Capital in the Twenty-First Century (49 page)

In the poorer half of the top decile, we are truly in the world of managers: 80–90
percent of income comes from compensation for labor.
⁷
Moving up to the next 4 percent, the share of income from labor decreases slightly
but remains clearly dominant at 70–80 percent of total income in the interwar period
as well as today (see
Figures 8.3
and
8.4
). In this large “9 percent” group (that is, the upper decile exclusive of the top
centile), we find mainly individuals living primarily on income from labor, including
both private sector managers and engineers and senior officials and teachers from
the public sector. Here, pay is usually 2 to 3 times the average wage for society
as a whole: if average wages are 2,000 euros a month, in other words, this group earns
4,000–6,000 a month.

Obviously, the types of jobs and levels of skill required at this level have changed
considerably over time: in the interwar years, high school teachers and even late-career
grade school teachers belonged to “the 9 percent,” whereas today one has to be a college
professor or researcher or, better yet, a senior government official to make the grade.
⁸
In the past, a foreman or skilled technician came close to making it into this group.
Today one has to be at least a middle manager and increasingly a top manager with
a degree from a prestigious university or business school. The same is true lower
down the pay scale: once upon a time, the least well paid workers (typically paid
about half the average wage, or 1,000 euros a month if the average is 2,000) were
farm laborers and domestic servants. At a later point, these were replaced by less
skilled industrial workers, many of whom were women in the textile and food processing
industries. This group still exists today, but the lowest paid workers are now in
the service sector, employed as waiters and waitresses in restaurants or as shop clerks
(again, many of these are women). Thus the labor market was totally transformed over
the past century, but the structure of wage inequality across the market barely changed
over the long run, with “the 9 percent” just below the top and the 50 percent at the
bottom still drawing about the same shares of income from labor over a very considerable
period of time.

Within “the 9 percent” we also find doctors, lawyers, merchants, restaurateurs, and
other self-employed entrepreneurs. Their number grows as we move closer to “the 1
percent,” as is shown by the curve indicating the share of “mixed incomes” (that is,
incomes of nonwage workers, which includes both compensation for labor and income
from business capital, which I have shown separately in
Figures 8.3
and
8.4
). Mixed incomes account for 20–30 percent of total income in the neighborhood of
the top centile threshold, but this percentage decreases as we move higher into the
top centile, where pure capital income (rent, interest, and dividends) clearly predominates.
To make it into “the 9 percent” or even rise into the lower strata of “the 1 percent,”
which means attaining an income 4–5 times higher than the average (that is, 8,000–10,000
euros a month in a society where the average income is 2,000), choosing to become
a doctor, lawyer, or successful restaurateur may therefore be a good strategy, and
it is almost as common (actually about half as common) as the choice to become a top
manager in a large firm.
⁹
But to reach the stratosphere of “the 1 percent” and enjoy an income several tens
of times greater than average (hundreds of thousands if not millions of euros per
year), such a strategy is unlikely to be enough. A person who owns substantial amounts
of assets is more likely to reach the top of the income hierarchy.
¹⁰

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).

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.

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.