Capital in the Twenty-First Century
Page 33
It is interesting that it was only in the immediate postwar years (1919–1920 in France and then again 1945–1946) that this hierarchy was reversed: mixed incomes very briefly surpassed income from capital in the upper levels of the top centile. This apparently reflects rapid accumulation of new fortunes in connection with postwar reconstruction.11
To sum up: the top decile always encompasses two very different worlds: “the 9 percent,” in which income from labor clearly predominates, and “the 1 percent,” in which income from capital becomes progressively more important (more or less rapidly and massively, depending on the period). The transition between the two groups is always gradual, and the frontiers are of course porous, but the differences are nevertheless clear and systematic.
For example, while income from capital is obviously not altogether absent from the income of “the 9 percent,” it is usually not the main source of income but simply a supplement. A manager earning 4,000 euros a month may also own an apartment that she rents for 1,000 euros a month (or lives in, thus avoiding paying a rent of 1,000 euros a month, which comes to the same thing financially). Her total income is then 5,000 euros a month, 80 percent of which is income from labor and 20 percent from capital. Indeed, an 80–20 split between labor and capital is reasonably representative of the structure of income among “the 9 percent”; this was true between the two world wars and remains true today. A part of this group’s income from capital may also come from savings accounts, life insurance contracts, and financial investments, but real estate generally predominates.12
Conversely, within “the 1 percent,” it is labor income that gradually becomes supplementary, while capital increasingly becomes the main source of income. Another interesting pattern is the following: if we break income from capital down into rent on land and structures on the one hand and dividends and interest from mobile capital on the other, we find that the very large share of income from capital in the upper decile is due largely to the latter (especially dividends). For example, in France, the share of income from capital in 1932 as well as 2005 is 20 percent at the level of “the 9 percent” but increases to 60 percent in the top 0.01 percent. In both cases, this sharp increase is explained entirely by income from financial assets (almost all of it in the form of dividends). The share of rent stagnates at around 10 percent of total income and even tends to diminish in the top centile. This pattern reflects the fact that large fortunes consist primarily of financial assets (mainly stocks and shares in partnerships).
The Limits of Income Tax Returns
Despite all these interesting patterns, I must stress the limits of the fiscal sources used in this chapter. Figures 8.3 and 8.4 are based solely on income from capital reported in tax returns. Actual capital income is therefore underestimated, owing both to tax evasion (it is easier to hide investment income than wages, for example, by using foreign bank accounts in countries that do not cooperate with the country in which the taxpayer resides) and to the existence of various tax exemptions that allow whole categories of capital income to legally avoid the income tax (which in France and elsewhere was originally intended to include all types of income). Since income from capital is overrepresented in the top decile, this underdeclaration of capital income also implies that the shares of the upper decile and centile indicated on Figures 8.1 and 8.2, which are based solely on income tax returns, are underestimated (for France and other countries). These shares are in any case approximate. They are interesting (like all economic and social statistics) mainly as indicators of orders of magnitude and should be taken as low estimates of the actual level of inequality.
In the French case, we can compare self-declared income on tax returns with other sources (such as national accounts and sources that give a more direct measure of the distribution of wealth) to estimate how much we need to adjust our results to compensate for the underdeclaration of capital income. It turns out that we need to add several percentage points to capital income’s share of national income (perhaps as many as 5 percentage points if we choose a high estimate of tax evasion, but more realistically 2 to 3 percentage points). This is not a negligible amount. Put differently, the share of the top decile in national income, which according to Figure 8.1 fell from 45–50 percent in 1900–1910 to 30–35 percent in 2000–2010, was no doubt closer to 50 percent (or even slightly higher) in the Belle Époque and is currently slightly more than 35 percent.13 Nevertheless, this correction does not significantly affect the overall evolution of income inequality. Even if opportunities for legal tax avoidance and illegal tax evasion have increased in recent years (thanks in particular to the emergence of tax havens about which I will say more later on), we must remember that income from mobile capital was already significantly underreported in the early twentieth century and during the interwar years. All signs are that the copies of dividend and interest coupons requested by the governments of that time were no more effective than today’s bilateral agreements as a means of ensuring compliance with applicable tax laws.
To a first approximation, therefore, we may assume that accounting for tax avoidance and evasion would increase the levels of inequality derived from tax returns by similar proportions in different periods and would therefore not substantially modify the time trends and evolutions I have identified.
Note, however, that we have not yet attempted to apply such corrections in a systematic and consistent way in different countries. This is an important limitation of the World Top Incomes Database. One consequence is that our series underestimate—probably slightly—the increase of inequality that can be observed in most countries after 1970, and in particular the role of income from capital. In fact, income tax returns are becoming increasingly less accurate sources for studying capital income, and it is indispensable to make use of other, complementary sources as well. These may be either macroeconomic sources (of the kind used in Part Two to study the dynamics of the capital/income ratio and capital-labor split) or microeconomic sources (with which it is possible to study the distribution of wealth directly, and of which I will make use in subsequent chapters).
