Education

Economics in Person

The Evolution of Top Incomes in the United States



Bradley Heim discusses widening income inequality in the United States (video, 31:04).

  1. Introduction & Talk Overview
    0:00 - 3:02
  2. Rising Top Income Shares: The U.S.
    3:03 - 8:23
  3. Rising Top Income Shares: Abroad
    8:24 - 11:14
  4. Potential Causes in Rising Top Income Shares: Relative Demand for Labor & Taxes
    11:15 - 17:16
  5. Potential Causes in Rising Top Income Shares: Superstars, Exec Pay, and Financial Professionals
    17:17 - 26:22
  6. Implications of Potential Causes in Rising Top Income Shares
    26:23 – 31:04

Transcript

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00:00:09     All right.  So thanks for inviting to give this talk on what’s happened at the top end of the income distribution.  So the title of the talk is the Evolution of Top Incomes in the United States.  And in this talk I’m gonna focus mainly on what’s going in the top 10 percent, the top one percent and the top one-tenth of one percent.  In this talk I’ll be talking about some data that I had access to in my time when I was at the Treasury Department.  And I’m working on a project with someone that’s still at the Treasure Department.  So I need to give the disclaimer that these are my views and not those of the Treasury Department.  In this talk I’m going to talk about three broad questions.  So first of all the question is going to be what has happened to top incomes in the United States over the past 80 years or so.  And especially in the past -- what’s happened in the past 30 years.  And secondly how does what’s happened in the United States compare to what’s happened in some other countries. 

00:01:09     And then finally what explains these trends that we see in top income shares in the United States over this time period.  So before I get to that though I think it’s important to put what’s gone on at the very top of the income distribution in context with what’s gone on elsewhere in the income distribution.  So this is a graph that comes from some work I’ve done with two economists that are at the Fed Board of Governors, so Ivan Vidangos and Vasia Panousi, and Jason DeBacker, who’s at the Treasury Department.  We’re looking at income inequality kind of throughout the income distribution.  And this one way that you can measure income inequality kind of broadly in the income distribution is to look at the variance of income across individuals or across households in a given year.  And what we see is -- here we’ve mapped out the variance in income for three different possible measures of earnings.  So we have earnings of males. 

00:02:09     We have household income before taxes are taken out.  And we have household income after taxes are taken out.  And what you see is that over the past 20 years or so all of these measures have been trending up.  And it’s not only just the past 20 years.  It’s actually the past 30 years that we see these trends up regardless of what kind of measure of income that we use.  And that’s also true regardless of what measure of income inequality we can use.  So another measure of income inequality, it’s called the Gini Coefficient.  It essentially measures how different the income distribution is from a completely equal income distribution.  And what you see is again for each of those three measures of income that measure of income inequality has been trending up.  So that’s what’s going on in the kind of broader income distribution.  Now what’s been going on at the very top, okay?  So what I do mean by the very top?  Well, if we’re talking about the top 10 percent in 2005 that was a household that made an excess of $94,000 a year. 

00:03:12     And it’s important to keep in mind that I’m talking about income at the household level.  So if a person is married we would be adding together their income with that of their spouse.  And so if we had a husband and wife and both made $50,000 in income that income would qualify them for being in the top 10 percent.  And so Thomas Piketty and Emmanuel Saez did some really nice work looking at what has happened to income shares at the very top.  And this is the graph that they came up with for the top 10 percent over a long time period.  So going back all the way 1917 and then out to 2007 using some published tax data.  And what they found was that if you look at the earlier -- the World War I years all the way through to the beginning of World War II the top 10 percent of income earners had about or earned about 40 to 45 percent of their income of the national income. 

00:04:12     That fell pretty dramatically at the beginning of World War II and then stayed between say 30 and 35 percent over the next 40 years.  But then around the late 1970s early 1980s that trend starts reversing again.  And we see this large tick up in the share of income going to the top10 percent where it increase from between 30 and 35 percent all the way up to above 45 and upwards of 50 percent depending on what income measure you’re using.  And so what you see is that the top 10 percent’s income share at the end of this period was about the same as it was in the pre-World War II period.  And that’s true regardless of whether you include capital gains into the measure of income or whether you don’t include that in the measure of income.  That’s what’s going on in the top 10 percent.  Now let’s go up a little bit in the income distribution.  So let’s focus on the top one percent. 

