There Will Be Rich Always: Finding a New Way to Think About Income Inequality

On Monday, Aaron Edlin and I published a cri de coeur op-ed in the New York Times calling for a Brandeis tax, an automatic tax that would put the brakes on income inequality. In the next few days, Aaron and I will be publishing a series of posts explaining more about our rationale and providing more details on how a Brandeis tax might be implemented.

There Will Be Rich Always
By Ian Ayres & Aaron Edlin

In one of the more memorable lyrics from the musical Jesus Christ Superstar (based on Matthew 26:11), Jesus tells his disciples “There will be poor always.”

The same is true of the rich. There will always be a top 1 percent of income earners. But what it takes to be rich can change drastically over the course of even a single generation. In 1980, you would have had to earn at least $158,000 to be a one-percenter; but by 2006 the qualifying amount had more than doubled to $332,000. (You can produce an estimate of your own household income percentile – albeit using a different definition of income that produces a much higher 1 percent cutoff –  at this wsj.com site.) The rise is not due to inflation as both these numbers are expressed in inflation-adjusted, constant 2006 dollars. The rise is due to the simple fact that our richest Americans in real terms were earning much more money.

The economic changes in the past 30 years were a rising tide that did not lift all boats. Over the same period the median household income remained relatively constant, at roughly $50,000. While inequality has increased in most wealthy economies, the United States, according to the OECD, remains among the most unequal.

The vast shift in national income toward our richest 1 percent is especially vivid if their income is expressed in terms of the median household income. Indeed, an important goal of our op-ed was to suggest a new unit of measure, “medians” to help us think about what it means to be rich. In 1980, if you earned 3.8 medians, you were in the top 1 percent, but by 2006 even the poorest in the 1 percent club earned 6.9 medians. 

What we call the “Brandeis Ratio,” the average income of the richest 1 percent (which includes the billions earned by the lucky few) has grown even more disproportionate. As shown in the chart below, in 1980, one-percenters on average made 12.5 medians, but in 2006 (the latest year in which data is available) the average income of our richest 1 percent was a whopping 36 medians.

Define Rich?

In August 2008, the Reverend Rick Warren asked each of the presidential candidates Barack Obama and John McCain to:

Define “Rich.”  Give me a specific number. Where do you move from middle class to rich?

The candidates’ answers, given at what might be the high-water mark of income inequality in our nation’s history, reveals the difficulties that both parties have talking about economic class. McCain was visibly uncomfortable in naming a number:

So I think if you’re just talking about income, how about $5 million? So, no, but seriously, I don’t think you can — I don’t think, seriously, that — the point is that I’m trying to make here, seriously — and I’m sure that comment will be distorted — but the point is, the point is, the point is that we want to keep people’s taxes low and increase revenues.

In part, McCain was reluctant to name a figure which might be used to construct a new bracket to raise taxes – so he picked a large number; very large in terms of “medians.” McCain suggested that you would have to earn an income that is 100 times the median household income in order to “move from middle class to rich.” 

Obama in contrast gave a much more reasonable answer:

Here’s how I think about it, and this is reflected in my tax plan. If you are making $150,000 a year or less as a family, then you’re middle class, or you may be poor. But 150 (thousand dollars) down, you’re basically middle class. Obviously, it depends on region and where you’re living. . . .  I would argue that if you’re making more than 250,000 (dollars) then you’re in the top 3, 4 percent of this country. You’re doing well. Now, these things are all relative, and I’m not suggesting that everybody who is making over 250,000 (dollars) is living on Easy Street.

Obama should be given points for easily relating his cutoff of $250,000 to those Americans who are “in the top 3, 4 percent of this country.” But we are a little troubled at Obama’s describing family incomes of $150,000 as still being in the middle class, when these families earn 3 times what the median households earn. Survey data reveals contested definitions of middle class, and there is evidence that Americans disagree with Obama. In a 2007 study conducted by NPR, the Kaiser Foundation, and the Harvard School of Public Health, 51 percent of respondents did not consider a family of four with an $80,000 income middle class – that consensus rose to 65 percent when the family income rose to $100,000.

We as a nation seem to have trouble facing up to the fact that most Americans earn far less than what it takes to be comfortably middle class. We would do well to give more emphasis in our definition of the middle class to incomes earned by average Americans. Our aspirational middle class is making it too easy for us to forget what is happening to our actual middle class. 

A larger goal of our op-ed is to spark a different kind of debate about income inequality. Rev. Warren was crafty in that he only asked the candidates the descriptive question: what is rich. But we want people of goodwill to ask a normative analog. In our op-ed, we claim that it “would be bad for our democracy if one-percenters started making 40 or 50 times as much as the median American.” 