Furthermore, different capital taxation laws may bias international comparisons. Broadly speaking, rents, interest, and dividends are treated fairly similarly in different countries.14 By contrast, there are significant variations in the treatment of capital gains. For instance, capital gains are not fully or consistently reported in French tax data (and I have simply excluded them altogether), while they have always been fairly well accounted for in US tax data. This can make a major difference, because capital gains, especially those realized from the sale of stocks, constitute a form of capital income that is highly concentrated in the very top income groups (in some cases even more than dividends). For example, if Figures 8.3 and 8.4 included capital gains, the share of income from capital in the top ten-thousandth would not be 60 percent but something closer to 70 or 80 percent (depending on the year).15 So as not to bias comparisons, I will present the results for the United States both with and without capital gains.
The other important limitation of income tax returns is that they contain no information about the origin of the capital whose income is being reported. We can see the income produced by capital owned by the taxpayer at a particular moment in time, but we have no idea whether that capital was inherited or accumulated by the taxpayer during his or her lifetime with income derived from labor (or from other capital). In other words, an identical level of inequality with respect to income from capital can in fact reflect very different situations, and we would never learn anything about these differences if we restricted ourselves to tax return data. Generally speaking, very high incomes from capital usually correspond to fortunes so large that it is hard to imagine that they could have been amassed with savings from labor income alone (even in the case of a very high-level manager or executive). There is every reason to believe that inheritance plays a major role. As we will see in later chapters, however, the relative importance of inheritance and saving
has evolved considerably over time, and this is a subject that deserves further study. Once again, I will need to make use of sources bearing directly on the question of inheritance.
The Chaos of the Interwar Years
Consider the evolution of income inequality in France over the last century. Between 1914 and 1945, the share of the top centile of the income hierarchy fell almost constantly, dropping gradually from 20 percent in 1914 to just 7 percent in 1945 (Figure 8.2). This steady decline reflects the long and virtually uninterrupted series of shocks sustained by capital (and income from capital) during this time. By contrast, the share of the top decile of the income hierarchy decreased much less steadily. It apparently fell during World War I, but this was followed by an unsteady recovery in the 1920s and then a very sharp, and at first sight surprising, rise between 1929 and 1935, followed by a steep decline in 1936–1938 and a collapse during World War II.16 In the end, the top decile’s share of national income, which was more than 45 percent in 1914, fell to less than 30 percent in 1944–1945.
If we consider the entire period 1914–1945, the two declines are perfectly consistent: the share of the upper decile decreased by nearly 18 points, according to my estimates, and the upper centile by nearly 14 points.17 In other words, “the 1 percent” by itself accounts for roughly three-quarters of the decrease in inequality between 1914 and 1945, while “the 9 percent” explains roughly one-quarter. This is hardly surprising in view of the extreme concentration of capital in the hands of “the 1 percent,” who in addition often held riskier assets.
By contrast, the differences observed during this period are at first sight more surprising: Why did the share of the upper decile rise sharply after the crash of 1929 and continue at least until 1935, while the share of the top centile fell, especially between 1929 and 1932?
In fact, when we look at the data more closely, year by year, each of these variations has a perfectly good explanation. It is enlightening to revisit the chaotic interwar period, when social tensions ran very high. To understand what happened, we must recognize that “the 9 percent” and “the 1 percent” lived on very different income streams. Most of the income of “the 1 percent” came in the form of income from capital, especially interest and dividends paid by the firms whose stocks and bonds made up the assets of this group. That is why the top centile’s share plummeted during the Depression, as the economy collapsed, profits fell, and firm after firm went bankrupt.
By contrast, “the 9 percent” included many managers, who were the great beneficiaries of the Depression, at least when compared with other social groups. They suffered much less from unemployment than the employees who worked under them. In particular, they never experienced the extremely high rates of partial or total unemployment endured by industrial workers. They were also much less affected by the decline in company profits than those who stood above them in the income hierarchy. Within “the 9 percent,” midlevel civil servants and teachers fared particularly well. They had only recently been the beneficiaries of civil service raises granted in the period 1927–1931. (Recall that government workers, particularly those at the top of the pay scale, had suffered greatly during World War I and had been hit hard by the inflation of the early 1920s.) These midlevel employees were immune, too, from the risk of unemployment, so that the public sector’s wage bill remained constant in nominal terms until 1933 (and decreased only slightly in 1934–1935, when Prime Minister Pierre Laval sought to cut civil service pay). Meanwhile, private sector wages decreased by more than 50 percent between 1929 and 1935. The severe deflation France suffered in this period (prices fell by 25 percent between 1929 and 1935, as both trade and production collapsed) played a key role in the process: individuals lucky enough to hold on to their jobs and their nominal compensation—typically civil servants—enjoyed increased purchasing power in the midst of the Depression as falling prices raised their real wages. Furthermore, such capital income as “the 9 percent” enjoyed—typically in the form of rents, which were extremely rigid in nominal terms—also increased on account of the deflation, so that the real value of this income stream rose significantly, while the dividends paid to “the 1 percent” evaporated.
