The Income Gap Cycle Continues: Millionaire Heirs

Data Source: Capital in the Twenty-First Century

Data Source: Capital in the Twenty-First Century

Income inequality has been a topic of interest in recent years as our economy underwent a period during which many Americans were laid off, received pay cuts, went through foreclosures, or simply had difficulty making ends meet. As many have already observed, the lower and middle class earners in particular were hit hard recently.

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The Century Foundation estimates that the bottom four-fifths of households saw around a 39 percent decline in their net worth between 2007 and 2010. The top 20 percent of earners, however, only suffered a 14 percent reduction in net worth. Logically, it makes perfect sense for lower and middle class workers to rely more heavily on economic stability — with resources strictly allocated, there’s little room for perturbation. However, with more incomes comes more assets and the ability to redistribute assets accordingly, and potentially even gain by anticipating market fluctuations. The chart above displays the portion of total earnings the top ten percent of earners have brought in. Although it’s not an exact year-by-year indicator, it provides an idea of the trends throughout the 20th century.

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In his recent book, Capital in the Twenty-First Century, Thomas Piketty examines the topic of wealth distribution. He posits that when the rate of return on capital (profitits, dividends, interest, rents, etc.) exceeds the growth rates of output and income, capitalism self-actively generates inequalities that go against the meritocratic values on which a democratic society is based.

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On one hand, inherited wealth is certainly a contributing factor in determining success. Education funding, networking opportunities, and startup capital are in many cases already provided, as opposed to being obtained through blood, sweat, and tears (excuse the dramatic sentiment.) Wealth does tend to generate more wealth. However, given all of the instances of rags to riches during the technological revolution and even during the industrial revolution and in times past, maybe meritocratic values are still present, albeit perhaps not as persistently.

Top Earners  

When people think of the top 1 percent of workers, they often think primarily of those on Wall Street. But in reality, people from all sorts of occupations are among the top 1 percent. A publication by The New York Times examined this several months back. It found that managers, from several industries ranging from health services to hotels, encompassed the largest portion of the top 1 percent, with around 375,000 members. Other occupations within this high-earning group include physicians, lawyers, sales people, dentists, engineers, athletes, and accountants and auditors. Some of the more surprising occupations within the top 1 percent group include cooks, farmers, artists, technicians, and even housekeepers.

Further narrowing the data, down to the highest .1 percent, many of these are the CEOs who we all know and love and the Wall Streeters who earn millions on capital gains. Oracle CEO Larry Ellison, for instance, brought in $77 million in investment compensation and earned a total of $96 million in 2012.

Born Into Money

A recent blog by The New York Times points out that six out of ten of the wealthiest Americans are heirs, as opposed to self-made entrepreneurs. Sure, it takes a level of diligence and tenacity to achieve success, regardless of whether your origins are humble or lavish. However, the required level of tenacity is much greater for those without financial advantages.

Pew Research examined the way the income of the previous generation impacts its heirs. It found that only 4 percent of those raised in the bottom quintile make it all the way to the top as adults. The rags to riches stories may not be as common as we think. However, 84 percent of us fare better than our parents, having higher incomes than our parents had at the same age. Overall, in spite of our higher earnings, those who were raised on the bottom rung are likely to continue to remain at that level as adults, and likewise, those who were raised wealthy are likely to grow into wealthy adults. Of those raised in the bottom quintile, 70 percent remained below the middle-mark during adulthood. For those children raised in the top quintile, 63 percent remained above the middle-mark.

How many of us are born into wealth? The Bureau of Labor Statistics conducted a study (albeit somewhat dated) on wealth transfers and inheritances. The study found that there was a drop in the number of households receiving an inheritance from 1989 to 2007. Income impacted inheritance as well as 45 percent of households earning above $1 million per year reported a wealth transfer, as opposed to only 15 percent in the lowest income group.

Piketty measures the impact of inheritance by examining three key metrics: the capital/income ratio, the mortality rate, and the ratio of the average wealth at death to the average wealth of the living. Each one of these measures does not paint a vivid picture on it’s own, but together, the picture becomes a bit clearer. According to Piketty, capital/income in most developed countries is around 5 or 6 (500 and 600 percent), sourcing mostly from private capital. The mortality rate measures the percentage of the population that dies in a given year and, as a single measure, does not provide any information about inheritance or income inequality. The last measure, however, gives us a bit more information. This tells us a bit about an individual’s wealth standing and gift activity.

Piketty also asserts “the average wealth at death is 20 percent higher than that of the living if one omits the gifts that were made before death, but more than twice as large if one re-integrates gifts.” When all three measures — capital/income, mortality rate, and wealth at death/average wealth of the living — are together considered, we are able to determine inheritance flow as a percent of income. This gives us an idea of how much money stems from inheritance.

Varying Opinions

While most Americans see there is income inequality in the United States, BBC reports that different sides have different views on how to handle the problem. Ninety percent of Democrats think the government should intervene and develop a policy to narrow the income gap. On the other side, only 45 percent of Republicans are calling for government help.

The BBC poll also found that 55 percent of Americans think the rich are more likely to be “greedy.” Income inequality is a worldwide problem and Thomas Piketty’s book does contain insightful and well-analyzed ideas.

Piketty’s Capital in the Twenty-First Century has received a great deal of attention, some negative, but a great deal of positive criticism as well. He provides a comprehensive view of economic inequality in the United States and elsewhere, providing insight, data analysis, plus his own economic theories and those of others, like Ricardo and Marx. He reminds readers from the onset that he by no means is attempting to create something all encompassing or all-knowing. Piketty examines data from three centuries and over twenty countries to draw his conclusions, and like any analyst or scholar, he has the understand that he will still be left with some questions unanswered. He says, “Social scientific research is and always will be tentative and imperfect … By patiently searching for facts and patterns and calmly analyzing the economic, social, and political mechanisms that might explain them, it can inform democratic debate and focus attention on the right questions.”

While no one has all the answers, discussion brings about new theories and proposals and brings more attention to a subject that needs examination. What do you think about income inequality?

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