Income inequality and Marginal Revolution

Tyler Cowen at Marginal Revolution discusses a recent demographic study of who, exactly, the top US wage earners are. We've discussed the problem of growing US income inequality here before.

To make the top 1 percent in AGI (IRS: Adjusted Gross Income), you needed to earn $309,160. To make it to the top 0.1 percent, you needed $1.4 million (2004 figures).

Here's a nice factoid:

...the top 25 hedge fund managers combined appear to have earned more than all 500 S&P 500 CEOs combined (both realized and estimated).

Somewhat misleading, as this includes returns on the hedgies' own capital invested as part of their funds. But, still, you get the picture of our gilded age :-)

One of the interesting conclusions from the study is that executives of non-financial public companies are a numerically rather small component of top earners, comprising no more than 6.5%. Financiers comprise a similar, but perhaps larger, subset. Who are the remaining top earners? The study can't tell! (They don't know.) Obvious candidates are doctors in certain lucrative specialties, sports and entertainment stars and owners of private businesses. The category which I think is quite significant, but largely ignored, is founders and employees of startups that have successful exits. Below is the comment I added to Tyler's blog:

The fact that C-level execs are not the numerically dominant subgroup is pretty obvious. The whole link between exec compensation and inequality is a red herring (except in that it symbolizes our acceptance of winner take all economics).

I suspect that founders and early employees of successful private companies (startups) that have a liquidity event (i.e., an IPO or acquisition) are a large subset of the top AGI group. Note, though, that this population does not make it into the top tier (i.e., top 1 or .1%) with regularity, but rather only in a very successful year (the one in which they get their "exit"). Any decent tech IPO launches hundreds of employees into the top 1 or even .1%.

It is very important to know what fraction of the top group are there each year (doctors, lawyers, financiers) versus those for whom it is a one-time event (sold the business they carefully built over many years). If it is predominantly the latter it's hard to attribute an increase in top percentile earnings to unhealthy inequality.

To be more quantitative: suppose there are 1M employees at private companies (not just in technology, but in other industries as well) who each have a 10% chance per year of participating in a liquidity event that raises their AGI to the top 1% threshold. That would add 100k additional top earners each year, and thereby raise the average income of that group. If there are 150M workers in the US then there are 1.5M in the top 1%, so this subset of "rare exit" or employee stock option beneficiaries would make up about 7% of the total each year (similar to the corporate exec number). But these people are clearly not part of the oligarchy, and if the increase in income inequality is due to their shareholder participation, why is that a bad thing?

We reported earlier on the geographic distribution of income gains to the top 1 percent: they are concentrated in tech hotbeds like silicon valley, which seems to support our thesis that the payouts are not going to the same people every year.