For all these reasons, the share of national income going to “the 9 percent” increased quite significantly in France between 1929 and 1935, much more than the share of “the 1 percent” decreased, so that the share of the upper decile as a whole increased by more than 5 percent of national income (see Figures 8.1 and 8.2). The process was completely turned around, however, when the Popular Front came to power: workers’ wages increased sharply as a result of the Matignon Accords, and the franc was devalued in September 1936, resulting in inflation and a decrease of the shares of both “the 9 percent” and the top decile in 1936–1938.18
The foregoing discussion demonstrates the usefulness of breaking income down by centiles and income source. If we had tried to analyze the interwar dynamic by using a synthetic index such as the Gini coefficient, it would have been impossible to understand what was going on. We would not have been able to distinguish between income from labor and income from capital or between short-term and long-term changes. In the French case, what makes the period 1914–1945 so complex is the fact that although the general trend is fairly clear (a sharp drop in the share of national income going to the top decile, induced by a collapse of the top centile’s share), many smaller counter-movements were superimposed on this overall pattern in the 1920s and 1930s. We find similar complexity in other countries in the interwar period, with characteristic features associated with the history of each particular country. For example, deflation ended in the United States in 1933, when President Roosevelt came to power, so that the reversal that occurred in France in 1936 came earlier in America, in 1933. In every country the history of inequality is political—and chaotic.
The Clash of Temporalities
Broadly speaking, it is important when studying the dynamics of the income and wealth distributions to distinguish among several different time scales. In this book I am primarily interested in long-term evolutions, fundamental trends that in many cases cannot be appreciated on time scales of less than thirty to forty years or even longer, as shown, for example, by the structural increase in the capital/income ratio in Europe since World War II, a process that has been going on for nearly seventy years now yet would have been difficult to detect just ten or twenty years ago owing to the superimposition of various other developments (as well as the absence of usable data). But this focus on the long period must not be allowed to obscure the fact that shorter-term trends also exist. To be sure, these are often counterbalanced in the end, but for the people who live through them they often appear, quite legitimately, to be the most significant realities of the age. Indeed, how could it be otherwise, when these “short-term” movements can continue for ten to fifteen years or even longer, which is quite long when measured on the scale of a human lifetime.
The history of inequality in France and elsewhere is replete with these short- and medium-term movements—and not just in the particularly chaotic interwar years. Let me briefly recount the major episodes in the case of France. During both world wars, the wage hierarchy was compressed, but in the aftermath of each war, wage inequalities reasserted themselves (in the 1920s and then again in the late 1940s and on into the 1950s and 1960s). These were movements of considerable magnitude: the share of total wages going to the top 10 percent decreased by about 5 points during each conflict but recovered afterward by the same amount (see Figure 8.1).19 Wage spreads were reduced in the public as well as the private sector. In each war the scenario was the same: in wartime, economic activity decreases, inflation increases, and real wages and purchasing power begin to fall. Wages at the bottom of the wage scale generally rise, however, and are somewhat more generously protected from inflation than those at the top. This can induce significant changes in the wage distribution if inflation is high. Why are low and medium wages better indexed to inflation than hi
gher wages? Because workers share certain perceptions of social justice and norms of fairness, an effort is made to prevent the purchasing power of the least well-off from dropping too sharply, while their better-off comrades are asked to postpone their demands until the war is over. This phenomenon clearly played a role in setting wage scales in the public sector, and it was probably the same, at least to a certain extent, in the private sector. The fact that large numbers of young and relatively unskilled workers were mobilized for service (or held in prisoner-of-war camps) may also have improved the relative position of low- and medium-wage workers on the labor market.
In any case, the compression of wage inequality was reversed in both postwar periods, and it is therefore tempting to forget that it ever occurred. Nevertheless, for workers who lived through these periods, the changes in the wage distribution made a deep impression. In particular, the issue of restoring the wage hierarchy in both the public and private sectors was one of the most important political, social, and economic issues of the postwar years.
Turning now to the history of inequality in France between 1945 and 2010, we find three distinct phases: income inequality rose sharply between 1945 and 1967 (with the share going to the top decile increasing from less than 30 to 36 or 37 percent). It then decreased considerably between 1968 and 1983 (with the share of the top decile dropping back to 30 percent). Finally, inequality increased steadily after 1983, so that the top decile’s share climbed to about 33 percent in the period 2000–2010 (see Figure 8.1). We find roughly similar changes of wage inequality at the level of the top centile (see Figures 8.3 and 8.3). Once again, these various increases and decreases more or less balance out, so it is tempting to ignore them and concentrate on the relative stability over the long run, 1945–2010. Indeed, if one were interested solely in very long-term evolutions, the outstanding change in France during the twentieth century would be the significant compression of wage inequality between 1914 and 1945, followed by relative stability afterward. Each way of looking at the matter is legitimate and important in its own right, and to my mind it is essential to keep all of these different time scales in mind: the long term is important, but so are the short and the medium term. I touched on this point previously in my examination of the evolution of the capital/income ratio and the capital-labor split in Part Two (see in particular Chapter 6).