/ January 5, 2020
The article was originally published in Chicago Booth Review.
Since the Great Recession, America’s wealthiest 1 percent have been demonized as fat cats who have grown ever richer while the middle class has stagnated. While protesters have called for the 1 percent to be taxed more heavily, economists have been digging into data to develop a better understanding of who the top earners are.
These economists have been seeking to measure income inequality and wealth inequality, and to understand the nature of the 1 percent’s income and assets. And views differ. Some say the 1 percent are predominantly entrepreneurs and the “working rich,” people who made their money by starting and running successful businesses. Other economists note that a significant proportion of the 1 percent are the heirs of wealth accumulated over time.
But the data also reveal disparities within the 1 percent. The 1 percent, it turns out, have their own 1 percent.
“Since the 1970s, average incomes have grown, but the growth has not been uniform across the income distribution. The incomes at the top, especially in the top 1 percent, have grown much faster than average,” wrote Harvard’s N. Gregory Mankiw, in a 2013 paper entitled “Defending the One Percent.” “These high earners have made significant economic contributions, but they have also reaped large gains. The question for public policy is what, if anything, to do about it. This development is one of the largest challenges facing the body politic.”
Mankiw noted that the 1 percent’s share of total income, excluding capital gains, rose from about 8 percent in 1973 to 17 percent in 2010, the latest figures available at the time. “Even more striking is the share earned by the top 0.01 percent. . . . This group’s share of total income rose from 0.5 percent in 1973 to 3.3 percent in 2010. These numbers are not easily ignored. Indeed, they in no small part motivated the Occupy movement, and they have led to calls from policymakers on the left to make the tax code more progressive.”
In the nearly five years since Mankiw’s paper, economists have assembled more data with which to analyze the 0.01 percent. In the 35 years ending in 2015, the share of total income has accrued faster to the 0.01 percent than it has to the rest of the 1 percent. The share of total income has risen, according to 2015 data, to 5 percent for the 0.01 percent and 22 percent for the 1 percent. The 0.01 percent’s share of total US wealth quadrupled in the 35 years ending in 2012 to 11 percent, argue University of California at Berkeley’s Emmanuel Saez and Gabriel Zucman, who have made wealth calculations through 2012.
Not all economists agree that the 0.01 percent are the most significant slice of the distribution. New York University’s Edward N. Wolff, using different data, notes that the wealth of the top 5 percent has grown faster than that of the 1 percent over the past 30 years. Chicago Booth’s Steve Kaplan says that income share for the 1 percent stagnated between 2000 and 2015.
But the disparities within the 1 percent have intrigued other economists. Who are the 0.01 percent? How well are they really doing? How are they making their money? And how, if at all, should policy makers respond?
The United States has 325 million people—in 160 million households, as viewed by the Internal Revenue Service. That means 1.6 million households fall into the 1 percent category.
The threshold for membership in the 1 percent in 2014 was an annual household income of $386,000, excluding any capital gains, according to Chicago Booth’s Eric Zwick. That’s more than seven times the median household income that year of $54,000. The 0.1 percent, 160,000 families, in 2014 made at least $1.5 million a year. The top 0.01 percent, 16,000 families, had annual income of $7 million.
Income share is another way to assess how the strata of the 1 percent are doing.
Between 1995 and 2015, the income share (including capital gains) of the top 1 percent rose from roughly 15 percent to 22 percent, according to Piketty and Saez’s data. The income share of the top 0.1 percent rose from 6 percent to 11 percent, and the income share of the top 0.01 percent rose from 2.5 percent to about 5 percent. In terms of percentage points, the top 1 percent’s rose the most. In terms of the rate of increase, the 0.01 percent’s did.
After-tax income tells a similar story. For the top 1 percent, it nearly tripled between 1980 and 2014, according to research by Paris School of Economics’ Thomas Piketty and UC Berkeley’s Saez and Zucman. For the top 0.1 percent, it almost quadrupled in the same period. And posttax income for the 0.01 percent rose 423 percent. Posttax income for the entire US population rose by only 61 percent during this time, the study demonstrates.