00:05:09     So this is the group that there was a lot of -- there were a lot of protests about last summer.  And early this year there’s been a lot of political attention on what’s going in the top one percent.  So who are these people?  Well, these are households that make an excess of about $300,000 a year -- again household income.  And so what’s happened to their income?  Well, in this graph the income share of the top 10 percent has been decomposed into three different groups.  So people who are within the top 10 percent, but outside the top five percent.  People who are within the top five percent, but outside the top one percent.  And people who are within the top one percent.  And the striking thing that you see there -- so the red and blue trends -- those are for the top 10 to five percent and the top five to one percent.  You see a slight increase in those two.  But it isn’t very dramatic.  The thing that sticks out is the share that’s gone to the top one percent has really gone up substantially over the past 30 years. 

00:06:12     So if you go back the 1970s their income share was around 10 percent.  If we look at in more recent years their income share is 20 percent or more.  Now, let’s go up even further in the income distributions.  Now, let’s focus on the top one-tenth of one percent. So these are people that have household income in excess of $1.25 million a year.  And what you see is of that increase in income share among the top one percent a lot of that was displaying in the increase in the income share among the top one-tenth of one percent.  So you see the same broad trends that we saw for the top 10 percent and the top one percents.  So a decline around World War II -- kind of a flattening out for 30 or 40 years and then an increase in the past 30 years.  And we saw that the top one percent share about doubled from 10 to 20 percent. 

00:07:09     Here the top one-tenth of one percent their share quadruples from about two percent to about eight percent.  Now what is that income made up of?  So what’s the composition of that income?  Well, there’s kind of an interesting pattern that you can see when you decompose that income into the type of income that we’re looking at.  So if you look at the early years in that graph -- so the bottom slice there is wage and salary income.  The next slice up is business income.  And that big slice there is capital income.  What you see is that in the kind of early years back in the 1920s, 30s, and leading up to 1940 about half of the top one percent income share was made up of capital income, okay?  And then it plummets around 1940 and never really recovers that large share.  Toward the end of the period the big increase isn’t in capital income.  Instead it’s in wage and salary income and business income, okay? 

00:08:09     And that’s going to help give a hint as to why top income shares might have gone up in this more recent period because it’s not an increase in capital income.  It’s an increase in business and wage and salary income that we’re seeing.  So what’s happened in the United States compared to some other countries?  So we’ve seen this before.  So here’s the top one-tenth of one percent income share in the US.  The increase from about two percent up to eight percent in the past 30 years.  Let’s look at the United Kingdom, okay?  So there -- you see the same broad general trend.  So the decrease, roughly flat, still maybe declining a little bit in the 40s through 1980s.  But we see an increase in the UK as well.  Albeit a smaller increase than we saw in the United States.  So their share went up from under two percent to about four percent or so. 

00:09:10     What about Canada?  So another English speaking country and there you see again, the pattern is similar to what’s happened in the United States.  So income shares were slightly lower in the early period in Canada than they were in the US.  Dropped down again to about the two percent range for those who were in the top one-tenth of one percent of income earners.  Increased toward the end of the period.  Greater than the increase in the UK, but still less than in the United States.  There the increase is from about two percent to around five percent.  What about Continental Europe?  There we see a big difference.  So here in the early years -- this is for France.  In the early years the graph for France looks very similar to what we saw in the United States.  So shares were at eight percent to six percent range, dropping some.  Drops around the same time that the top one-tenth of one percent income share dropped in the US. 

00:10:12     But we don’t see that big recovery and increase in the past 30 years that we’ve seen in the United States.  What about Asia?  What’s going on there?  So here’s a similar graph before Japan.  And I want you focus on that top set of -- that top line that’s marked with diamonds.  That’s the top one-tenth of one percent share in Japan.  And again we see something similar to what we saw for France.  So large top income share -- around eight percent of national income leading up to World War II, a big drop, but again no big recovery toward the end of the period.  And so the studies that have looked at different countries seem to follow this pattern that this increase in income shares among top income earners seems to be something that’s heavily focused in English speaking countries and not so much in Continental Europe and not so much in Asia. 

