2003 IncomeInequalityintheUnitedStat

• (Piketty & Saez, 2003) ⇒ Thomas Piketty, and Emmanuel Saez. (2003). “Income Inequality in the United States, 1913--1998.” In: The Quarterly Journal of Economics, 118(1). doi:10.1162/00335530360535135

Subject Headings: Income Inequality Measure

Cited By

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Quotes

Abstract

This paper presents new homogeneous series on top shares of income and wages from 1913 to 1998 in the United States using individual tax returns data. Top income and wages shares display a U-shaped pattern over the century. Our series suggest that the large shocks that capital owners experienced during the Great Depression and World War II have had a permanent effect on top capital incomes. We argue that steep progressive income and estate taxation may have prevented large fortunes from fully recovering from these shocks. Top wage shares were flat before World War II, dropped precipitously during the war, and did not start to recover before the late 1960s but are now higher than before World War II. As a result, the working rich have replaced the rentiers at the top of the income distribution.

I. INTRODUCTION

According to Kuznets’ inuential hypothesis, income inequality should follow an inverse-U shape along the development process, ?rst rising with industrialization and then declining, as more and more workers join the high-productivity sectors of the economy [Kuznets 1955]. Today, the Kuznets curve is widely held to have doubled back on itself, especially in the United States, with the period of falling inequality observed during the ?rst half of the twentieth century being succeeded by a very sharp reversal of the trend since the 1970s. This does not, however, imply that Kuznets’ hypothesis is no longer of interest. One could indeed argue that what has been happening since the 1970s is just a remake of the previous inverse-U curve: a new industrial revolution has taken place, thereby leading to increasing inequality, and inequality will decline again at some point, as more and more workers bene?t from the innovations.

To cast light on this central issue, we build new homogeneous series on top shares of pretax income and wages in the United States covering the 1913 to 1998 period. These new series are based primarily on tax returns data published annually by the Internal Revenue Service (IRS) since the income tax was instituted in 1913, as well as on the large micro-?les of tax returns released by the IRS since 1960.

First, we have constructed annual series of shares of total income accruing to various upper income groups fractiles within the top decile of the income distribution. For each of these fractiles we also present the shares of each source of income such as wages, business income, and capital income. Kuznets [1953] did produce a number of top income shares series covering the 1913 to 1948 period, but tended to underestimate top income shares, and the highest group analyzed by Kuznets is the top percentile. Most importantly, nobody has attempted to estimate, as we do here, homogeneous series covering the entire century. Second, we have constructed annual 1927 to 1998 series of top shares of salaries for the top fractiles of the wage income distribution, based on tax returns tabulations by size of salaries compiled by the IRS since 1927. To our knowledge, this is the ?rst time that a homogeneous annual series of top wage shares starting before the 1950s for the United States has been produced. Finally, in order to complete our analysis of top capital income earners, we have also used estate tax returns tabulations to construct quasi-annual series (1916 to 1997) of top estates.

Our estimated top shares series display a U-shape over the century and suggest that a pure Kuznets mechanism cannot fully account for the facts. We ?nd that top capital incomes were severely hit by major shocks in the ?rst part of the century. The post-World War I depression and the Great Depression destroyed many businesses and thus significantly reduced top capital incomes. The wars generated large ?scal shocks, especially in the corporate sector that mechanically reduced distributions to stockholders. We argue that top capital incomes were never able to fully recover from these shocks, probably because of the dynamic effects of progressive taxation on capital accumulation and wealth inequality. We also show that top wage shares were at from the 1920s until 1940 and dropped precipitously during the war. Top wage shares have started to recover from theWorldWar II shock in the late 1960s, and they are now higher than before World War II. Thus, the increase in top income shares in the last three decades is the direct consequence of the surge in top wages. As a result, the composition of income in the top income groups has shifted dramatically over the century: the working rich have now replaced the coupon-clipping rentiers. We argue that both the downturn and the upturn of top wage shares seem too sudden to be accounted for by technical change alone. Our series suggest that other factors, such as changes in labor market institutions, ?scal policy, or more generally social norms regarding pay inequality may have played important roles in the determination of the wage structure. Although our proposed interpretation for the observed trends seems plausible to us, we stress that we cannot prove that progressive taxation and social norms have indeed played the role we attribute to them. In our view, the primary contribution of this paper is to provide new series on income and wage inequality.

