Taxes, surplus, and the top 1 percent

We know that U.S. economic inequality—especially the share of income going to the top 1 percent—has been increasing for about three decades. The question is, can the latest research assist us in making sense of the ways top income-earners in the United States have been managing to capture a larger and larger share of the surplus?

In a new paper, “The Top 1 Percent in International and Historical Perspective,” Facundo Alvaredo, Anthony B. Atkinson, Thomas Piketty, Emmanuel Saez note that there’s nothing universal or given (as suggested by theories of globalization and skill-based technological change) about the rising share of the top 1 percent. Instead, country-specific policies explain a large share of growing inequality that has been occurring in some places and not in others.

Alvarado et al. start by focusing on changes in top marginal tax rates and find that top tax rates have moved in the opposite direction from top income shares. In the United States, for example, top marginal tax rates have fallen while top income shares have been on the rise since the mid-1970s. That’s their springboard to consider the causes behind the rise in top income shares, of which two are particularly significant for our purposes: bargaining power of those at the top and the relationship between so-called earned income and capital incomes.

The first point is that cuts in top tax rates meant that top executives had additional incentives to bargain more aggressively to increase their compensation. The result was that, in the context of other changes (such as financial deregulation and the increased extent of performance-pay), executives of large corporations were able to secure a large share of the surplus for themselves—perhaps at the expense of growth and employment.

international evidence shows that current pay levels for chief executive officers across countries are strongly negatively correlated with top tax rates even controlling for firm’s characteristics and performance, and that this correlation is stronger in firms with poor governance. . .This finding also suggests that the link between top tax rates and pay of chief executive officers does not run through firm performance but is likely to be due to bargaining effects.

The second point is that, at least in the United States, where wealth concentration is much higher than in other developed countries, there has been an increasing degree of association between earned income and capital income. Thus, for example (as can been seen in the table below), whereas in 1980 only 17 percent of capital-income and labor-income recipients were in the top one per cent for both, that number had risen to 27 percent in 2000.

In other words, those at the top have been able to receive an increased share of the surplus in the form of both “earned income” (i.e., their salaries) and “capital income” (i.e., having claims on the surplus through their accumulated wealth).

It’s that combination of increased bargaining power and the ability to accumulate private wealth that explains the growth of inequality—the amount of the surplus captured by the 1 percent—in the United States over the last three decades.

The only thing missing from the Alvarado et al. story is an analysis of where the surplus itself comes from, that is, how the surplus that is being captured by the top one percent has been originally pumped out of employees in the United States and around the world.