The 0.01 percent also perform best in comparisons of wealth. Saez and Zucman, in an influential 2014 study, used income data from the IRS to “capitalize,” or derive, wealth based on the expected aggregate rate of return from every asset class or source of income reported on tax returns. They say the share of total wealth of the top 1 percent has increased steadily, from below 25 percent in 1978 to 42 percent in 2012. The share of total wealth of the top 0.1 percent has roughly tripled, and the share of the 0.01 percent has more than quintupled. The top 0.01 percent of US households had at least $111 million in net worth in 2012, compared to $4 million for the 1 percent.
Not everyone slices the data the same way, or draws the same conclusions. New York University’s Wolff, using data from the Federal Reserve Board’s Survey of Consumer Finances, finds that between 1983 and 2013, the top 5 percent of households saw their wealth grow faster than the top 1 percent did. This would challenge the notion that wealth is increasingly concentrating at the top. He also argues that the rise in overall wealth inequality in the US from 2007 to 2010 is due less to very wealthy people’s success than to the middle class’s failures, chief of all taking on debt only to lose value in their homes.
And Piketty and Saez’s income-share data show that long-term growth has stagnated since 2000 for the 1 percent, 0.1 percent, and 0.01 percent, argues Chicago Booth’s Kaplan. All three groups saw their income shares and inflation-adjusted incomes peak in 2007, and those shares have yet to recover to those pre–Great Recession levels, he points out.
University of Chicago’s Greg Kaplan says the main point of recent research he did with University of Minnesota’s Fatih Guvenen is to highlight that there’s variety in the group so many know as the 1 percent. “When I hear people talk about top income inequality, I hear words and phrases such as ‘top 1 percent,’ ‘top 0.1 percent,’ ‘top earners,’ ‘CEOs’ . . . thrown around all the time,” he says. “I think we need to keep in mind that these are very different people. They get their income from very different sources. They live in different parts of the country. . . . There is a huge amount of diversity, even within a group that we think is small but is actually very big, which is the top 1 percent.”
When discussing the super-rich, many bring up family dynasties such as the Waltons of Wal-Mart, or the Rockefellers and Koch brothers of energy fortunes. They may think, too, of highly paid corporate executives such as Apple CEO Tim Cook (who made $150 million in 2016, according to Bloomberg), celebrities such as Diddy (who took home $130 million pretax in the year through June 2017, per Forbes), and entrepreneurs such as Facebook founder Mark Zuckerberg (No. 5 on Forbes’ 2017 list of the world’s billionaires).
But who is actually in the 0.01 percent? Researchers are developing a better understanding of how people in various rungs of the 1 percent make their money. And some research suggests business income plays a big part.
Since the late 1990s, “nearly all of the recent rise in top incomes has come in the form of business income,” write Matthew Smith of the US Treasury Department, Danny Yagan of UC Berkeley, and Chicago Booth’s Owen Zidar and Zwick, whose work focuses on the 1 percent and 0.1 percent. “The demand for top skill has outpaced its supply, with the returns to top skill increasingly taking the form of business income.”
This income is broad-based among the 1 percent. “What’s covered on CNBC or in the Wall Street Journal or New York Times might be overemphasizing the drivers of wealth in Wall Street and Silicon Valley, and the economy is much bigger and more diverse than that,” Zwick says. “There are a few Carnegies and Rockefellers, a Bill Gates and a Jeff Bezos here and there, but there are a lot more people earning between $300,000 and a few million dollars doing a lot of different things.”
Smith, Yagan, Zidar, and Zwick find that the 1 percent’s income is being driven by owner-managers, mostly of small and medium-sized companies—specifically S corporations, partnerships, and limited liability companies. These are talented managers: the researchers find that profits of companies run by these 1 percent-ers are far higher than those of businesses owned by people in the top 5-–10 percent. In the researchers’ sample, when these businesses’ owners died prematurely, while still running their companies, profits plunged by more than half.
The average company in the top 1 percent of income has $7 million in sales and 57 employees, according to the research. “If that firm has, say, a 10 percent profit margin to split between two owners, it’s enough to put someone in the top 1 percent category,” says Zwick. The businesses earning the most profits in the bulk of the top 1 percent were physicians’ and dentists’ offices, professional and technical services, specialty trade contractors, and legal services.
To reach the top 0.1 percent of income, the average company has $30 million in sales and 150 employees. “If you’re an auto dealer and you have five or six dealerships and you’re doing $30 million in sales, you have a bunch of workers and you split $3 million in profits between one or two owners, that would put you in that top 0.1 percent group,” says Zwick. In the top 0.1 percent, physicians’ offices ranked only sixth in profits—behind managements of private companies, financial and investment activities, auto dealers, professional and technical services, and oil and gas extraction.