One additional motivation for constructing long series is to be able to separate the trends in inequality that are the consequence of real economic change from those that are due to ?scal manipulation. The issue of ?scal manipulation has recently received much attention. Studies analyzing the effects of the Tax Reform Act of 1986 (TRA86) have emphasized that a large part of the response observable in tax returns was due to income shifting between the corporate sector and the individual sector [Slemrod 1996; Gordon and Slemrod 2000]. We do not deny that ?scal manipulation can have substantial short-run effects, but we argue that most long-run inequality trends are the consequence of real economic change, and that a short-run perspective might lead to attribute improperly some of these trends to ?scal manipulation.

The paper is organized as follows. Section II describes our data sources and outlines our estimation methods. In Section III we present and analyze the trends in top income shares, with particular attention to the issue of top capital incomes. Section IV focuses on trends in top wages shares. Section V offers concluding comments and compares our U. S. ?ndings with comparable series recently constructed for France by Piketty [2001a, 2001b] and for the United Kingdom by Atkinson [2001]. All series and complete technical details about our methodology are gathered in appendices of the working paper version of the paper [Piketty and Saez 2001].

II. DATA AND METHODOLOGY

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III. TOP INCOME SHARES AND COMPOSITION

III. A. Trends in Top Income Shares

The basic series of top income shares are presented in Table II. Figure I shows that the income share of the top decile of tax units from 1917 to 1998 is U-shaped. The share of the top decile uctuated around 40 to 45 percent during the interwar period. It declined substantially to about 30 percent during World War II and then remained stable at 31 to 32 percent until the 1970s when it increased again. By the mid-1990s the share had crossed the 40 percent level and is now at a level close to the prewar level, although a bit lower. Therefore, the evidence suggests that the twentieth century decline in inequality took place in a very speci Žc and brief time interval. Such an abrupt decline cannot easily be reconciled with a Kuznets-type process. The smooth increase in inequality in the last three decades is more consistent with slow underlying changes in the demand and supply of factors, even though it should be noted that a signiŽcant part of the gain is concentrated in 1987 and 1988 just after the Tax Reform Act of 1986 which sharply cut the top marginal income tax rates (we will return to this issue).

Looking at the bottom fractiles within the top decile (P90–95 and P95–99) in Figure II reveals new evidence. These fractiles account for a relatively small fraction of the total uctuation of the top decile income share. The drop in the shares of fractiles P90–95 and P95–99 during World War II is less extreme than that for the top decile as a whole, and they start recovering from theWorld War II shock directly after the war. These shares do not increase much during the 1980s and 1990s (the P90–95 share was fairly stable, and the P95–99 share increased by about 2 percentage points while the top decile share increased by about 10 percentage points).

In contrast to P90–95 and P95–99, the top percentile (P99 – 100 in Figure II) underwent enormous uctuations over the twentieth century. The share of total income received by the top 1 percent was about 18 percent before World War I, but only about 8 percent from the late 1950s to the 1970s. The top percentile share declined during World War I and the postwar depression (1916 to 1920), recovered during the 1920s boom, and declined again during the Great Depression (1929 to 1932, and 1936 to 1938) and World War II. This highly speciŽc timing for the pattern of top incomes, composed primarily of capital income (see below), strongly suggests that shocks to capital owners between 1914 and 1945 (depression and wars) played a key role. The depressions of the interwar period were far more profound in their effects than the post-World War II recessions. As a result, it is not surprising that the uctuations in top shares were far wider during the interwar period than in the decades after the war.

Figure II shows that the uctuation of shares for P90–95 and P95–99 is exactly opposite to the uctuation for P99–100 over the business cycle from 1917 to 1939. As shown below, the P90–95 and P95–99 incomes are mostly composed of wage income, while the P99 –100 incomes are mostly composed of capital income. During the large downturns of the interwar period, capital income sharply fell while wages (especially for those near the top), which are generally rigid nominally, improved in relative terms. On the other hand, during the booms (1923–1929) and the recovery (1933–1936), capital income increased quickly, but as prices rose, top wages lost in relative terms.

