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We are the super rich

In many countries the richest of the rich are getting richer. Your political power is also growing. But is that really bad?

By Norbert Berthold and Klaus Gründler

Much of the rising income inequality is due to the wealth of top earners. These are the real giants of the income distribution, ranking in the top 10 percent, the top 1 percent, and the top 0.1 percent.

First of all, we should ask ourselves who is actually earning a top income. If we look at the global distribution of income, the provocative answer to this question is probably simply: You, dear readers! The website “globalrichlist.com” offers the opportunity to compare one's own annual household income with the global income distribution. An example: People who earn an annual net income of 15,000 euros in Germany are already among the richest 4.68 percent of the global income distribution and thus rank among the richest 280 million people on earth. An annual net income of 35,000 euros even helps achieve a place among the top 0.48 percent or the richest 28 million people on the globe.

When we talk about top earners, in most cases we don't mean the global context, but rather the national environment. Here the picture is indeed changing drastically: To belong to the top 10 percent in Germany, an annual income of around 70,000 euros must be achieved, the limit to the top 1 percent is around 150,000 euros, the limit the top 0.5 percent is even 500,000 euros.

The income share of this top group is significant and has risen sharply in recent years. By far the greatest increase was recorded by the top earners in the United States. In the early 1980s, the income share of the super-rich, at around 8.5 percent, was already above the OECD average (7.1 percent), but was exceeded by Germany (9.6 percent). In the decades that followed, however, the United States' income share of the top 1 percent doubled. Today, around 30 years later, the concentration of just under 20 percent is unique even in the group of developed OECD nations: While the value in the OECD is currently 9 percent, Austria (6.6 percent), France (8th , 4 percent) and Japan (9.5 percent) far below American standards. Germany ranks in the upper middle field with 13.6 percent and is in a group with Mexico and Israel.

A closer look at the various groups of countries reveals a clear pattern: especially in the Anglo-Saxon nations, the income shares of the super-rich have risen sharply since the beginning of the 1980s (from 7.5 to 13.5 percent), while in the rest of them they have increased OECD countries remained at a more or less constant level of around 8 percent. From this development we can draw an important conclusion: The parallels in the development of market inequality between the OECD nations suggest a strong influence of global trends. The asynchronous increase in the income shares of the rich, on the other hand, suggests an institutional explanation.

To understand this argument, let's first look at the relatively well-paid technical professions. The “Entgeltatlas” of the Federal Employment Agency provides detailed information on the average salaries in the various fields of activity. According to this, the average annual salary of a business informatics graduate is between 40 260 euros and 54 312 euros, a software developer is paid on average between 44 112 euros and 54 888 euros, while the average annual income of a mechatronics engineer is between 40 920 euros and 51 936 euros . Depending on the region and degree, there are strong fluctuations, but none of the professions can be found among the top ten percent (75,000 euros) or even the top one percent (150,000 euros).

Why have top incomes soared? The institutional adjusting screw that influences the net income shares of high-income earners more than any other is the tax system. The more progressive this is, the lower the income of the super-rich after taxes and transfers. The French economists Thomas Piketty, Emmanuel Saez and Stefanie Stantcheva made an astonishing discovery in 2011: Apparently not only the net income shares of the top one percent correlate with the top tax rate, but also the gross income shares in particular and to a much greater extent.

Thomas Piketty, one of these economists, became known to the general public in 2014 when he published his influential popular science book “Capital in the 21st Century”. The approximately 800-page work was also widely used outside the specialist audience and even made it onto the bestseller lists. The discovery that Piketty made shortly before the publication of his book is illustrated in the graphic opposite. This shows the connection between the change in the income ratio of the top one percent and the change in the top tax rates from 1960 to 2009. In total, there is a relatively strong negative correlation between the two figures of almost 50 percent. While the top tax rates were reduced in all of the abolished countries between 1960 and 2009, the decline is particularly pronounced in America and Great Britain. At the same time, the share of top income earners has increased most significantly there. On the other side of the spectrum are Spain, Finland and Germany, where the top tax rates are still or are at a similar level as in 1960. In these countries the increases in the super-rich are significantly lower.

