim. There are lots of people working on inequality and I’ve yet to see the above claim being put forward seriously…and I’ve looked. A few years ago Kevin Drum got on this “inequality is toxic” kick. I kept asking, “Why?” Of course, Drum didn’t really respond so I went looking. I found articles that pointed to inequality as being both good or bad indicating to me that the matter was far from settled and the “bad” articles focused on how inequality reduced overall economic growth not that the rich were getting richer at the expense of the non-rich.

    So the above would be great…if you had evidence. Now that being said….

    The best reason I can see for income inequality being a problem is that we live in a democracy where our government has very strong discretionary powers. Couple that with rent seeking and you can have a situation where corporate interests are being served more than those of the individual. I think we are seeing that shift right now. We have instituted a formal bailout process that not only fails to address the issue of moral hazard, but will make it the law of the land to increase moral hazard when it comes to the financial sector. We’ve had the government take money that was to be used for one purpose and spend it on completely different goals (propping up the automotive industry). Now we have the government becoming even more entrenched and extended in the health care industry…i.e. making that situation worse not better in terms of controlling costs.

    Is there large scale looting going on? Yeah, I’d say there is. And it is being done by Republicans and Democrats at the behest of various corporate interests.

    Case in point.

    Quite a bit of other evidence can be brought out too. For example, some of the richest counties in the country are…in Northern Virginia…i.e. the homes of many lobbyists in DC. Take a look at where the Secretary of Treasury usually comes from? Look at guys like Rahm Emanuel or Larry Summers to pick the guys currently with access to the President’s ear. I’m sure if we started looking around at where former Bush administration officials went it wouldn’t be much better.

    And to be clear for the partisans here, this isn’t a Democrat or Republican issue, it is a problem with the way our government has evolved. It allows for too much intervention via discretion…i.e. not grounded in any rules.

    For example, the current financial “reform” states that creditors of any business that is in trouble will have to take some losses, but those losses are not clearly delineated. The intent is to keep creditors from taking undue risks. Problem is that when the time comes the government may very well decide that not imposing losses on the creditors is the better course. Once that happens, then any incentives not to take undue risks will be completely removed and no more worries about risk, the newly enacted legislation will make sure you get your money back at the very least, and if that risk pays off you’ll have even more money. Heads I win, tails you lose.

  • Drew Link

    Alex and Dave –

    Perhaps I wasn’t clear. I have no appetite, or sympathy, for public subsidies of sports franchises, stadiums (or NPR or the Opera House) etc – or for monopoly grants. (If you haven’t gleened that worldview from my posting history I don’t know what to tell you.) But even if we scraped that subsidy away, we find outsized (my words) salaries for the participants, and it is rarely invoked in discussions of income inequality for reasons I’m sure you understand already, so I won’t preach.

    Would those salary structures remain in the absence of subsidy and monopoly? I wish we could find out. But I do not know.

    Let me put a stake in the ground. At the core, my small government orientation has its roots in the empirical fact that large and active government inevitably leads to those most clever and capable of bending or creating rules to facilitate that rent seeking to their benefit. Hence, I always just shake my head at anyone who votes for activist (mostly Democrat, but recently Republican as well) government – all well intentioned – but later lamenting the inevitable debacle with “what happened? My response: What the hell did you expect?

  • sam Link

    I’m not sure what you were disagreeing with me (or Cowen) about, Steve. All I said, really, was that most Americans do not think the income distribution is unfair. That is to say, “most Americans are unwilling to frame national issues in terms of rich versus poor.” Do you think most Americans do frame issues in those terms? That they frame issues in terms of some kind of class warfare? I don’t see it. What “claim” do you understand me as putting forward?

  • Sam,

    I think casting it as rich vs. poor is the wrong way. I think it should be recast more as corporations vs. individuals. Granted, that probably correlates fairly well with rich vs. poor, but I don’t have any doubts that corporations would trample the rights of the rich if they felt it was good for their bottom line. I don’t think too many people are aware of this for at least a couple of reasons.

    1. Most people are still thinking Right vs. Left, thanks mainly to politicians being in the hip pocket of corporations.
    2. While I think this trend has been growing and started awhile ago, it is something that is only now starting to really become more noticeable.

    What I don’t really buy into is your Rawlsian argument.

  • sam Link

    The point was, it is not understood as rich vs. poor at all. I’m not sure you understand Rawlsian point I was making. It’s not really an argument about causes and effects. It’s a kind of economic phenomenology. I’ll repeat it: Our sense of fairness is not challenged by the income distribution (as regards the wealth of individuals) — most of us do not think it is unfair. For example, we don’t think it unfair that Bill Gates is worth $billions and we’re not. Most of us would say, Well, you know, he earned it . Good on him. We would think it unfair if it could be shown that the wealthy are becoming more wealthy at the expense of the rest of us, but, for the most part, we don’t think that. I was not saying there is only one way to cast the situation — only if the situation is cast the way Cowen did, then our notions of fairness vis-a-vis the income distribution as regards individuals come into play as an explanation of people’s attitudes toward individual wealth. Now if you cast it as individuals vs. corporations, I’d be inclined to say that you’re right, and, as far as our notions of fairness go, the economic power of corporations is believed by most of us to be weighted against us, and in ways that might not work to our individual benefit. And most of us, I’d say, would think this unfair. (People’s attitudes toward financial institutions is good example of the this.)

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