00:11:15     Okay.  Now, we’ve seen what’s been going on at the top.  So then the questions is why have these income shares been going up.  So first set of explanations has to do with changes in relative demand for labor.  One story has to do with globalization.  So as communications costs have gone down, as transportation costs have gone down, so as globalization has increased the story goes that there’s more competition among low wage and low skilled workers in the US.  There’s more competition from workers in other countries that are low wage countries.  And that’s tended to lead to wage stagnation perhaps whereas at the high end of the skill distribution and high income earners globalization has led to maybe larger markets for their skills, more demand for their skills and ultimately higher earnings for those workers, okay? 

00:12:13     And skill-biased technical change is another concept that works in a similar way.  So this is the idea that technological change has served to work as a compliment for high skilled workers and as a substitute for low skilled workers.  So if you were a worker that was working as a secretary typing out papers for a professor, for example, now that professor can just go up to his computer and type up the paper himself or do the research himself.  So as a result that type of skill might be less in demand and so wages might suffer.  At the same time that technology has served as a compliment to higher skilled workers.  And so those higher skilled workers can become more productive and earn higher incomes.  Now, my reading of the literature is that this might help to explain what’s going on kind of the in the broad part of the income distribution. 

00:13:10     So what’s going in the middle?  In order to explain what’s going on at the very top you have to come up with an explanation as to why globalization and skill-biased technical change impacted incomes in English speaking countries, but it did not impact incomes in Continental Europe or in Asian countries.  And it’s hard to come up with a story as to why globalization affected the US to a much greater extent than say a non-English speaking country in Europe.  So the next set of explanations that have been offered have to do with taxes.  And there are two reasons why taxes might impact top income shares.  So one has to do with incentive effects.  So it’s a kind of standard model of the individual behavior.  If you raise the marginal tax rate on someone they take less home in after-tax income and so there’s less of an incentive for them to engage in income generating activities. 

00:14:12     And going along with this theory is the fact that there have been some major tax laws that have been passed over this 30 year period that have tended to lower top marginal tax rates.  So when you think of the early ‘81 tax change, the early Regan tax change, the tax reform after 1986, the top marginal rate dropped down from 70 percent to 28 percent.  People think of the more recent Bush tax cuts.  So in 2001, 2003 those also lowered rates.  Now what’s left out of this explanation is that tax rates or marginal tax rates on top incomes went up during this period as well in 1990 and 1993.  And so to the extent that incentive effects might have led to higher earnings that are higher incomes at the top.  You’d expect to see a decrease in their income share around those tax changes that raise marginal tax rates at the top end. 

00:15:14     A second possible explanation has to do with something that was peculiar about the tax reform after 1986 in which individuals who had businesses of a certain size there was an incentive to organize them as what’s known as an S Corporation where the income would show up on individual income tax forms instead of on corporate tax forms.  And all of those graphs that I showed you based their tabulations on tax data.  And so to the extent that income shows up on individual income tax forms instead of on corporate tax forms that would lead to an increased income share for those taxpayers.  But again, those explanations struggle with the international evidence.  So this is a graph that shows the top marginal tax rates in three of the countries that I showed you graphs for previously.  So the United States is the blue line or the purple line there.  The -- France is the red line. 

00:16:11     So we see less of a decline in France.  But we see a similar decline in Japan if we look at the top marginal tax rate at the beginning of this period -- so 1981-- versus the top marginal tax rate in Japan at the end of this period.  And so if marginal tax rates are driving what’s going on in top income shares, again we would expect to see much more of an increase in the top income share in Japan.  And as I’ve already shown you we really don’t see that increase in Japan, okay.  Now, the big run up in the top income share around 1986 on the other hand suggests that the tax reform after 1986 and the shifting of income between tax bases may have something to do with that one blip up of the top income share.  But it can’t explain the increase in the top income share beyond that point.  And on top of that we really don’t see a big decline in 1990 and 1993 when marginal tax rates went up at the top. 

00:17:11     Okay.  So if that doesn’t help to explain much what might?  So there are a number of theories that have to do with occupations of the top income earners.  So changes in earnings for certain occupations might be driving this.  So one explanation has to do with what’s known as superstar theories.  This is the idea that because of changes in technology or changes in the market for especially people in creative occupations -- actors and actresses, musicians, athletes and so on.  People want to see the best actress and they want to see best sports star.  And so as a result the best are able to sell their skills to a wider audience and their income might have gone up as a result, okay.  A second set of explanations have to do with executives.  So I think it’s not too controversial that executive compensation has gone up over this time period. 

