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Inequality and Capitalist Income

PostPosted: Sat Apr 18, 2015 4:02 pm
by blairfix
For a long time now I've been bothered by the lack of a clear connection between capitalist income and inequality. I've always thought that the connection should be straightforward: since the vast majority of capitalist income (interest and profit) flows to wealthy individuals, it follows that an increase in the capitalist income share ought to lead to an increased income share of the wealthiest individuals.

Unfortunately, this simple logic is not supported by empirical evidence. Using data from the US, there is no significant relation between capitalist share of national income and the income share of the top 1%. Even if we disaggregate profit and interest and compare them to income inequality, there is still no significant correlation.

I'm not sure why it took me so long to realize this, but last week I realized that corporate profits are not really a type of personal income. Simply because a corporation earns a profit, does not mean that any individual necessarily gets to count this money as income. Only when profits are paid out as dividends do they become a source of personal income. Therefore, if we want to connect capitalist income to inequality, we ought to look at dividends as a share of national income. This removes from the equation profits that are taken by the government (as tax) and profits that are reinvested by the company.

The resulting relation between dividends and income inequality jumps off the page. As the figure below demonstrates, the two series are highly correlated.

Dividends.png (260.81 KiB) Viewed 3226 times

It appears that the size of corporate profits has no bearing on income inequality. Rather, it is the composition of this profit that matters. When companies reinvest most of their profits, income inequality is low. Conversely when companies pay out most of their profits as dividends, income inequality is high.

Re: Inequality and Capitalist Income

PostPosted: Sat Oct 22, 2016 9:03 pm
by max gr
Thanks for sharing this, Blair. Your talk at the conference reminded me I wanted to take a closer look at the data.

I think your conclusion might have been too hasty. The dividends in national income depend on net profits and the share of net profits distributed as dividends. We can isolate the second factor and estimate the effect of aggregate dividend distribution policy independently.
I found no long term correlation between the share of dividends in net profits to the share of dividends in national income. Looking at the relationship between dividends share in NI and dividends share of the 1% income (using saez&piketty's data), a good correlation only existed up until the mid-70's:
Div.1.png (42.72 KiB) Viewed 1838 times

The composition of the 1% income shows the relative decline in the importance of dividend income to this group - when what we usually consider as non-capital income (mainly wage and entrepreneurial income since the late 80's) becomes more dominant over time. Realized capital gains also experienced relative growth. It seems those are the components responsible for the inequality surge in recent decades, not dividends.
1% income by type.png
1% income by type.png (93.29 KiB) Viewed 1838 times

The 1% is a fairly large population group, comprising almost 1.7 million 'tax units' (families, single adults, etc.) So maybe we shouldn't be surprised it's not very dependent on "direct" capital income (the wage category includes distributed stock options and the likes, while entrepreneurial income includes s-corporations, perhaps some of which we should consider as regular capitalist entities. I'm not familiar with the subject).
But even if we look at the 0.01% income composition we find a similar pattern - this time capital gains are very central, comprising about half of all income over time while the other components look like this:
0.01% income by type.png
0.01% income by type.png (90.67 KiB) Viewed 1838 times

So i don't think income inequality is about dividends, at least not anymore. But the relationship between dividends share in NI to inequality might suggest formally non-capital income moves together with capital income in a way that might allow us to consider part of it as distributed profits de-facto. What do you think?

Re: Inequality and Capitalist Income

PostPosted: Sun Oct 23, 2016 9:52 am
by blairfix
Great work here Max. Lots to consider. Yes, its clear in Piketty's work that top incomes have become more and more salary dominated. So attributing a rise in inequality solely to increasing dividends is too simplistic.

I did not know that the World Top Income database had time series data on top 1% composition. This is important data, so thanks for showing me this. I think your conclusion is correct. Formally non-capitalist income in top incomes must move with dividends.

Actually, I now realize that this is implicit in my hierarchy model. The capitalist share of income in top 1% earnings was fixed using Piketty's most recent data. So your findings are actually consistent with the model, but show that my interpretation of the model was incorrect.


Re: Inequality and Capitalist Income

PostPosted: Tue May 16, 2017 6:57 am
by rsalisbury
Does anyone have a possible explanation for the precipitous drop in dividends in that last graph starting in the 60s?

Re: Inequality and Capitalist Income

PostPosted: Sun Aug 27, 2017 11:09 am
by max gr
Some of it has to do with the long term trends: the rising share of other income components. But i think it has to do also with taxation. Take a look at the top 0.01% income including realized capital gains. Up until 1986 it was relatively favourable, taxation wise, to report income as capital gains, which can provide a kind of earnings substitute for dividends (undistributed earnings realized with assets sold, instead of dividends payment).
0.01% income (C-gains).png
0.01% income (C-gains).png (86.63 KiB) Viewed 1023 times

Note that while the last graph includes capital gains income, the fractile's group score excludes C.gains (in accordance with the researchers baseline methodology). This significantly underestimates realized C.gains in general but makes the last two graphs commensurable.