Where does this strong correlation come from? The explanations for this phenomenon clearly show us the channels through which the top earners contribute to inequality. The first explanation argues with the different tax avoidance strategies. The lower the top tax, the lower the incentive for high income earners to avoid national taxes in various ways. The second argument is aimed at wage negotiation. If the top tax rate is very high, the additional net income from a wage negotiation is small. Accordingly, those earning top incomes have little incentive to insist on a higher wage in wage negotiations. However, if the top tax rates fall, the proportion of each additional gross euro that remains after taxes increases. In this case, top earners have a great incentive to use their bargaining power in favor of higher wages.

The third explanation argues that the relationship in our graph reflects a correlation but not a causality and is influenced by a third variable. During the 1980s, both in America under Ronald Reagan and under Margaret Thatcher in Great Britain, there was more or less simultaneous substantial tax cuts, which went hand in hand with a large number of deregulations. The latter have particularly benefited those earning top incomes.

But investment income also plays an important role. These arise when households save part of their income and the wealth created in this way generates annual income in the form of dividends or interest. The worldwide savings rate is currently 24 percent, in Germany the percentage saved is slightly higher (27 percent), in the United States lower (18 percent). On average, therefore, very few households will migrate to the group of the richest through investment income on their own savings deposits. Many households may therefore dream of the "rich heir aunt from overseas" who promises an unexpected windfall. That this scenario is in fact not unrealistic becomes clear when we consider the share of inherited wealth in relation to total wealth. This has risen sharply in Europe and America since the 1970s and is currently almost 60 percent. This development suggests that some of the top earners did not move to the top through earned income, but that participation in the top group is based on capital income, which arises from the inheritance of large fortunes.

Finally, the relationship shown in our graphic can also be interpreted in reverse. Since the graph does not provide any conclusions about the direction of causality, it is quite conceivable that it is not the low taxes that lead to high income shares for the super-rich, but that a strong elite exerts political influence and thus contributes to a reduction in the top tax. In 2014, the two American political scientists Martin Gilens and Benjamin Page examined a total of 1779 policy decisions that were adopted between 1981 and 2002. The authors compared these decisions with the preferences of average voters and those earning top incomes. It turns out that there is only a weakly positive correlation between the preferences of the average voter and the corresponding policy measures. In contrast, the preferences of the economic elite are strongly correlated with the political actions carried out. More precisely, the study shows that the probability is close to zero that a measure is carried out against the will of the top income earners. Conversely, the probability of taking a measure increases sharply as soon as it finds broad support among the top income earners.

The political influence of the top earners can be found in a similar form in other countries. One of our studies examines the influence of the rich on the generosity of the social system in a broad country sample. The results clearly show that those earning top incomes - who are ultimately net contributors to a redistributive policy - have a significantly negative impact on national redistributive efforts. This effect is stronger the further we climb the income ladder. This means that the top 0.01 percent have a stronger effect than the top 0.1 percent, who in turn have greater political power than the top 1 percent.

The endeavor to improve economic success through the relationship to politics is referred to by economists as "crony capitalism", which in German is usually concisely translated as nepotism or simply nepotism. The examples in reality are diverse and range from financial benefits, tax loopholes, subsidies to market entry barriers for competitors and various protectionist measures. Through these channels, nepotistic tendencies lead to an increase in the proportion of top earners and increase economic inequality. In the long term, such action can have serious consequences for economic development and democracy.

However, it is important to emphasize that not all top incomes are of course detrimental to living standards. The top income earners finance transfer payments to poorer families through higher tax payments, while entrepreneurial activity creates jobs that create welfare for private households. According to the latest compilations from the German Institute for Economic Research (DIW) from 2016, 41.5 percent of all taxes paid in Germany were paid by the top 10 percent of the income distribution. In an attempt to defend the top 1 percent, Harvard professor Gregory Mankiw set up the following thought experiment: In a society with perfect equal distribution, one member suddenly develops a product that all other members want. This happened, for example, when Joanne K. Rowling broke all sales records with her Harry Potter series in the late 1990s. By buying the books, both sides were better off. The readers of the Harry Potter series for being taken into the magical world of Hogwarts by Joanne K. Rowling; Joanne K. Rowling for having earned around $ 1 billion in personal fortune by selling the series, making her a safe place in the top 0.01 percent of distribution in the UK. Since in this case many buyers face one seller, inequality in society increases sharply. Nevertheless, millions of readers would protest indignantly if the author were forbidden to publish further stories from the Harry Potter universe for distribution reasons.

Norbert Berthold is Professor of Economics at the University of Würzburg; Klaus Gründler is a research associate there.

Norbert Berthold and Klaus Gründler: Inequality, Social Mobility and Redistribution A preprint.