It’s harder to get at the source of income for the top 0.01 percent, but several studies indicate that finance could be an important sector for the group. Williams College’s Jon Bakija, the US Treasury Department’s Adam Cole, and Indiana University’s Bradley T. Heim find that one-fifth of the primary taxpayers in the top 0.1 percent of income (including capital gains) work in finance. The latest data used in this study are from 2005, before the 2007–10 financial crisis altered the landscape. But between 2008 and 2012, “finance and insurance is by far the most highly represented industry among the highest earners,” find Guvenen and Kaplan, who looked at the 0.1 percent. In the rest of the 1 percent, health care is the most represented sector.
Beyond that, there’s more detailed information about only the very richest of the 0.01 percent, and it seems to suggest that the richest members of the group may own large, successful businesses. Kaplan and Stanford’s Joshua Rauh used Forbes’ “rich list” as a data set on the wealth of the richest Americans. Since 1982, Forbes has compiled an annual list of the 400 wealthiest Americans, using public information, private interviews, and valuations of comparable assets. As the rich list comprised 400 households, it represents the top 2.5 percent of the 0.01 percent—the top 0.00025 percent of US households.
But this small group could control more than a quarter of the income in the 0.01 percent. According to Saez and Zucman’s calculations, in 2012 the top 0.01 percent had an average wealth of $371 million, which would imply a collective total of $6 trillion. That same year, the estimated combined net worth of the individuals on the Forbes 400 list was $1.7 trillion.
Among the group who made the rich list, for almost one in four, finance—especially hedge funds and private equity—was the source of wealth, while 15 percent came from technology-based companies. Food and beverage companies accounted for 10 percent.
And these sectors were on the upswing. “The ‘finance and investments’ category grew in representation by around 16 percentage points, technology (both computer and medical) by 11 percentage points, and retail/restaurant by 10 percentage points,” Kaplan and Rauh write.
On the 2016 rich list, two-thirds were self-made and one-third had inherited at least part of their fortune. More than 10 percent were immigrants to the US.
Piketty and Saez have theorized that investments grow faster than the economy, giving entrenched dynasties insuperable advantages. But Kaplan and Rauh argue that the super-rich are predominantly creating rather than inheriting wealth. Kaplan also says that wealth in this group has been fueled by a marriage of in-demand skills, globalization, and technology—the combination of which are allowing businesses to scale up as never before.
Skills, say many economists, are critical to the modern economy. As the US economy grows, jobs are going unfilled as companies scramble to find skilled people to hire. There’s a flip side to this: as certain skills have become scarce, this has raised the amount companies are willing to pay people who have them. The situation has similarly raised the amount of profits skilled company owners can make, and technology and globalization are further magnifying the value of in-demand skills.
If this is true, the 0.01 percent are most likely benefiting from what economists call “skill-biased technological change”—the increasing return on certain skills in an economy driven by technology and globalization. Under this well-established theory, a shortage of in-demand skills raises the value of those skills in rapidly expanding markets, and new technology helps some workers’ productivity grow much more than others’, exacerbating inequality.
In the Information Age, the change has been particularly pronounced. “In business, you can use technology to do things you couldn’t do 30 years ago,” says Steve Kaplan. “You can scale your business using technology, and you can use people in India and China and all over the world—you couldn’t do that as effectively 30 years ago.” This, he argues, has been spectacularly positive for poorer people in developing countries. In 1990, the World Bank estimated that roughly 35 percent of the world lived in extreme poverty. Today, less than 11 percent of the world’s population is so impoverished.
And it has been good for wealthy residents of developed countries. For them, the result has taken the form of the “superstar” or “winner-take-all” phenomenon, first identified in a landmark 1981 paper by the late Sherwin Rosen, who taught at the University of Chicago. “In certain kinds of economic activity there is concentration of output among a few individuals,” wrote Rosen. “Relatively small numbers of people earn enormous amounts of money and dominate the activities in which they engage.”