Is there any Brandeis Ratio that would give concern to this year’s Republican candidates? We suspect they would be unwilling to express unease with any level of inequality produced by market forces. They would argue that any government attempts to lean against inequality by taxing job-creators would invariably produce distortions (including sending one-percenters abroad, beyond the reach of our tax laws) that would end up making things worse off for middle class Americans. This is a debate worth having, but we cannot begin unless we find a way to engage in normative debate about income and wealth inequality. Asking whether the government should be concerned about the rapid rise of the average one-percent income from 12.5 to 36 median incomes is our way to provoke a more explicit debate.

Seeing Medians

Framing income inequality in terms of “medians” is also part of a larger goal of making the median household incomes more salient. As we said in our op-ed, “Part of our goal is to change the way politicians speak about income equality. Framing the income of the wealthy in relation to the median income will help us all keep in mind the relative success of the middle class.”

It might even be useful to describe other things in terms of medians. A new Cadillac Escalade will run you 1.4 medians. A  year’s tuition at Yale Law School is about .88 medians. We might even restructure government salaries so that they automatically adjust with the median. Paying a congressman 3.5 medians (instead of the current $174,000), might make it easier for our representatives to remember and even pursue the interests of their typical constituents.

To raise the prominence of the median measure, government could standardize a “mi” symbol. A stylized icon figure representing a median earner might even be more effective in letting us remember that to earn 36 median incomes is to earn as much as 36 actual households:

 

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  1. MrAtoZ says:

    I found the NY Times “cri” to be problematic on several levels, but here are three:
    First, how is the IRS supposed to determine this ratio in a real-time basis if the most recent data available to make the case of the op-ed is 5 years old?
    Second, if this is really how it’s supposed to work — “a tax that would limit the after-tax incomes of this club to 36 times the median household income” – are we really going to institute a varying marginal rate that could be 90%, or 99%, or 99.999% of income at that level?
    And lastly, regardless of how the Brandies ratio is flattened, how does a confiscatory tax rate really help the median household?

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    • Travis says:

      First, it isn’t difficult for the IRS to determine the ratio, and at worst they could use the previous year’s economic statistics on actual income to determine it.

      Second, yes, it would vary the marginal rate above roughly 1.5 million dollars.

      Third, this is an economics blog. Certainly you have thought abour incentives before. CEO’s are in a unique position to increase the median household income. If CEO’s want to increase their marginal income by reducing their actual tax rate, they are given an incentive to increase the median income in general.

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      • MrAtoZ says:

        Travis -
        To your third point: So you’re saying that these incentivized CEO’s, being all powerful, will collaborate on raising the income of everyone they possible can, even those not in their employ, as well as those who are retired, so the median household income rises to the point where the 99.99% tax on them is reduced?
        Okay, you are right that I thought this was an economics blog. I didn’t realize it was the magic elves workshop at the North Pole.

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  2. Artie Gold says:

    On so many occasions things published under the greater Freakonomics banner, while certainly both thoughtful and thought provoking, tend to just tick me off. Fre

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  3. chris says:

    Why the focus on income? Income isn’t wealth. Is it better to inherit a million dollars and work at the counter in fast food or be a doctor with a massive student loan?

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    • John B says:

      Chris is completely right.

      Wealth is the proper measurement, not income. Unfortunately these writers and many government programs confuse the two.

      Apply for student aid from a college; the forms ask about income, but not wealth.

      Apply for food stamps (like the Michigan lottery winner)–if you have $ in the bank, but low income–you qualify.

      Ridicuopous–just like this article.

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    • aepxc says:

      Exactly this.

      Income is a product not a cause. The amount of value one can create is a product of one’s effort, one’s skill at a given task, and what tools one has access to. So a lazy builder with the right tools will not build a the best house, a super-motivated person with the right tools but no knowledge or skill at construction will not build the best house, and a super-motivated builder stranded on a desert island will also not build the best house.

      The “tools one has access to” is otherwise known as wealth. Wealth inequality is what determines “equality of opportunity” and social mobility is what measures it. Income inequality, especially as a static measure, is really about “equality of outcome”.

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  4. Artie Gold says:

    On so many occasions things published under the greater Freakonomics banner, while certainly both thoughtful and thought provoking, tend to just tick me off. Frequently there’s a tacit acceptance of “just the way things are”, when it’s really a specific human construct that they are — for now — that way. Sometimes I find a correlation/causation fallacy running just under the surface.

    Not this time.

