The dynamics of high incomes over the last century

The dynamics of high incomes over the last century

auteur

Facundo Alvaredo

date de sortie

01/11/2011

discipline

Économie

présentation

There is widespread concern about growing economic inequality and about its long-run development and transmission across generations. After a post-war period when the welfare state, the spread of education, and progressive taxation combined to steadily reduce economic inequality, the decades since 1980 have seen sharply rising income concentration in a number of countries, notably the US, the UK, Scandinavia, and Germany.

 

A wave of tax reductions have favoured the well-off during the last twenty-five years, in parallel with an upsurge in the shares of very high incomes in most English-speaking countries, to levels not seen since the years before the Great Depression. Today’s crisis has reinforced the interest in looking at the upper part of the distribution, the more so after observing that recent financial crises tended to be followed by an increase in income concentration. The public debate has been also re-kindled by a few wealthy businesspersons around the world asking to pay higher taxes. Concern about the rise in the shares of top incomes has led to a range of proposals. Some countries have already announced increases in top income tax rates, and the re-enforcement of wealth taxes that had been abolished not long ago; others are considering limits on remuneration. These are being implemented at a time of recession or stagnation and leave many questions unanswered.

 

Ten years ago, Thomas Piketty’s work on the dynamics of high incomes in France (2001, 2003) demonstrated the necessity of looking at the very high-income earners in order to understand the new developments in the distribution of income, and to reinterpret those observed in the past. Since then, a succession of studies has constructed top income shares time series for more than twenty countries to date. The first twenty-two studies have been included in two volumes edited by Anthony B. Atkinson and Thomas Piketty. They cover several European countries (France, Germany, Netherlands, Switzerland, UK, Ireland, Norway, Sweden, Finland, Portugal, Spain, Italy), Northern America (United States and Canada), Australia and New Zealand, one Latin American country (Argentina), and five Asian countries (Japan, India, China, Singapore, Indonesia). The data and conclusions generated by this research programme have revealed crucial insights for the present debate on the key issues around distribution and taxation.

 

The World Top Incomes Database

 

These projects (carried by over 25 researchers around the world) have generated a large volume of data, which are intended as a research resource for further analysis. In January 2011, Anthony B. Atkinson, Thomas Piketty, Emmanuel Saez and myself launched The World Top Incomes Database, freely available at the École d’Économie de Paris’ website at http://g-mond.parisschoolofeconomics.eu/topincomes/. The webpage aims to providing convenient on line access to all the existent series. This is an ongoing endeavour: we progressively update the base with new observations, as the series are extended forwards and backwards. Recently, estimates for South Africa, Mauritius, Tanzania and Denmark have been added to the list. We are actively working on over 40 additional countries, including the former British and French colonies, Israel, Brazil, Colombia, Chile, Iceland, and Greece. Despite the database’s name, we also plan to incorporate information on the distribution of earnings and the distribution of wealth.

 

In using data from the income tax records, these studies use similar sources and methods as the pioneering work by Kuznets (1953) for the United States. It is surprising that Kuznets’ lead was not followed and that for many years the income tax data were under-utilised. This means however that the findings of recent research are of added interest, since the new data provide estimates covering nearly all of the twentieth century -a length of time series unusual in economics: for example, Norway’s series start in 1875 and Japan’s in 1886. In contrast to existing international databases, generally restricted to the post-1970 or post-1980 period, the top income data cover a much longer period, which is important because structural changes in income and wealth distributions often span several decades.

 

Warnings

 

The top income share series are constructed, in most of the cases presented in The World Top Incomes Database, using tax statistics. The use of tax data is often regarded by economists with considerable disbelief. These doubts are well justified for at least two reasons. The first is that tax data are collected as part of an administrative process, which is not tailored to the scientists’ needs, so that the definition of income, income unit, etc., are not necessarily those that we would have chosen. This causes particular difficulties for comparisons across countries, but also for time-series analysis where there have been substantial changes in the tax system, such as the moves to and from the joint taxation of couples. Secondly, it is obvious that those paying tax have a financial incentive to present their affairs in a way that reduces tax liabilities. There is tax avoidance and tax evasion. The rich, in particular, have a strong incentive to understate their taxable incomes. Those with wealth take steps to ensure that the return comes in the form of asset appreciation, typically taxed at lower rates or not at all. Those with high salaries seek to ensure that part of their remuneration comes in forms, such as fringe benefits or stock-options which receive favorable tax treatment. Both groups may make use of tax havens that allow income to be moved beyond the reach of the national tax net. These shortcomings limit what can be said from tax data, but this does not mean that the data are worthless. Like all economic data, they measure with error the ‘true’ variable in which we are interested.

 

The data series presented here are fairly homogenous across countries, annual, long-run, and broken down by income source for several cases. Users should be aware, however, about their limitations. Firstly, the series measure only top income shares and hence are silent on how inequality evolves elsewhere in the distribution. Secondly, the series are largely concerned with gross incomes before tax. Thirdly, the definition of income and the unit of observation (the individual vs. the family) vary across countries making comparability of levels across countries more difficult. Even within a country, there are breaks in comparability that arise because of changes in tax legislation affecting the definition of income, although most studies try to correct for such changes to create homogenous series. Finally and perhaps most important, the series might be biased because of tax avoidance and tax evasion. Last, but not least, the relatively easy access to the data made possible through the website cannot –and should not– replace the detailed accounts given in the authors’ original papers and chapters from which the data have been obtained.

