How important is human capital at the top of the U.S. income distribution? Using tax data linking 11 million firms to their owners, this paper finds that entrepreneurs are key for understanding top income inequality. Most top income is non-wage income, a primary source of which is private “pass-through” business profit. These profits—which can include labor income disguised for tax reasons—accrue to working-age owners of closely-held, mid-market firms in skill-intensive industries. Pass-through business profit falls by three-quarters after owner retirement or premature death. Classifying three-quarters of pass-through profit as human capital income, we find that the typical top earner derives most of his or her income from human capital, not financial capital. Our approach also raises the overall top 1% labor share in 2014 from 45% to 56%. Growth in pass-through profit is explained by both rising productivity and a rising share of value added accruing to owners.
This is from Matthew Smith, Danny Yagan, Owen M. Zidar, and Eric Zwick, “Capitalists in the Twenty-First Century,” NBER Working Paper No. 25442. The NBER paper is gated, but here’s an ungated version.
Why is this important? Because it contradicts the image of the coupon-clipping rentier who doesn’t work for a living.
READER COMMENTS
Alan Goldhammer
May 27 2019 at 6:33pm
Are those either self-employed in the financial services industry or working for a large FS company entrepreneurs? What is the definition of an entrepreneur? Both are serious questions deserving of an answer in order to understand the statement.
I’m currently retired but I am running an investment portfolio to make sure I don’t have to go back to a day job. I don’t consider myself a “coupon-clipping rentier!”
David Henderson
May 27 2019 at 6:41pm
It’s not financial services particularly.
Thaomas
May 27 2019 at 6:37pm
Returns from human capital or financial capital is in turn relevant in decisions about taxation based on elasticity of income with respect to a progressive income or progressive consumption tax.
Phil H
May 27 2019 at 9:53pm
I’m not sure about this. The quote says that 50% of top earner income comes from their labour. I have to say, I don’t get 50% of my income from capital. If I did, I might be much more comfortable! Having that 50% of (a very high) income assured gives you leisure and the freedom to pick and choose your labour, which most of the rest of us don’t have. So I’m not convinced that the effects of capital inequality have been fully accounted for here.
There are also a couple of very common associated arguments that fall into statistical fallacy.
(A) One is that these high earners make much of their money from labour, therefore they deserve their income. There are two errors in such an argument: (1) It assumes that their income is caused by their excellence – a statistical mistake that assumes the income distribution would be flat if there were no variation in skill. It wouldn’t. (2) It assumes that their income is not caused by their capital, as above.
(B) The other is that if high earners make much of their money from labour, then there is in fact no problem with the way income is distributed. But there are many ways in which labour incomes can be skewed and cause unhelpful incentives.
Finally, I find these arguments a bit frustrating on this website. The best piece I ever read on Econlog was this: https://www.econlib.org/is-capital-morally-superior-to-labor/, in which the author bites the bullet of income from property. Does Henderson really believe that income from property is bad? If not, why make these arguments?
Vivian Darkbloom
May 28 2019 at 2:44am
It doesn’t strike me that the study adequately controlled for the amount of capital employed in the flow-through business before and after retirement/death. Much of what they report as a decline in income from “human capital” could well be a result of a decline in (financial) capital retained in the business. It seems likely that in many closely-held businesses there would be a reduction of monetary capital following death/retirement and not simply the elimination of the human capital of the owner. The reduction of capital in the business would not directly show up in IRS data. I read the summary of their methodolody and nothing I read suggests they controlled for that factor.
Cyril Morong
May 28 2019 at 2:00pm
Your headline uses 0.1% but the abstract says top 1%
David Henderson
May 28 2019 at 2:09pm
Thanks, Cyril. You’re right. They discuss both in the paper and I confused the two. Correction made.
Cyril Morong
May 28 2019 at 2:04pm
Here is something from Gary Becker in 2011
“According to a November 2010 study by Bakija, Cole, and Heim (I am indebted to Steve Kaplan for referring me to this study), more than 60% of the persons in the top 1% of the income distribution in 2005 consisted of (non-finance) executives, managers, and supervisors, medical personnel, lawyers, and non-finance persons doing computing, math, or engineering.”
https://www.becker-posner-blog.com/2011/11/the-occupy-wall-street-movement-becker.html
David Henderson
May 28 2019 at 2:10pm
Thanks for reminding me of that source.
Cyril Morong
May 28 2019 at 2:17pm
You’re welcome
Mattb
May 30 2019 at 11:50am
For a good example of this, you can look at how many doctors and lawyers are compensated. Law firm partners, who are often in the top 1%, aren’t paid on a W2, but are paid on a K-1. This might looks superficially like a return on financial capital, but it is really a return on human capital.
Vivian Darkbloom
May 30 2019 at 1:39pm
Not so fast, please. First, not all lawyers and doctors working in firms are partners in a partnership. Some work through professional service corporations and receive salaries even if they are managing owners. Those that do work as partners in flow-through partnerships don’t receive all (and, in many cases not a majority) of their income as flow-through business profits. Many, if not most large law firm partnerships provide “guaranteed payments” to partners. These are reported separately on Schedule K-1 and treated as self-employment income. Also, many, if not most, law partnerships will set aside a (significant) percentage of their annual profits to be paid out in the form of bonuses to partners who perform particularly well. This, too, is treated as self-employment income just as guaranteed payments are. Long gone are the days when senior partners are paid out a percentage of profits automatically in accordance with their capital share without performing valuable personal services. This explains the bonus pool rather than the lock-step business profit allocation. Finally, the portion of law firm (and medical firm) profits that actually is paid out and reported as “ordinary business income” may actually be just that. Law firms and medical firms have significant capital requirements just like any other business. Partners, particularly senior partners, have a significant amount of financial capital invested in their firms. In fact, a modern firm needs to invest a lot more in equipment, software, client advances, etc., not to mention non-partner employees, than has been the case in the past. It is possible to argue that some portion of the income actually reported on Schedule K-1 as a distributive share of ordinary income from the business is income from “human capital” rather than the financial capital invested in those firms, but to suggest that all income reported on Schedule K-1 disguises income from human capital as income from business capital is simply wrong.
Perhaps I don’t understand how this study controlled for changes in capital after retirement/death; but, as I noted in my earlier comment, there appear to be some serious methodology issues with this study. Therefore, I don’t have a great deal of confidence in the accuracy of the findings.
Comments are closed.