Income Inequality: Top 1% Myths

Time magazine recently named “The Protestor” the person of the year. No doubt this year we saw complaints between the bottom 99% and the top 1%. However, although many people in the bottom 99% may be complaining I would question whether they have all their facts. According to Federal Reserve data 33% of the people in the top 1% in 2007 were no longer in the top 1% in 2009. Note that this is only over a two year time horizon. Less than 15% of people on the Forbes 400 stay on the list for over a 21 year period. Also it is important to note that inherited wealth is in fact the minority of people on the Forbes 400 list. What is even more interesting is that according to the Edward Wolff of NYU is that the percent of inherited wealth has been decreasing. In 1989, 23% of the top 1% inherited their wealth. By 2011, this percentage decreased to 9%. Also it is interesting that income inequality is lower now than where it was in 1995. Also the concentration of wealth in the top 1% is lower now than where it was in 1998.

People will always want more. This desire is part of human nature. What seems puzzling is why people are envious of other people who work harder, longer, and smarter than themselves. To me if someone wants to work 80-100 hours per week earn all that money and contribute to society more power to them. As long as they are not asking for government money everyone should be fine with this arrangement. We could of course cure income inequality by having recessions. Everyone would feel more equal yet it would come at the price of growth and expansion. One point people forget is that the top 1% often take the most risks. This is known what Robert Frank describes as the “high-beta rich”. Frank makes an interesting argument that the top 1% has more because they took more on more risk. This is common sense. Often people who have large amounts of wealth have most of their net worth tied up in their stock options or their business. The majority of Americans don’t have stock options and live off their paychecks. Since a large percentage of people in the top 1% have their net worth in one asset they have to constantly worry about what happens if that asset implodes. This means that the super rich have much more volatility in their net worth than say the average person. One year you might have $200 million and then the next $50 million if the stock market drops.

Income inequality should make people want to work harder (if they decide they want more money). Complaining about why other people are successful does nothing for any individual. Everyone wants more money yet very few people want to do what is required or necessary to get there. We can’t forget that people are paid on value creation and productivity.

Special thanks to Robert Frank for giving me the idea for this post.

Bottom 99% Are Already Top 1%

I think it is interesting when people show graphs of income inequality over time between the top 1% and everyone else. One thing I think people fail to understand is that the top 1% of today is not the same top 1% of yesteryear. Recent data from the Tax Foundation drives home this point. The Tax Foundation looked at tax returns between 1992-2008 and looked at the top 400 taxpayers. The results are somewhat interesting.

Close to 73% of individuals were only in the top 400 taxpayers for one single year over the 17 year period. Only 3% stayed on the list for 5 years. Only .4% of people stayed on for 15 years and .1% stayed in the top 400 taxpayers for 17 years. This would say only 4 taxpayers were in the top 400 taxpayers for 17 straight years. People might complain that even 4 is too high. The evidence shows that an overwhelming majority of people only stay in the top for a short period of time. One explanation is that people do sell their businesses or they retire and have options that get exercised. So what is actually happening is that people are high income earners and then drop out of the top 1%. In fact, according to

a report entitled “Income Mobility in the U.S. from 1996-2005” 57% of the people in the top 1% had dropped into the bottom 99%. For the top 5% around 46% moved into lower income groups. The major point is that the top 1% or even top 5% are not some elite group that stays constant.

An even better point is that even the bottom 99% have a higher standard of living than many of the people in 10% in other countries. Real per capita GDP over a longer period of time has been increasing. When people complain how things are today the question should be would you rather live today or in the 19th century? The things people had to worry about in the 19th century are much different than things we worry about today. Infant mortality was much higher during this time period. People had to worry more about sanitation and also worry if there would be enough food. People during this time didn’t even shower daily. Today, these are things even the homeless don’t really have to worry about (if they seek a homeless shelter) I have seen people at stores purchasing their groceries with food stamps yet they have IPhones. No one a decade ago had an IPhone. The amazing thing about markets is that it brings creative destruction. Entrepreneurs and inventors figure out what people want and bring it to the masses. Competition keeps out bad products and services while ensuring high quality and low prices. The bottom 99% should be embracing markets and income inequality should be an incentive to want to work hard to get in that top 1% (even if it is only for one year).

