Tuesday, April 19, 2011

The rich in Europe are poor.

Most of the focus of the policy discussion is the income of the poor and working class. As I have written previously, the American working and middle class is economically better off than their European counterpart. The poorest five percent have it better in Sweden compared to Swedish-Americans, whereas all other income groups earn more in the United States.

It is reasonable to focus on the well being of poor as a central measure of fairness and overall well being in a country. However, this focus can go to far, the poor are not the only group in society.

Today I want to discuss a different social group, the currently much maligned top ten percent of income earners. The group includes managers, successful business owners, professionals such as lawyers, doctors, consultants, civil engineers and also workers without a college degrees who are very good at what they do.

There are several reasons why we should care about the rich and upper middle classes.

The top percent of income is a non-negligible share of the population whose well being shouldn't be ignored just because they score low on the victimhood scale. Keep in mind that the share of the population who will be in the top ten percent at some point in their life-cycle is much higher than ten percent. The right over-exploits this argument (obviously not everyone has an equal chance of becoming rich, and many in society have close to zero opportunity). However the completely static view of the left is also an exaggeration.

More importantly, creating an environment where the most productive in society have incentives to acquire a lot of human capital, work hard, put their carrier ahead of leisure, work intensively and if necessary with unrewarding tasks, take risks and aim for the top is good also for everybody else.

* The more the high-skilled earn, the more we can tax them and fund welfare for the poor. According to the OECD, the top ten percent of American income earners pay 45% of taxes (this includes payroll taxes). In Sweden, the corresponding figure is only 27%, and in France 28% . Wouldn't ordinary Swedes be better off if our most talented worked more and paid more taxes?

* When you put a lot of skilled people together in knowledge industries and entice them to work hard, productivity appears to go up exponentially. This is what we observe in cities such as New York, and in elite organizations such as Mckinsey, Google or Harvard. These high-skilled individuals and organizations create a great deal of so-called innovation spillovers. The people who developed the microprocessor thus only captured a small fraction of the societal value created as private wealth. This is one reason I believe the standard estimates underestimate the negative effects of taxes on the economy, since they neither include innovation and knowledge spillovers or the effect skilled people have on the productivity of other skilled people.

* The high-skilled likely not only raise the productivity of each other, but also of the rest of society. When someone created a new venture he or she raises the productivity of the people hired. Similarly good managers are needed for companies to be productive.

* Lastly the high-income raise the wages of the poor by bidding up demand for their labor. Thus busboys in the U.S earn much more than busboys in El-Salvador, even if they perform the exact same task. The left tends to become angry whenever you point this out, although I have never seem them offer any arguments why this simple implication of economics doesn't hold.

Needless to say, raising the labor supply of the high-skilled generally does not imply theft from the poor. If a doctor or civil engineer postpones retirement for one year and earns more, that reflects more value created, not exploitation. There are examples when the high-skilled earn "rents" rather than create value (such as many lobbyist) or engage in zero-sum activity (some but far from all people in finance), but this is a minority of overall economic output of the professional classes.

We should be honest and admit that skilled professionals contribute more to society than the bottom ten percent. However I also believe that those at the top tend to have had a more privileged life and hence should feel a stronger social obligation.

In would guess that the behavior of the top ten percent is one of the most important reasons for the success of the U.S economy compared to that of Europe. Highly skilled Americans work crazy hours, are professional and motivated, and tend to be quite good at what they do. Probably mainly due to lower taxes and a better business climate, the top ten percent earn far more in the United States than in Europe.

An exciting new database by economists Facundo Alvaredo, Tony Atkinson, Thomas Piketty and Emmanuel Saez amongst others has data on the income level of the tenth percentile for several countries. This measure, P90, is the level of income that would make someone richer than exactly 90% of the population.

I have adjusted the figures for inflation and PPP based on OECD data. For a couple of countries the data was a few years prior to 2005, so I assumed their income share remained constant and their income increased with GDP.