Technology, from the internet to media such as ESPN and Bloomberg terminals, has given elite athletes, entertainers, entrepreneurs, and financiers the ability to profit on a much larger, global scale, making the fruits of their labor more valuable than what previous superstars, such as, say, Pelé or Babe Ruth, brought in. Ruth’s peak salary of $80,000 would be worth about $1.1 million in 2016 dollars, around one-thirtieth of the $33 million the highest-paid Major League Baseball player, pitcher Clayton Kershaw of the Los Angeles Dodgers, made in salary alone in 2016.
The world’s hundred highest-paid athletes, led by Cristiano Ronaldo and LeBron James, stars of soccer and basketball, respectively, “banked a cumulative $3.11 billion” over the past 12 months, Forbes calculated this past June. Among entertainers, rapper/entrepreneur Diddy and singer Beyoncé each raked in more than $100 million over the same period, Forbes estimated.
And hedge-fund managers make multiples more than top athletes and entertainers. James Simons of Renaissance Technologies and Ray Dalio of Bridgewater Associates each made more than $1 billion in 2016, even though, as Institutional Investor’s Alpha reported, the top-25 hedge-fund earners took in the least as a group since 2005, largely because of the industry’s overall poor investment performance.
“Technology allows a hedge fund to be able to manage $20 billion and invest it,” says Steve Kaplan. “I don’t think people had the systems and information to do that 20 to 30 years ago. Now they have the systems and the information to do that. That technological change is here and is not going away. If anything, it’s getting stronger.”
The question of what, if anything, should be done in response to the spectacular rise of the 0.01 percent is a thorny one, as Mankiw acknowledged. “At the outset, it is worth noting that addressing the issue of rising inequality necessarily involves not just economics but a healthy dose of political philosophy,” he wrote.
When policy makers want to address the concentration of income and wealth, the first place some have looked is the top marginal tax rate, which slid in the US and other developed countries after the Reagan and Thatcher revolutions. The US and UK had tax rates as high as 80 percent, wrote Saez and Piketty in the Guardian in 2013. “The job of economists should be to make a top rate tax level of 80 percent at least ‘thinkable’ again.” But on this, Steve Kaplan disagrees. Raising the top marginal rate could send people and their money scurrying for tax havens, he says, pointing to France as an example.
Raising the top tax rates in the US could also send people to take advantage of more favorable tax rules within the code itself. And closing perceived loopholes can be controversial. For example, some people working in finance benefit from the code’s treatment of carried interest, where income flowing to the general partner of an investment fund is typically treated as capital gains and therefore taxed at a lower rate.
“This tax preference is viewed as an unfair, market-distorting loophole by some but consistent with the tax treatment of other entrepreneurial income by others,” writes the Tax Policy Center.
Then there’s the issue of whether raising the top marginal rate could discourage business activity. The marginal rate is intended to tax individuals on their earnings, and it rises with income. But a lot of business income is being taxed at that marginal rate rather than a corporate rate. Because the top US marginal personal tax rate was lower than the corporate rate for some time, business owners had an incentive to change their form of corporate organization from the traditional C corporation, which has profits taxed at the higher, corporate rate, to a partnership, limited liability corporation, or S corporation, taxed at the lower, individual rate. By 2011, these pass-through entities accounted for most of the business income earned in the US. (For more, see “The $100 billion tax dodge,” Summer 2016.)
Policy makers should design an income-tax system that takes into account the nature of the income, and design a system that harmonizes taxes to discourage people from shopping the code for the best tax rates, Zwick suggests—recognizing this is a tall order.
And despite his research interest, Greg Kaplan says we should be careful about populist reactions that lead us to focus too much on the super-rich: “We are better off concentrating on how to improve the lives of those in the bottom 50 percent.” In this group, many workers are in desperate need of a skills upgrade. As these workers fall behind, many economists say, policy makers need to focus on better preparing them for the workforce, perhaps by investing in education, working more closely with local companies to determine what skills their workers need, and removing barriers such as onerous regulations preventing people from entering certain professions. (For more, see “How to create middle-class jobs,” Summer 2017.)
In short, there’s a split among economists. Some argue that income needs to be distributed more equitably, while others say governments should focus less on taking actions that could inhibit top earners and more on addressing the reasons others aren’t as successful. Do we slow the 0.01 percent or lift the 99.99 percent, which could be a heavier and more complex assignment? As the debate continues, members of the 0.01 percent continue on their course.