00:18:13     But there’s a lot of debate as to why it’s gone up.  And the explanations kind of the run the gamut from organizations have become more and more complex and so pay has gone up as a result.  There’s been an increase in trying to align the incentives of executives with those of the shareholders.  And so pay has had to go up as a result.  Pay has become more and more tied to asset prices.  As a result even during this period there’s a run up in the stock market.  That might have something to do with it.  There’s been an argument that there’s been an increase pay-setting by peers.  And so things like benchmarking of executives of one company to a certain percentile of pay of similar corporations -- that might lead to higher executive compensation.  There’s been a set of explanations that have to do with social norms that previously maybe workers or society at large might have disapproved of high executive pay. 

00:19:11     And so as those norms have lessened maybe executive pay has gone up as a result, okay?  And a third set of explanations have to do with the compensation of financial professionals.  So again, pay being more tied to asset prices, increasing skill intensity in the financial sector, increasing rent capturing.  So all of those might lead to a higher pay for people in those professions.  But the questions is can those explanations as to why pay has gone up in those professions explain what’s been going on at the top of the income distribution.  So in other words are there enough of people that have these professions at the top to plausibly explain what’s been going on at the top.  And some previous work suggested that maybe there wasn’t.  But that work relied on some publicly available information on executive pay, on press reports, on what sports stars were making and so on. 

00:20:07     And so in some work that I have done with Jon Bakija, who’s at Williams College and Adam Cole who is at the Treasury Department we collected what we think is the best information on the occupation of top income earners.  And it turns out that it comes from tax data.  And so where this comes from is that if you’re in the process of filling out your taxes right now if you look at the back of the 1040 form you’ll see a box or a set of boxes that are outlined in red there where you’re asked to write down your occupation.  And fortunately for us a division of the IRS did a project where they tried to code up what people had written in into a format that was useable for research.  And so we match up what people wrote in as their occupations with some information on what industry they’re involved in from information on their W2 forms and then matched that up to the income that they reported on their income tax return.  So we can get a much better picture of what the people at the top of the income distribution do.  And then can that help explain what’s going -- or can these theories about executive compensation, financial compensation and superstars help to explain why there’s been an increase in the top income share. 

00:21:20     Okay.  So this is what the occupational distribution of the top one percent of taxpayers looks like.  So we tried to group taxpayers into a set of occupations that made sense for our purposes.  And so you can see the third of the bottom and the bottom group.  These are people -- the bottom group are the share of people who are executives, managers or supervisors -- one of those titles they used in filling out their form.  And then the third group up from the bottom -- that’s the orange bars -- those are people who are in financial professions.  And we don’t have perfect data for each of these years.  So the IRS coded up this for a select number of years.  So the earliest information we have is 1979 and then we have it in ‘93.  And it’s kind of intermittent for a couple years. 

00:22:12     And since 2001 we’ve had this information for every year.  And what you can see if the question is are there many executives at the top or are there many financial professionals at the top, the answer seems to be yes.  So if you add those two groups together their share of the top one percent of income earners is about 45 percent.  Now, if the question is are there many people that are in the arts, media or sports at the very top - LeBron James and Wayne Gretzky and Peyton Manning and Angelina Jolie and so on -- are they a big group at the top -- the answer seems to be no.  So their share is about one to two percent of the top one percent.  Now, that was if we don’t include capital gains in our measure of income in how we sort people.  If we include capital gains the answer is about the same.  So the graph really doesn’t change much between those two graphs. 

00:23:12     Again, about 45 percent of the top one percent fall in either executive, managers and supervisors or financial professions.  What about the top one-tenth of one percent?  So now here we see that the financial professions are now the second largest group.  So they’ve moved up a slot.  Executives, mangers and supervisors are still the largest group.  If we add those two groups together they constitute about 60 percent of the top one-tenth of one percent of income earners.  So more than a majority of the top one-tenth of one percent are in one or two of those top professions.  Arts, media and sports people -- they moved up in the rankings, but again, they’re still a relatively small group.  So it’s about two to three percent of the top one-tenth of one percent. 