These are not perfect estimates, because the data comes from different sources, have different units and different standards, you should just view them as illustrative. These are pre-tax income. Payroll taxes are not included, nor is employer funded benefits such as health insurance and pensions. These are mainly based on the statistics gathered by the tax-agency, so unreported income will not be included.


In 2005 the P90 threshold in the United States was $105.000, which means that ten percent of Americans had income at or above that level.

The same year the P90 threshold in Sweden was $43.000 (37700 kr), so if you earned this paltry sum you were among the top ten percent highest earners. In fact, less than 1 percent of Swedes earn more than $100.000 per year, about 880.000 kronor per year purchasing power adjusted.

This is confirmed by the Swedish Statistical Agency, which reports that in 2005 there were 61.000 Swedes who earned more than 800.000 kronor per year, or merely 0.8% of the adult population. 10.2% earned more than 360.000 kr, which again indicates that the figures are almost identical to the Top Income Database.

No doubt, those at the bottom are better off in Sweden than in the United States. However the middle class in Sweden is still somewhat poorer than the middle class in the United States, while high-skilled Swedes are far poorer than high-skilled Americans.

I don't think having few poor people requires us to keep the rich down. The left considers the relative poverty of the top earners in Sweden a good thing for Sweden, while I believe it is a problem. The comparative poverty of the rich is problematic both from the perspective of those hired by entrepreneurs, those who benefit from new technologies and products developed by skilled workers, those who sell their goods and services to the rich and not the least from the perspective of tax collection and the welfare state.

19 comments:

  1. Which table are you using? I get $102k nominal from "Total income, 2009". PPP seems to be doing the work here, but it's not clear to me that this allows us to ferret out a problem.

    ReplyDelete
  2. I guess that pay-roll taxes can explain say 50% of the difference, at least between Sweden and the US. Hours perhaps at most 20% more.

    Still, there is enormous wage-compression in Sweden. I've been trying to understand why, and maybe we economists do not understand bargaining within firms properly. That is, minimum wages etc. spill over and reduces income for the top earners. But I don't know.

    Any ideas?

    ReplyDelete
  3. Let's remember that there is a poor central part of Europe: Poland, Ukraine. We can only look up to our rich European friends: Germany, Norway, France, Italy....

    ReplyDelete
  4. What about the value of public services?

    ReplyDelete
  5. Pontus:

    The U.S data is for 2005, since most European countries don't have data after that. I picked the latest available year, and used GDP growth to scale up to 2005.

    Let me write the year used for all countries:

    US: 2005
    Sweden: 2005
    Spain: 2005
    Portugal: 2005
    Italy: 2004
    Canada: 2000
    France: 1998
    Germany: 1998

    The payroll tax explains much less than we might think, because payrolls taxes are the equivalent of pensions and health care contributions that employers make in the United States and which are not included in taxable income (typically equivalent to 25-30% of income).

    Hours are very important, I agree.

    You should remember that at around $50.000 the top marginal tax becomes 67% in Sweden. If you include consumption taxes, which you should, the top marginal tax becomes 75%. Why should I kill myself working 80 hours a week in a stressing job when I get to consume a quarter of what I produce?

    It is possible that there is a degree of "taxation" though flat wages structures induced by unions, so Swedish engineers are not only taxed directly, but also indirectly in the firm to cover the wages of low-income people. Still this doesn't explain why lawyers, accountants and others who work in firms without lots of low-skilled workers are so poor.

    hires:

    Remember, these are largely pre-tax income. Sure, the rich get public services, but they pay for these through taxes, which I have not removed. By design the rich pay more taxes than they get public services, so if you include taxes the difference becomes even larger!

    Let's do a after-tax comparison:

    The starting wage for an academic economist in a decent school in the United States is currently $140.000. On average they will pay 25-30% of this in federal and local taxes, let's say 30%.

    They are left with $108.000 after tax, of PPP adjusted 950.000 Swedish kronor. In addition they get health care and some pension subsidies from the employer.

    The starting after tax wage for elite Swedish universities for economists is currently 390.000 kronor per year. In a normal university you get around 310.000.

    We covered health care. Social Security is more or less the same as Swedish public pensions.

