The return of the ‘Misery Index’
The United States is currently experiencing its fastest rate of inflation, year over year, since mid-1982. Those of you who are old enough to remember that might also remember the…
A while back, I replied to Robert Reich, an economist who was Secretary of Labor under President Clinton, who had tweeted:
There are basically 5 ways to accumulate a billion dollars in America:
1) Profiting from a monopoly
3) Political payoffs
None of these has anything to do with being successful in the supposed free market.
— Robert Reich (@RBReich) November 10, 2019
This is an increasingly common argument and it has important policy implications. Did ‘the rich’ just get their money from their parents? Did they earn it? If it is the former, we might be much more willing to try and tax it all away from them than if it is the latter. Fortunately, there is a large body of research which allows us to address this question.
How did ‘the rich’ get their money? They earned it, for the most part. In a paper titled ‘Family, Education, and Sources of Wealth among the Richest Americans, 1982–2012‘, economists Steven N. Kaplan and Joshua D. Rauh examined the characteristics of the 400 wealthiest individuals in the United States over the past three decades as reported by Forbes magazine. They found that, in recent years, the Forbes 400 did not grow up as advantaged as in past decades. They are more likely to have started their businesses and to have grown up upper-middle class, not wealthy. Today’s Forbes 400 were able to access education while young, and apply their skills to the most scalable industries: technology, finance, and mass retail. The share of the Forbes 400 who are self‐made rose from 40% in 1982 to 69% in 2011.
Other analysis supports these findings. BMO Private Bank found that 67% of Americans with $1 million or more in investible assets are self‐made. U.S. Trust found that 70% of individuals with investable assets of more than $3 million grew up in middle‐ or lower‐income households. Economists Maury Gittleman and Edward N. Wolff found that 23% of the top 1%’s wealth was inherited in 1989, but that this had fallen to 15% in 2007. Looking at estate tax returns, economists Lena Edlund and Wojciech Kopczuk found that the importance of inherited wealth at the top in the United States has been declining since the 1970s. In 2010, the economist Tino Sanandaji found that “self‐employed business owners account for an astonishing 70 percent of the wealth of the top 0.1 percent”. Economists Mariacristina De Nardi, Phil Doctor, and Spencer D. Krane estimate that one‐third of all household wealth in the United States is owned by self‐employed people who actively manage their businesses.
In a recent paper titled ‘Capitalists in the Twenty-First Century’, economists Matthew Smith, Danny Yagan, Owen M. Zidar, and Eric Zwick ask the question “Are the richest Americans idle rich—who derive most of their income from their non-human capital—or are they entrepreneurs and other working rich—who derive most of their income from their human capital?” They write:
We first establish how much top earners make from three broad sources: wage income, business income, and other more passive capital income such as interest and rent payments. In 2014, most income at the very top is non-wage income, the primary source of which is business income.
Most top business income comes from private “pass-through” businesses that are not taxed at the entity level; instead, income passes through to the owners who pay taxes on their share of the firm’s income. This feature allows us to build a new dataset linking pass-through firms to their owners for 11 million firms between 2001 and 2014. This dataset enables us to ask whether top pass-through income should primarily be thought of as labor income accruing to the human capital of active owner-managers or as capital income accruing to the financial and physical capital of idle owners.
Their findings are that:
Consistent with the labor income view…top earners are predominantly working rich rather than idle rich, and that the majority of top income accrues to the human capital of these wage earners and entrepreneurs.
This trend – of self‐made wealth displacing inherited wealth – has been found worldwide, but the U.S. has been a leader. In ‘The Origins of the Superrich: The Billionaire Characteristics Database‘, Caroline Freund and Sarah Oliver of the Peterson Institute for International Economics find that:
…among advanced countries, the share of self‐made billionaires has been expanding most rapidly in the United States.
A good number of ‘the rich’ have had to work especially hard to get there. Looking at the 100 wealthiest Americans in 2013 according to the Bloomberg Billionaires Index, Catherine Clifford found that 73 are self‐made and 27 have inherited wealth. She noted that:
Thirty-six were born to humble households, if they have a family at all, and 18 have no college degree.
On the Forbes 400 list, 20% grew up poor.
When someone says that “it’s a physical impossibility to lift yourself up by a bootstrap, by your shoelaces,” they may be right physically, but economically they are just spouting rubbish.
Also, ‘the rich’ don’t stay ‘the rich’. In a paper titled ‘The Myth of Dynastic Wealth: The Rich Get Poorer‘, economists Robert Arnott, William Bernstein, and Lillian Wu examined the Forbes lists and found that of the 400 individuals on the 1982 list, just 69 individuals or their descendants – 17.25% of the total – remained on the list in 2014. They found that the wealth of those 69 people had grown far more slowly than if they had simply invested passively in stocks and bonds in 1982 and let their holdings grow. They conclude that “dynastic wealth accumulation is simply a myth.”
The economist William McBride makes a similar point. Looking at changes in wealth for the Forbes 400 from 1987 to 2014, he found that the average annual real growth rate of wealth over 26 years for the people on the 1987 list was at best a rather lame 2.4% (by contrast, the average annual real return on U.S. stocks over the decades has been about 7%). Furthermore, he found that those who inherited their wealth grew their fortunes more slowly than those with self‐made wealth.
Economists Ryan Bourne and Chris Edwards point out that:
Among those on the Forbes 2018 list, 43 percent were new in the prior 10 years. Many of the new billionaires have impressive achievements in building companies:
Jensen Huang cofounded graphics chipmaker Nvidia, which has revenues of $10 billion.
Shahid Khan built automotive parts maker Flex‐N‐Gate, which has revenues of $8 billion.
Judy Faulkner founded medical records software firm Epic Systems, which has revenues of about $3 billion and supports the records of 230 million patients.
Acton and Koum cofounded WhatsApp, which provides free phone service globally for 1.5 billion users, as noted.
Reinhold Schmieding founded Arthrex, a surgical tools company that has developed many new products and has revenues of more than $2 billion.
Robert Pera founded wireless equipment maker Ubiquiti Networks, which specializes in bringing low‐cost internet access to rural areas.
Thai Lee built business IT provider SHI International, which has revenues of $9 billion. Like Huang, Khan, and Koum, Lee is an immigrant to the United States.
People like Reich are living in a fantasy land. Their claims about ‘the rich’ just getting rich from inheritance or ripping people off simply do not hold up to any rigorous analysis. They should not be taken seriously. Neither, then, should their policy prescriptions.
John Phelan is an economist at the Center of the American Experiment.