The negative effect of the wars on top incomes is due in part to the large tax increases enacted to Žnance them. During both wars, the corporate income tax (as well as the individual income tax) was drastically increased and this mechanically reduced the distributions to stockholders. National Income Accounts show that during World War II, corporate proŽts surged, but dividend distributions stagnated mostly because of the increase in the corporate tax (that increased from20 percent to over 50 percent) but also because retained earnings increased sharply. The decline in top incomes during the Žrst part of the century is even more pronounced for higher fractiles within the top percentile, groups that could be expected to rely more heavily on capital income. As depicted in Figure III, the income share of the top 0.01 percent underwent huge uctuations during the century. In 1915 the top 0.01 percent earned 400 times more than the average; in 1970 the average top 0.01 percent income was “only” 50 times the average; in 1998 they earned about 250 times the average income. Our long-term series place the TRA86 episode in a longer term perspective. Feenberg and Poterba [1993, 2000], looking at the top 0.5 percent income shares series ending in 1992 (respectively, 1995), argued that the surge after TRA86 appeared permanent. However, completing the series up to 1998 shows that the signiŽcant increase in the top marginal tax rate, from 31 to

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IV. TOP WAGE SHARES

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V. CONCLUSION

This paper has presented new homogeneous series on top shares of income and wages from 1913 to 1998. Perhaps surprisingly, nobody had tried to extend the pioneering work of Kuznets [1953] to more recent years. Moreover, important wage income statistics from tax returns had never been exploited before. The large shocks that capital owners experienced during the Great Depression and World War II seem to have had a permanent effect: top capital incomes are still lower in the late 1990s than before World War I. We have tentatively suggested that steep progressive taxation, by reducing the rate of wealth accumulation, has yet prevented the large fortunes to recover fully from these shocks. The evidence for wage series shows that top wage shares were at before World War II and dropped precipitously during the war. Top wage shares have started recovering from this shock only since the 1970s but are now higher than before World War II.

To what extent is the U. S. experience representative of other developed countries’ long-run inequality dynamics? Existing inequality series are unfortunately very scarce and incomplete for most countries, and it is therefore very difŽcult to provide a fully satisfactory answer to this question. However, it is interesting to compare the U. S. top income share series with comparable series recently constructed for France by Piketty [2001a, 2001b] and for the United Kingdom by Atkinson [2001]. There are important similarities between the American, French, and British pattern of the top 0.1 percent income share displayed in Figure XII.</ref> In all three countries, top income shares fell considerably during the 1914 to 1945 period, and they were never able to come back to the very high levels observed on the eve of World War I. It is plausible to think that in all three countries, top capital incomes have been hit by the depression and wars shocks of the Žrst part of the century and could not recover because of the dynamic effects of progressive taxation on capital. Piketty [2001a] also shows that in France, there was no spontaneous decline of top wage shares before World War II. In France, top wage shares declined during World War I, but they quickly recovered during the 1920s and were stable until World War II.

Some important differences, however, need to be emphasized. First, the shock of World War II was more pronounced in France and in the United Kingdom than in the United States. This is consistent with the fact that capital owners suffered from physical capital losses during the war in Europe, while there was no destruction on U. S. soil.39 Second, the World War II wage compression was very short-lived in France, while it had longlasting effects in the United States. In France, wage inequality, measured both in terms of top wage shares and in terms of interdecile ratios, appears to have been extremely stable over the course of the twentieth century. The U. S. history of wage inequality looks very different: the war compression had long-lasting effects, and then wage inequality increased considerably since the 1970s, which explains the U. S. upturn of top income shares since the 1970s.40 The fact that France and the United States display such diverging trends is consistent with our interpretation that technical change alone cannot account for the U. S. increase in inequality.

These diverging trends in top wages over the past 30 years explain why the income composition patterns of top incomes look so different in France and in the United States at the end of the century. In France, top incomes are still composed primarily of dividend income, although wealth concentration is much lower than what it was one century ago. In the United States, due to the very large rise of top wages since the 1970s, the coupon-clipping rentiers have been overtaken by the working rich. Such a pattern might not last for very long because our proposed interpretation also suggests that the decline of progressive taxation observed since the early 1980s in the United States could very well spur a revival of high wealth concentration and top capital incomes during the next few decades.

References

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	Author	volume	Date Value	title	type	journal	titleUrl	doi	note	year
2003 IncomeInequalityintheUnitedStat	Thomas Piketty (1971-present) Emmanuel Saez									2003

[[title::Income Inequality in the United States, 1913--1998|]]