    The main benefit you get in Sweden but not in the U.S is childcare. Also the minority of Americans who send their children to a private University have to pay high tuitions, unless they get financial aid or want the student to borrow.

    But when you earn 2-3 times as much after tax, you can afford to pay for childcare yourself and save a little money for future tuition, no?

    ReplyDelete
  6. I would argue that the social compact in Sweden provides a much higher quality of life than there is generally in the US. Fancy cities such as NYC, LA, Seattle, Boston are exceptions, along with most private university communities. These cities are not the norm. People in Sweden and other countries making less money than some Americans have a much better life surrounding them. The wealthiest Americans reportedly payed only 17% in taxes in 2010, if any at all, see economist/NYT/WSJ article in the last weeks. Most corporations paid no taxes. Nearly 50 million Americans are at or below the poverty level. The USA has 2.3 million in prison and spends more on prisons than the entire educational system. Obesity is rampant. The Washington Post last month reported that while the average income for the top one percent of earners rose 281 percent, or $973,000 per household, in the last decade, the bottom 20% saw their incomes increase only 16 percent, or $2,400 per household, which is less than inflation for the period. How someone could argue that the mental and physical well-being of people living in poor circumstances, or even declining middle class communities of America, is on par with that of a people making an average of $943,000 per household isn't dealing with reality. Note also that people who have already accumulated wealth stand to earn a lot in capital gains, unearned income, which is also taxed at a lower rate. This wealth accumulates over time until the disparity between those who can accumulate and those who can't becomes striking. It is not a simple matter of hardworking people being fairly rewarded. It is a matter of manipulation of the system by those who have the wealth to do so.

    ReplyDelete
  7. Janjamm:

    First, I refuse to compare Swedes with all ethnic groups in the United States, including the Scott-Irish and newly arrived Mexicans . I compare them with Swedish-Americans. The poverty rate of Swedish Americans is 6.8% according to U.S Census. The poverty rate of Sweden using the American threshold is 6.8% [sic]. Now, the poor in Sweden get more benefits, so they are still somewhat better off, but the disparity is no nowhere near what you think.

    Other than the 5-10 percent poorest, every income group of Swedish-Americans does better than Swedes.

    According to the IRS the rich (those making more than 1 million) in 2008 paid 23% of their income in federal income taxes alone. You have to add to this payroll taxes, taxes collected at a corporate level, state and local taxes, sales taxes, property taxes.

    http://www.irs.gov/taxstats/indtaxstats/article/0,,id=96981,00.html

    Overall and using figures from memory the rich in the United States prior to the crisis paid a little more than 40% of their income in total taxes. After all, total tax revenue as a share of U.S national income was more than 30 percent prior to the crisis.

    A lot of your facts are myths. The U.S spends $1000 billion on education, $700 billion of which is public, and around $60 billion on prisons. Don't believe everything the left tells you.

    The number of corporation that pay taxes is irrelevant and misleading, out of the 22 million corporation in the United states 17 million have 0 employees. U.S corporation pay around $400 billion each year in taxes (though of course not during the crisis where many are losing money). This is above average for rich countries, despite the impression you have.

    I agree with you that we should close tax loopholes for the rich and for corporations.

    I don't agree that it is a problem that the United States has a lot of rich people, which would likely not be the case if you brought their taxes to Swedish or French levels.

    ReplyDelete
  8. I am not good at English.
    Sorry for my terrible English.

    I have a question about wage stracture.
    In Japan, People get salaries based by age.
    I guess US has same stracture.
    I heard Swedish people's salaries have not changed by age.
    These stracture would affect gini coefficient. But I do not know these analysis.
    Would you tell me a paper which write relationship between wage stracture and gini coefficient, or would you answer my question in this blog?

    ReplyDelete
  9. I understand your question, if the age-earning profile is such that income doesn't vary by age, compared to a country where it does vary the first country will appear to have less inequality in a snapshot, even though life-time inequality is the same.

    Here are average wages per month 2009 by age group in Sweden for workers.