"Old Americans are 47 times richer than young"

A story I recently saw was titled “Old Americans are 47 times richer than young”. Data shows that in 1984 people 35 and under had a net worth of $11,521 while people who were 65 and older had a net worth of had a $120,457. This numbers for 2009 show a different picture. The net worth of people under 35 in 2009 was decreased to $3,662. Meanwhile, people 65 and older had a net worth of $170,494 (numbers adjusted for 2010 dollars). What this would say is that older Americans now have a net worth that is 47 times that of younger people. Why are not people shouting about net worth inequality?

What people forget is that people who are 65 have had 30 years more to income to accumulate net worth. It would make sense that older people have more assets than younger people. Also another interesting data point is that 37% of young household have a zero or negative net worth. In 1984, this same percentage was only 14%. Perhaps this generation is spending more than previous generations.

One argument I find very interesting is how we can’t afford to cut back on Social Security payments to senior citizens when the data clearly shows they have a larger net worth than anyone else. A large majority older people are in low tax brackets because they are not working. The income they earn usually comes in the form of dividends, interest, and other fixed income. Not only are these older people using their income from all these sources to live on, but also can sell assets if they need money to live on.

Having a net worth of a little over $170,000 is still not a lot to live on. If you consider health care costs and nursing home costs it could be hard to live with this net worth. If a 22 year old started with a $1 and saved $3,000 per year until the age of 70 invested it in the market (average return of around 7.5% over the long-term), that individual by the time they turned 70 would have $1.34 million. If the individual become ambitious and saved $5,000 per year they would have $2.23 million. I have a feeling very people consistently save year after year. People nowadays have credit cards and can charge almost anything. One of the rules of personal finance is never to put anything on a credit card that you will consume before you get your next bill. The best way really to reduce spending is to just spend the cash you have on hand. This way you feel the “pain” when you pay for things out of pocket. When you buy things on credit you might have an idea of what something costs, but you don’t feel how much it costs. The key to accumulating wealth is saving.

The Poor: Better Off Than People 20, 30, and 100 Years Ago

Rich Nonsense

In a Gallup poll when asked if America had the “right” number of millionaires. In this poll, 31% of people stated that we have too many millionaires. While 42% of people said that we had just the right amount millionaires. What I find shocking is that people act as if there is a predestined number of millionaires. Wealth is not predestined. If people want to be rich they have to work hard and make something that other people find appealing. What is really maddening is that 31% of people believe that we have too many people with money. Millionaires did not take anything away from anyone. If anything these millionaires made the lives of many people better. The popular belief is that millionaires somehow became successful at the expense of others. Clearly, this is not true. People voluntary are getting out of chairs, drive to a store, select an item, and telling the company that made that product “Look I need your product more than I need x amount of dollars”. This process is an exchange and not coercion of any kind. People get wealthy figuring out what products and services people want. Going back to the study I really believe that this 31% is just envious or jealous of people that make more than they do. We all try to compare ourselves to other people on many different things, but what is not taken into account are the inputs the wealth have to sacrifice. In a way it’s like a song that went “I will do anything but I won’t do that”. The people that become wealth go the extra mile and make sacrifices in order to make sure other people are satisfied. Corporate executives and CEOs often get to work very early (6 A.M.) and stay late into the night. The people making extraordinary amounts of money are not on their behinds watching TV all day. No, these people are making deals, flying around the country, calling people, and creating wealth.

Not only the wealthy creating jobs and increasing the standard of living for everyone but they are also spending a lot of money as well! According to Moody’s Analytics, the top earning 5% of Americans make up 36% of consumer outlays. Note this is income and not net worth which shouldn’t be confused. People can have high incomes but low net worth. So the top 5% makes around $342,000 yet has only a 1.4% savings rate while the rest of the country has a savings rate of close to 8%. Many of the people we believe to be rich really aren’t. People often try to “signal” that they are rich. I would imagine doctors and lawyers have high incomes yet maybe not a high net worth.

To say we have too few or too many millionaires is rich nonsense. In a voluntary market these millionaires can only improve our lives by thinking of better ways to improve their product or service. I don’t see anything wrong with people making money for making our lives easier or more enjoyable. Money isn’t simply distributed by some money man. Income is earned. As Thomas Sowell would say newspapers and not income is distributed. In a sense, we get these great things like computers, televisions, and other products and we really don’t have to do anything to develop them. All we have to do is earn enough to buy them (if we can afford them).