00:24:06     And another thing that we found is that if we look within the executive, managers and supervisors group we’re able to do a rough cut between people who seemed to be getting salary from a company that they don’t own and people who seemed to be drawing salary from a closely held business.  And one thing that we’ve seen is that if we look within in that executives, managers and supervisors group that the share of people who seem to be working for another company has gone down over this time period.  And the share who seemed to be executives, managers or supervisors of a closely held business has increased over this time period.  That’s their composition.  Okay, so that’s the composition of income at the very top by occupation.  Now, what’s happened to the incomes of these different occupations?  So this graph shows the share going to the top one percent over this time period in our data.  And you can see the overall share has gone from about nine percent to about 17 percent in 2005. 

00:25:14     If we add together the people who report an occupation as being a financial professional or who are an executive manager or supervisor and we add up their share of income, their share of income went from about four and a half percent in 1979 to an excess of nine percent in 2005.  So about doubling of their share.  And if you compare the doubling of their share to the overall increase in share that went to top one percent, they can explain about 60 percent of the increase in income at the top.  Now, if we go up to the top of one-tenth of one percent in 1979 -- if we add together the financial professions and the executives, managers, and supervisors in ‘79 their share was about 1.7 percent.  At the end of the period their share was about 4.9 percent.  And the overall share of this group went from about 2.8 percent to 7.3 percent. 

00:26:10     So if you look at the former as a fraction of the latter those two groups can explain about 70 percent of the increase in income shares going to the very top over this time period.  One final way to look at this data.  In this graph we’ve graphed out the income shares of each of these occupations in years after 1979 relative to what their income share was in 1979.  So we can see how the income shares of each of these groups changed over time.  So if we look at the income share going to the top one percent of financial professionals who were in the top one percent during this time period we see that they’re the top line there.  Their share -- as a fraction of their share in ‘79 increased pretty dramatically.  So their share was about three and a half times in 2005 what it was in 1979. 

00:27:09     Executive, managers and supervisors are about the third line from the bottom toward the end of the period.  So the increase in their share was much less dramatic.  So their share went up by about 70 percent.  But their share was so large at the beginning of the period that that 70 percent increase in their share over this time period relative to their ‘79 is what helps to explain so much of the overall increase.  And if we look at the top of the one-tenth of one percent again we see the share of financial professionals now among this group went up more than four times relative to what it was in 1979.  Executives, managers and supervisors -- that increase was larger than it was for the top one percent.  So their share went up by two and a half times. 

00:28:07     And looking at both of these graphs you see a couple of things.  One is that there’s been a fanning out across occupations.  There’s been a variety of relative changes across these occupations.  So all of the occupations didn’t move up in lock steps.  Certain occupations had a much larger increase than other occupations.  So for example, that second line down those are people who are in real estate, their share went up by almost five and a half times at the end of the period what it was in 1979.  But again their share was relatively small at the beginning of the period.  And so they don’t help to explain that much of the overall increase.  So what does this say about why income shares have gone up over this time period?  Given the large number of executives, managers, supervisors and financial professionals in the top one-tenth percent of income earners and in top one-tenth of one percent of income earners it’s hard to make an argument that those explanations as to as why executive pay and financial pay have gone up don’t explain or don’t help to explain the overall increase in the top income share. 

00:29:16     There are a lot of these people at the top.  And as we saw their increase in income explains a large amount of the overall increase in income, okay?  It also looks like shifting between tax bases helps to explain some of the increase in income shares not just because of that blip up around 1986, but because of this change in the composition of executives, managers and supervisors from people working for someone else to people who are executives of their own closely held business.  So that also could help to explain the increase.  Superstar theory might play a small role.  But it’s going to be a small role given that the share of the top income earners that are in one of those professions is relatively small.

00:30:07     And finally in trying to search for an explanation as to why top incomes have gone up if the explanations is based on something that changed in the same way for every one at the top -- tax policy, larger economic forces and so on -- all of those explanations have to contend with this fanning out of changes across occupations and within occupations.  And so if there is some role for tax policy you have to come up with another story as to why different occupations responded differently to those changes.  Thanks. 

00:31:05 [END OF TRANSCRIPT]