Sunday, May 4, 2014

A whopping 73 percent will spend a year in the top 20 percent of the income distribution

Excellent information in From Rags to Riches to Rags by Mark R. Rank.

Thomas Sowell has been arguing for years that our pundits, politicians, ideologues and other ne'er-do-wells are intellectually stymied by their persistent confusion between categories and populations. In other words, it is easy to talk about the category of 1%ers in income and mistake that for a population of 1%ers. But the reality is that the population of who constitutes the category of 1% changes year in and year out.

This confusion of what is being measured also underpins the mistaken chatter surrounding income inequality. There have been studies out in the past year suggesting that Europe, and Scandinavia in particular, has a higher income mobility than the US. This is based on measuring the Geni coefficient and comparing the income quintile of an adult with that of their parents when they were born.

Both Geni and intergenerational quintile comparisons are both rather crude measures of income mobility. Having lived in both Europe and the US, my personal experience is that there is much greater income dynamism in the US than in Europe and that the conclusions being reached are based on the limitations of the crude measures rather than an accurate reflection of reality.

What you really want to know is what are the patterns of income movement over a lifetime, and in particular whether there are populations that are able to entrench themselves by race, class, gender, education, profession, etc. in such a way that they are able to retain control over both income generation and wealth accumulation over long periods of time.

The answer, for the US, is No.
In order to answer such questions, Thomas A. Hirschl of Cornell and I looked at 44 years of longitudinal data regarding individuals from ages 25 to 60 to see what percentage of the American population would experience these different levels of affluence during their lives. The results were striking.

It turns out that 12 percent of the population will find themselves in the top 1 percent of the income distribution for at least one year. What’s more, 39 percent of Americans will spend a year in the top 5 percent of the income distribution, 56 percent will find themselves in the top 10 percent, and a whopping 73 percent will spend a year in the top 20 percent of the income distribution.

Yet while many Americans will experience some level of affluence during their lives, a much smaller percentage of them will do so for an extended period of time. Although 12 percent of the population will experience a year in which they find themselves in the top 1 percent of the income distribution, a mere 0.6 percent will do so in 10 consecutive years.
It is important to understand what we are talking about and to take particular care with what we are measuring and how. Too often, measurement is simply an effort to provide substantiation to a pre-existing belief rather than an exercise in truth seeking. To illustrate the importance of understanding what is going on, compare the possible policy implications between three different scenarios. Posit three countries in which there are 100 individuals who earn more than $10 million a year. In Country One, the 100 are simply the number of entrepreneurs reaching retirement age who are cashing out by selling their business. They have worked hard, long and legally and generated tremendous value but are now ready to retire. Every year it is a different group of 100 entrepreneurs.

In Country Two, the 100 are simply the 100 richest families with accumulated capital that allow them to weather the swings and roundabouts of economic flux and earn above average returns on their investment. It is basically the same 100 people each year with just five individuals moving in and out of the list.

In Country Three, the 100 are the 100 wealthiest professionals who generate their high income from regulatory capture and rent seeking. While there is some churn year to year, you basically see the same names time and again.

In terms of productivity, economic health and national productivity, Country One is in the best situation and Country Three in the worst. What do Geni indexes and intergenerational quintile numbers tell us about whether a country is One, Two or Three? Not much. You need something like a 1% Churn Rate to begin to get clarity on that.

You can see why this is important. If you are Country Three, you are probably well justified in pursuing some sort of confiscatory tax rates. You would certainly not want to do that in Country One - it would harm everyone by suppressing productive economic activity.

I think the US is far from Country One but much closer to Country One than any country is in Europe where models Two and Three are much more prevalent. Evidence supporting at least part of that assumption is available in the article.
A further example of such fluidity can be found in an analysis by the tax-policy expert Robert Carroll. Using data from the Internal Revenue Service, Mr. Carroll showed that between 1999 and 2007, half of those who earned over $1 million a year did so just once during this period, while only 6 percent reported millionaire status across all nine years.

Likewise, data analyzed by the I.R.S. showed similar findings with respect to the top 400 taxpayers between 1992 and 2009. While 73 percent of people who made the list did so once during this period, only 2 percent of them were on the list for 10 or more years. These analyses further demonstrate the sizable amount of turnover and movement within the top levels of the income distribution.
The importance of focusing on productivity and especially focusing on values and behaviors is underscored by
One of the reasons for such fluidity at the top is that, over sufficiently long periods of time, most American households go through a wide range of economic experiences, both positive and negative. Individuals we interviewed spoke about hitting a particularly prosperous period where they received a bonus, or a spouse entered the labor market, or there was a change of jobs. These are the types of events that can throw households above particular income thresholds.
This is part of the message of Thomas J. Stanley in The Millionaire Next Door. Most of those who become rich do so through slow and steady accumulation and disciplined constraint of consumption. In other words, you save on the up cycle and are protected from losses due to cyclical downturns by limited spending and the buffer represented by accumulated savings.

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