    For once (well, more than once; after all I *do* read this stuff more than occasionally) there is an appropriately normative dimension surfacing here. I’ve often said that in our current situation *even it you’re a true believer in the rightness of capitalism* (which, I’m not; on a good day I can at least subscribe to the “well, better than the others, when all is said and done” camp) you can’t believe that the current level of inequality of wealth is a reasonable thing, if only because it makes the entire system unsustainable. As wealth concentrates, more demand is funneled into assets, and specifically into assets whose value is not related to productive capacity, exactly the kinds of assets whose valuation is the most brittle. And, when things get off track, large amounts of wealth goes “pfffft”, those losses tend to be socialized, and we are where we are…

    Of course, I would argue that 36mis is probably too much, I would also argue that the shape of the curve matters, and matters a lot (not to mention its fractal nature). Of course, were there “mi”-based taxation, ways would be found to raise the “mi” without raising the actual meaningful median income…but that’s another issue entirely.

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  5. Eric M. Jones. says:

    See: http://www.periheliondesign.com/downloads/Wealth%20Distribution%202007%20update.pdf

    Here is the bad news…when the wealthy have all the power and the poor suffer, the economy spirals into undernourished diseased children on one end and overfed gout-afflicted plutocrats on the other.

    Lest conservatives zombies chime in with their preprogrammed “You can’t penalize the job creators…” let me say, we all make the decision whether we are our brother’s keepers or not. If not, then prepare to reap the whirlwind bubela.

    Arthur B. Kennickell of the Federal Reserve will (if allowed!) publish the real figures in the Spring of next year (I am told) and we may see that 50% of the wealth of the US is held by 1% of the people, and 50% of the people have 1% of the wealth.

    But, what the Hell, the jails are full.

    The way France solved this problem was to build a guillotine in every village square and chop the heads off 50,000 aristocrats. Let’s hope we can do better.

    Most people have NO IDEA what a Billion dollars is: What could one do with a billion dollars? A billion dollars is more than all the Alaskan gold mined in 2010—more than a cubic stack of gold bars 1 METER on a side. Just five percent of that billion dollars ($50 million) would get you: A lifetime lease on a Gulfstream jet at your beck and call. A home, condo or apartment in ten major exotic destinations, with a (leased) luxury fleet of cars at each, a coterie of servants to follow you around, memberships in every exclusive club, all you could possibly eat, wear, play with and see for the rest of you life. And Hell, throw in a yacht. Then you could sail around sipping expensive wines imagining ways to spend the other $950-million dollars.

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  6. Enter your name... says:

    This seems to have completely ignored two major issues, which are the variations in household characteristics and the regional variations.

    The “median household” is an adult with a $50K income. The “median family of four” has a $70K income and two children. Do we really want to tell that family that they’re relatively well off, because they’re supporting four people 140% of the income that someone else is supporting only one person (and with no childcare bills)?

    If you’re worrying about social issues, it makes more sense to compare the income of multi-person families against other multi-person families, and single adults against other single adults. It also makes more sense to compare people of similar ages. That’s what we do in the real world. We don’t look around at age 20 and say life is unfair because we’re making only $40K a year and a worker with 30 years more experience is making $60K. We don’t look at other families at school and say how great it is that most of us make more money than the single guy at the coffee shop. We’re more nuanced than that.

    Related to that, we compare against people in our actual social environment, not the whole country. It’s a big country, and the regional differences are substantial. In my town, the median household income is more than $90K. In my grandmother’s town, it’s $40K. An income that puts you at the 85th percentile in my grandmother’s town (and therefore relatively high-income) is barely middle of the pack in my town.

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  7. Enter your name... says:

    “We as a nation seem to have trouble facing up to the fact that most Americans earn far less than what it takes to be comfortably middle class.”

    This is illogical. It is not *possible* for more than half of a population to earn less than the median, just like it is not possible for all of the children to be above average, even in Lake Wobegon.

    The middle is the middle. Perhaps what you mean to say is that we as a nation seem to have trouble facing up to the fact that most Americans want a lifestyle that greatly exceeds what most Americans can pay for, and that we like to call that extravagant, television-fueled lifestyle “middle class” even though it is actually a more luxurious lifestyle than even wealthy people had before WWI.

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  8. Wm_Adams says:

    There’s a real fallacy in your logic when you try to compare overall medians with the mean of the top 1%. I would argue that the mean of that 1% is greatly distorted by the top 0.1%. Why not use the median of the top one percent?

    Your exception to the President’s definition of 150k as middle class sounds logical, but I doubt that many who make sun a sum think of themselves as upper class or even upper middle class. While they certainly make more than the median, how people self-identify is a greater measure. Perhaps you should consider that the middle is the old lower class, the 3-4% is all that’s left of the middle class, and the 0.1% is the upper class.

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