Debating the Rise of the Top 1 Percent

So some papers that will make up a symposium in the summer issue of the Journal of Economic Perspectives about the rise of the top 1 percent of incomes are hitting the airwaves. Larry Mishel and I are contributing one as well, The Pay of Corporate Executives and Financial Professionals as Evidence of Rents in Top 1 Percent Incomes. Greg Mankiw mounts a self-described “defense” of the top 1 percent here (PDF), Miles Corak writes about the implications of inequality for mobility here (PDF), and Alvaredo, Atkinson, Piketty and Saez examine the top 1 percent in historical and international perspectives here (PDF).1

Our argument (shocker) is that the rise of the top 1 percent of incomes is not simply the result of a competitive, well-functioning market rewarding skills and capital to the precise degree necessary to elicit their supply. Instead, lots of the rise in top 1 percent of incomes is about the creation and/or redistribution of economic rents.

We highlight the two occupations that dominate the top 1 percent—corporate executives and finance professionals—and review the voluminous data and research literature that strongly suggests that these occupations exercise substantial market power over their own pay, and that their pay exceeds the contribution they make to economic output. We also provide new evidence that CEO compensation has grown far more than that of other top wage earners, those in the top 0.1 percent of the wage structure. The current pay gap between CEOs and other top earners is much greater than during the 1947-79 period and has grown far faster than the college-high school wage premium since 1979. This is evidence that directly contradicts the claim that CEO pay has been largely set by the market for talent.

We don’t think the case for rents driving incomes stops at these two occupations—the fields of medicine and information technology, for example, see huge incomes driven their way through explicit rents guaranteed through patents and other intellectual property protections. But because the circumstantial case (direct evidence on rent-creation and redistribution is awfully hard to come by) for rents accounting for significant portions of the pay of corporate executives and finance professionals is so rich, and because their share of the top 1 percent is so large, even if there were not rents elsewhere in the top 1 percent salaries would be bid up through the distortions imposed by these professions. To say it another way, even in a competitive labor market doctors’ pay would have risen in recent decades to attract potential new physicians away from the ever-more lucrative finance and corporate executive sectors.

We then present direct evidence that there is no positive relationship between growing top 1 percent income shares and overall economic growth. We argue that too many people who are rightly upset about the rise in top income shares seem to think that they need to argue that it has harmed the overall, average growth rate of the economy to prove that it is bad for low and middle-income Americans. However, as long as economic growth is largely unaffected by the top 1 percent share, every dollar that goes to this group is a dollar that could’ve gone to everybody else. This invariance of growth/efficiency to the incomes of the top 1 percent is also, not coincidentally, what one would expect if the top 1 percent of incomes were substantially composed of economic rents.

We end the piece with the obligatory ‘what to do about it.’ Our first recommendation would be to attack the obviously efficiency-crushing rents that boost top 1 percent incomes—so, improving corporate governance to better align executive pay with actual performance and regulating finance to make sure that profitable but socially worthless activities are not a major part of the sector’s income (a financial transactions tax would work well here).

Our second recommendation is a significant increase in top marginal tax rates. Besides blunting the incentive to engage in these efficiency-crushing instances of rent-seeking, higher top marginal rates also allow the pain-free redistribution of even those economic rents that lead to overpayment for the labor and capital supply of the top 1 percent, but which don’t necessarily change the allocative efficiency of markets.

This is a slightly subtle point, but can be phrased pretty simply. LeBron James is obviously a great basketball player, and hence it makes sense that he is paid significantly more than other basketball players.2 So in this regard, the NBA labor market is not totally failing in its task of efficiently allocating players to teams—the best players get the highest salaries. But, this allocative efficiency would still hold if we raised marginal taxes enough to cut salaries significantly. After all, even after this tax increase the best players would still be receiving the highest salaries. Those salaries (and all others) would just be a bit lower.

A separate question about higher tax rates concerns labor supply; raising taxes enough to push against the top 1 percent’s shares could theoretically make LeBron James just stop playing basketball altogether, or sit out 20-30 games a year. Do we think that would really happen? Andrew Fieldhouse has reviewed research by Saez and co-authors (summarized as well in their own contribution to the symposium) presenting evidence that the answer to this is no—labor supply will not contract markedly in response to higher top marginal rates. So, raising these rates shouldn’t be the only way to combat inequality, by a long shot. But it’s an important tool in the toolbox.