    18-24 year 20900
    25-34 year 25600
    35-44 year 29400
    45-54 year 29700
    55-64 year 29200

    Here is total income per year 2009 by age group (this includes non-wage income, and includes people who don't work). Thousand Swedish kronor.

    20-24 år 110.4
    25-29 år 184.2
    30-34 år 242.1
    35-39 år 281.8
    40-44 år 305.6
    45-49 år 311.1
    50-54 år 308.3
    55-59 år 302.1
    60-64 år 290

    As you see income does vary by age also in Sweden, although perhaps not as much as Japan.

    http://www.scb.se/Pages/SubjectArea____1885.aspx

    ReplyDelete
  10. janjamm, I consider obesity to be the result of among other things being able to more easily afford food (after all you cannot get fat if you cannot afford to consume a lot of calories). I bet the 5% lowest earning Americans are heavier that the lowest earning 5% in any other country on weight. I have also Heard that even poor Americans have relatively high amounts of living space and vehicles.

    ReplyDelete
  11. Janjamm,

    When you are speaking of 'The Wealthiest Americans' I assume you are talking about those that only live off capital gains tax. Even then they do not only pay 17% however far be it from me to question a reporter from the Washington post...

    My father ( who is moderately wealthy ) pays when you include payroll taxes, health care costs, property taxes, etc and so on pays 5.1 Million in taxes on 6.5 Million of income. Not to mention the wages of $10 Million to employees. You see income from a business is taxed in SO MANY WAYS it is not even funny. I suppose we could throw sales tax in as well which ultimately means he spends close to 85% of income earned on taxes. Now is he still very well off? of course he is but for crying out loud please do not say that the 'wealthy' do not pay taxes, The Government finds so many ways to 'tax' you it is ridiculous.

    Add to this the stress of trying to keep people employed and find sources of revenue in a down economy and you begin to wonder if it is worth the trouble of employing people at all. I have seen him more than once sit at a table and break down in tears when he has to let people go because he can either pay taxes or let people go ( you may say why not simply pay himself less ) the answer is that if he were to do that Banks would not loan him money when he needs it. It is all an intricate balancing game and the Government and people who do not understand it simply cry for more taxes on them.

    I am not wealthy myself, I don't want to be. It is too much trouble, too much stress, and I do not have the temperament for it.

    Now admittedly what I am saying is anecdotal at best, however it is perhaps a point of view that you have never heard before. So when you read articles please do not simply accept them as truth. They are written often times in ignorance or with a point of view already decided.

    ReplyDelete
  12. Tino,

    First, thanks for the great post. I love hearing about all things Swedish. (Don't ask me why...)

    You may have already answered this question, but here it goes:

    Don't middle-class Swedes have it pretty good compared to their American counterparts, even if they technically don't earn as much money? I'm ignorant of what life in Sweden is really like, but it seems that the middle class in Sweden has a lot of advantages over middle-class Americans.

    For example, in the U.S., most people in the middle-class go deeply into debt to pay for college. Not so with Swedes, who just get taxed more, right?

    Also, healthcare coverage is extremely pricey in the States. My family was middle class, but there was no way in hell my parents could afford to pay several hundred dollars (per person) to cover me and my siblings every month. Not so with Swedes, who just get taxed more, right?

    So, although middle-class Swedes pay higher taxes and earn less, don't those tax dollars come back in ways that sustain the middle class in propitious ways, i.e. college education and healthcare?

    Thanks!

    ReplyDelete
  13. Remember, I write that even before taxes, middle class Swedes have *somewhat less* money. The services you talk about are paid by taxes. After taxes, Swedes have *much less* money.

    The middle class and the rich in Sweden pay more in taxes than they get back in benefits. Why? Because much of their taxes go towards subsidizing the poor and the 20% or so of the working age Swedish population that lives of government benefits.

    Let's do a comparison.

    The median male full time worker in the United States currently earns $50.000 per year. He also gets health insurance and typically some pension benefits.

    The median male full time worker in Sweden currently earns $35.000 (26.000 kr. per month).

    http://www.census.gov/hhes/www/income
    /data/historical/people/P24_2009.xls

    The American with this income will pay around $8.000 in federal, local and sales taxes, and ends up with around $42.000 after tax to consume for.