 

Call for Data
 

As a step in the direction of the democratization in the production of knowledge, we have published a ‘call’ for researchers interested in getting involved in the project, should they be aware of data that have not been exploited yet, or should they have the possibility of getting unpublished data for so-far uncovered countries (even if only for a few recent years). In fact, in many developing countries authorities are reluctant (or explicitly refuse) to disclose income tax data (the primary source of this kind of studies) on the grounds of confidentiality issues and statistical secrecy. In light of the evidence gathered in The World Top Incomes Database, the concerns expressed are clearly unfounded.

 

A Historical Overview

 

Figures A to D display the top 1 percent income share between 1900 and 2008 for twenty-four countries. The grouping corresponds not only to cultural or geographical reasons, but also to the historical evolution of top shares. Western English speaking countries display a clear U-shape over the century. Continental European countries and Japan display an L-shape. Nordic and Southern European countries are somewhere in between, as the drop in inequality in the early part of the century is much more pronounced than the rebound in the late part of the period. Finally, there is substantial heterogeneity among developing countries.

 

Some elements for analysis:
• Most countries experienced a sharp drop in the shares of top incomes during the first half of the twentieth century.
• The fall in the top percentile share before 1945 was primarily a capital income phenomenon: income inequality dropped because capital owners –the “rentiers”– were hit by major shocks (wars and crisis) to their capital holdings. Upper income groups below the top percentile, which were (and still are) comprised primarily of labor income, fell much less than the top percentile, and recovered much more quickly from those shocks.
• The dramatic increase in recent decades in the share of income going to the top 1 percent in the Anglo-Saxon world is due to a partial restoration of capital incomes and, more significantly, to very large increases in the compensation for top executives. As a result, the “working rich” have joined capital owners at the top of the income hierarchy. We have not then simply returned to a previous level of inequality; the inequality has different origins. As a result, the fraction of labor income in the top percentile is much higher today in most countries than earlier in the 20th century.
• Continental European countries (France, Germany, Netherlands, Switzerland) and Japan experienced no or modest increases in top income shares in recent decades. As an explanation, it has been proposed that top capital incomes had not been able to recover from those shocks after 1945; post-war progressive income and inheritance taxation seem to have prevented the re-establishment of large fortunes.
• The unprecedented scale of the recent crisis has placed the distributional impact of macroeconomic shocks back on the agenda, as witnessed by some of the recent literature and press commentaries. However, looking only at the consequences of crises leaves aside the analysis of previous years, when the imbalances and the potentials for financial meltdown are building up. Iceland is an striking example: it has been established that the benefits of the financial bubble before the collapse of 2008 went overwhelmingly to a small minority at the top of the income distribution, the top 1%.

 

The United States, and why high incomes have become a key concern

 

To get a sense of magnitude of the upsurge of high incomes in recent years in the United States, consider the real income growth displayed by the top 1 percent and the bottom 99 percent, illustrated in table A. Average real incomes grew at a 1.3 percent annual rate between 1993 and 2008. But if the top 1 percent is excluded, average real income growth was only about 0.75 percent per year. Incomes of the top 1 percent grew 3.9 percent per year; consequently they captured more than half of the overall economic growth.

 

During the expansions of 1993–2000 and 2001–07, the income of the top 1 percent grew far more quickly—at an annual rate of 10.3 percent and 10.1 percent, respectively—than that of the bottom 99 percent, whose incomes grew at a 2.7 percent annual rate in the earlier expansion and 1.3 percent in the later one. Consequently, during the last expansion, the top 1 percent captured two thirds of all income growth. Moreover, top incomes tax rates went up in 1993, during the Clinton administration, while they went down in 2001, during the Bush administration. As E. Saez states, “those results help explain why the dramatic growth in top incomes during the Clinton administration did not generate much public outcry while over the last two years an extraordinary amount of attention has been given to top incomes by the media and in the public debate.”

 

Growth and Inequality

 

The new historical data call for a deep revision of existing knowledge on the dynamics of inequality and put radically into question the standard version of Kuznets’ hypothesis about the relationship between economic development and income distribution. This theory, which has dominated the debate on this issue during the last fifty years, has strong and optimistic policy implications: if developing countries are patient enough and do not worry too much about the short-run social costs of development, at some point they should reach a situation in which poverty rates drop sharply while growth and inequality reduction go hand in hand. Today, the Kuznets curve is widely held to have doubled back on itself, especially in Anglo-Saxon countries, with a period of falling inequality during the first half of the twentieth century followed by a reversal of the trend since the 1970s. It would be misleading, however, to conclude that Kuznets’s hypothesis is no longer of interest: many poor and developing countries have not yet passed the initial industrialization stage, and we still need to understand why advanced economies went through an initial inverse-U curve.

 

The reasons why inequality declined in industrialized countries during the first half of the twentieth century do not have much to do with the optimistic process derived from Kuznets’s ideas. The compression of income distribution that took place between 1914 and 1945 in the developed world was due, for the most part, to specific capital shocks—on one hand, the very peculiar conditions of the Great Depression and the stock market crash; on the other, the world wars. Progressive income and estate taxation likely explain to a great extent why capital concentration did not regain the high levels observed during the first part of the twentieth century.

biographie

Chercheur associé à l’École d’économie de Paris, il est également chercheur au Consejo Nacional de Investigaciones Científicas y Técnicas (Buenos Aires, Argentine), et chercheur au Nuffield College (Oxford, Royaume-Uni). Il est invité à l’IEA-Paris dans le cadre du programme de mobilité européenne EURIAS.

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