We also highlight the need for complementary policies that boost the wages of the vast majority of workers and overcome the wage stagnation that has affected nearly everyone (college graduates, including STEM and business occupations, and those with ‘some college’ or high school educations) over the last ten years. Major policy steps toward reestablishing broad-based wage growth include reconstituting labor standards that boost bargaining power at the low and middle-end of the wage-scale (higher minimum wages and labor law reform that allows willing workers to bargain collectively if they choose) and the dedicated pursuit of genuinely full-employment.

Last, we use Congressional Budget Office income distribution data to show that rising top shares over the 1979-2007 period have been driven by concentration within all forms of market income. In particular, the top 1 percent’s share of labor income doubled and the share of total capital income grew from 31.8 to 56.2 percent. The direct, arithmetic influence of taxes and transfers has been minimal, with rising inequality of market incomes explaining more than 100 percent of the rise in the after-tax income share of the top 1 percent. Last, the increased share of capital income in total income explains almost a third (31.6 percent) of the growth of the top 1 percent of income shares.

Endnotes

1. I haven’t come across other contributions yet floating around on the internet.

2. Yes, LeBron and some other Heat players took a pay cut so they could play together under the NBA’s salary cap, so there are a handful of other players who make as much as or more than he does. Nevertheless the broad point stands—even in the odd NBA labor market, higher productivity tends to admittedly correlate pretty tightly with higher salary.


  • Douglas Hopkins

    Tax and monetary policies have made tax avoidance and valuation manipulation far more profitable than productive enterprise – thereby destabilizing our economy. If we want to reinvigorate our productive economy we need to structurally reform our approach to taxing investment. I invite and urge you to read the recent OpEd published in The Hill 6/7/13,

    http://thehill.com/blogs/congress-blog/economy-a-budget/303045-tax-preferences-aimed-at-wealth-obstructing-job-creation-

  • Peter E. Greulich

    I have been doing a study of Tom Watson Sr.’s leadership during several recessionary times in the 20th century – specifically the Recession of 1921 (sometimes called the Depression of 1921 – fifth largest of all time) and The Great Depression. In the former he mandated a 10% across the board wage cut for all employees including himself. He actually suffered a 40% pay cut because his pay was linked to his performance as CEO (not stock price). In the first publications of CEO pay by the U.S. government he was making 365,000 dollars per year (more than Will Rogers) and he was called the “$1,000 a day man” and the new “Robber Baron” titles undeserving because he would lead American Capitalism in four areas, “paying stockholders dividends when IBM stock was a widow and orphan stock,” “employee benefits,” “customers with great products, service and support” and “society with jobs and stability.” He also pointed out that his pay was taxed at 60% at the time and was gladly willing to pay it. He would calmly state that he even after taxes he was making more than selling pianos when he first got started. (He was not so calm on corporate taxes though, as he wanted them lowered to get out of the depression).

    What we need is more CEO’s that see it as their duty to (1) make a profit to stay in business and then (2) equitably share those profits with the four investors in their corporation: stockholders, employees, customers and the society we all co-inhabit. Sometimes I think we believe that capitalism and democracy are one in the same. Not so, in a democratic society we can chose to do away with capitalism or put such restraints on it when its leadership fails to be responsible as to make it not function as it should. When the leaders of today’s business come to this realization, maybe they will go back to a Watson type of capitalistic leadership otherwise we will continue to see the belief in capitalism degrade – and as Peter Drucker pointed out in “End of Economic Man” we may not like the alternative.

    A comparison of Drucker and Watson’s beliefs of the time can be seen on my blog here:

    http://www.mbiconcepts.com/2/category/drucker%20and%20watson/1.html

    Peter E. Greulich
    Author, Speaker and Publisher
    MBI Concepts Corporation

  • Packard27

    Josh,
    I think you are being much too myopic to concentrate only on the top 1%. The fact of the matter is that the top 10% as measured by their annual income and their net worth (i.e. >$160k income & >$1B of investment assets) have done extraordinarily well beginning six weeks after the start of the Obama Administration. These are the folks who reaped 90% of Wall Street’s record breaking profits. Yes, the good times are certainly rolling for all of the “Washington DC and Wall Street Patriots” these days.

    Unfortunately, the next 40% of American households with their meager 401k/IRA balances, split up the remaining 10% of Wall Street’s profit crumbs. It goes without saying, the uneducated, unskilled, and otherwise unmotivated living in the bottom 50% actually lost ground during these past five years. “Hope and change” it would seem, can neither be very much eaten nor can it be used to pay the rent.

    So what lesson have we learned from all of this?
    Answer: El hambre es la mejor salsa