    The Swede will pay around $12.000 in income and sales taxes (the sales tax in Sweden is 25%), and ends up with $23.000 to consume for.

    These results are similar to others I have seen, where the American household had 70% more private consumption than Swedish households.

    Sure, the American has to pay childcare, make contributions to health care, save a buffer for sickness and unemployment, and save for college. But he has 19.000$ a year extra for this.


    Indeed the *median* net wealth of American households is if I remember correctly 7 times higher than Swedish households.

    One point about college. If you son goes to college, he is expected to earn a median salary of more than $70.000 per year. There is nothing preventing him from borrowing some of the cost of college himself and paying it with this future income, just as I did.

    Now not everything is about money, some people might like the fact that Sweden is clean, more ethnically homogenous, has a more equal distribution of income, has prettier girls and has lower crime (although the crime rate in middle class Americans areas is also low, whereas crime is rising in Sweden).

    Others might say that America is more free, has a stronger sense of community, is more culturally diverse, has a superior higher education system, has much more expensive but better health care (in my experience), generally has better weather (Chicago aside), has maintained stronger norms and better values, and offers motivated people more opportunity in life.

    But these things are hard to quantify. I can quantify income however, and the U.S does better for the middle class.

    ReplyDelete
  14. http://onlinelibrary.wiley.com/doi/10.1002/pam.20564/full

    Is this article correct?

    http://lanekenworthy.net/2011/01/31/the-great-decoupling/#comments

    And what do you think Miller's coment and Fred Thompson' reply?

    ReplyDelete
  15. I use an alternative way to estimate the increase in the income of those earning less than 100.000 per year from 1973

    http://super-economy.blogspot.com/2011/02/are-we-worse-off-than-in-1973.html

    ReplyDelete
  16. Indeed the *median* net wealth of American households is if I remember correctly 7 times higher than Swedish households.

    What's the source for that? According to this book (table 2.1, p. 32), the median individual net worth in Sweden was $83.3k in 1997, while int the US it was $93.1k (or $96.5k) in 2001.

    ReplyDelete
  17. The $83300 for median net worth of Swedes in 1997 would be far higher than anything I have ever seen.

    According to Statistics Sweden, in 2007 the *mean* net worth of Swedish households was $68.000!

    http://www.scb.se/Pages/TableAndChart____195803.aspx

    (601 thousand kronor, PPP is either 9.2 or 8.8, I use 8.8 to err on the side of caution).

    In 2007 according to the Federal Reserve the median net worth of Americans was $121.000, and the mean net worth $558.000.

    http://www.federalreserve.gov/pubs/oss/oss2/2007/bulletin.tables.int.xls

    According to Statistics Sweden the median net worth of Swedes in 2007 was 65 thousand kronor, or $7.400.

    http://www.scb.se/Pages/TableAndChart____166386.aspx

    Remember though that we are comparing American Households and Swedish individuals.

    Sweden is infamous for having low-net worth median families, in part because of the low income after taxes makes it hard to save, and in part because Swedes have a social safety net and don't need to save as much.

    ReplyDelete
  18. The book is likely wrong, those are weird numbers.

    According to Statistics Sweden median wealth was $7.000 in 2007, and mean wealth $68.000. These are individuals.

    http://www.scb.se/Pages/TableAndChart____166386.aspx

    According to the 2007 Federal reserve survey of consumer finance median wealth in U.S was $121.000 (households) and mean wealth $558.000.

    Swedes have notoriously low wealth, because they have too little post-tax income to save, and because they have less need to save due to the social safety net.

    ReplyDelete
  19. Tino, that book is a thorough study of wealth differences, so I would think that it is more reliable than your quick-and-dirty comparisons of statistics and surveys. There's much discussion in the book about how wealth is defined differently in different countries, making straightforward comparisons like yours difficult and potentially highly misleading.

    Here's the table I referred to above. I can send the book to you on pdf if you want to take a closer look.

    ReplyDelete

Google Analytics Alternative