The Meritocracy Trap

by Daniel Markovits

  nearly seven in ten are: See Steven Kaplan and Joshua Rauh, “Family, Education, and Sources of Wealth Among the Richest Americans, 1982–2012,” American Economic Review 103, no. 3 (May 2013): 158–62, 159. Hereafter cited as Kaplan and Rauh, “Family, Education, and Sources of Wealth.” Between 1982 and 2011, the share of Forbes 400 members who grew up with wealth dropped from 60 percent to 32 percent. See also James Pethokoukis, “How Super-Rich Americans Get That Way Is Changing,” AEIdeas, American Enterprise Institute, March 23, 2016, www.aei.org/publication/how-super-rich-americans-get-that-way-is-changing/.

  outnumber purely inherited ones: See James Pethokoukis, “More and More of America’s Superrich May Be Getting That Way Through Entrepreneurship,” AEIdeas, American Enterprise Institute, December 22, 2014, accessed August 26, 2018, www.aei.org/publication/americas-superrich-getting-way-entrepreneurship/.

  between 1961 and 2007: See Winters, Oligarchy, 247, Table 5.4. The percentages are: 1961, 22.3 percent; 1992, 47.4 percent; 2007, 34.4 percent. The Forbes list was inaugurated in 1982, but we have data for 1961 on account of the fluke that, in that year, 398 taxpayers had income sufficient to get into the highest tax bracket, and so were counted by the IRS. David Cay Johnston, “Is Our Tax System Helping Us Create Wealth?,” Tax Notes, December 21, 2009, www.taxnotes.com/tax-notes/budgets/our-tax-system-helping-us-create-wealth/2009/12/21/qjq2.

  between 1982 and 2011: From 17 percent in 1982 to just 5 percent by 2011. See Kaplan and Rauh, “Family, Education, and Sources of Wealth,” 158–62, 160.

  24 percent from finance: See Les Leopold, “Five Obscene Reasons the Rich Grow Richer,” Salon, October 1, 2012, accessed August 26, 2018, www.salon.com/2012/10/01/five_obscene_reasons_the_rich_grow_richer/. In 2017, ninety-two of the four hundred (approximately 23 percent) richest people worked in finance or finance and investments, and fifteen (3.75 percent) worked in manufacturing. See “Forbes 400,” Forbes, accessed August 26, 2018, www.forbes.com/forbes-400/list/.

  do not make the papers: See Nathan Vardi, “The 25 Highest-Earning Hedge Fund Managers & Traders,” Forbes, March 14, 2017, accessed August 26, 2018, www.forbes.com/sites/nathanvardi/2017/03/14/hedge-fund-managers/#3402d78d6e79.

  on average $2.4 million: See Will Wainewright and Lindsay Fortado, “Hedge Fund Manager Compensation Rises 8% to $2.4 Million,” Bloomberg, November 6, 2014, accessed August 26, 2018, www.bloomberg.com/news/articles/2014-11-06/hedge-fund-manager-compensation-rises-8-to-2-4-million.

  reached over $420,000: See “The Securities Industry in New York City,” Office of the New York State Comptroller, September 2018, accessed October 24, 2018, www.osc.state.ny.us/osdc/rpt6-2019.pdf. Incredibly, bonuses were even higher just before the 2007–8 financial crisis, when they reached over $190,000. See “New York City Securities Industry Bonuses,” Office of the New York State Deputy Comptroller, January 28, 2009, accessed August 20, 2018, www.osc.state.ny.us/osdc/wallst_bonuses/2009/bonus2009.pdf, and “New York City Securities Industry Bonus Pool,” Office of the New York State Comptroller, March 26, 2018, accessed August 20, 2018, www.osc.state.ny.us/press/releases/mar18/wall-st-bonuses-2018-sec-industry-bonus-pool.pdf.

  Small wonder that according to one calculation, the financial sector’s overall representation in the top tiers of wealth has increased by a factor of ten since the 1970s. See Eric Posner and E. Glen Weyl, “Against Casino Finance,” National Affairs 14 (Winter 2013): 58–77, 62, accessed November 18, 2018, www.nationalaffairs.com/publications/detail/against-casino-finance. Hereafter cited as Posner and Weyl, “Against Casino Finance.” Posner and Weyl cite Kaplan and Rauh, “Wall Street and Main Street,” which examines the composition of the top 0.1 percent, 0.01 percent, 0.001 percent, and 0.0001 percent of income distribution by employment sector.

  an owner of bank stocks: See, e.g., “Going Overboard,” The Economist, July 16, 2009, accessed August 21, 2018, www.economist.com/node/14034875/print?story_id=14034875.

  nearly $14 million: “Executive Paywatch,” AFL-CIO, accessed August 21, 2018, https://aflcio.org/paywatch.

  The highest-paid CEO in 2013 made $141.9 million and the two-hundredth-highest-paid CEO made $12.4 million. See Karl Russell, “The Pay at the Top,” New York Times, June 7, 2014, accessed August 26, 2018, www.nytimes.com/interactive/2014/06/08/business/the-pay-at-the-top.html.

  In 2014, the highest-paid CEO made $156.1 million and the two-hundredth-highest-paid CEO made $12.6 million. See “Highest-Paid Chiefs in 2014,” New York Times, May 16, 2015, accessed August 26, 2018, www.nytimes.com/interactive/2015/05/14/business/executive-compensation.html.

  In 2015, the highest-paid CEO made $94.6 million and the two-hundredth-highest-paid CEO made $12.2 million. See Karl Russell and Josh Williams, “Meet the Highest-Paid C.E.O.s in 2015,” New York Times, May 27, 2016, accessed August 26, 2018, www.aflcio.org/Corporate-Watch/Paywatch-2014/100-Highest-Paid-CEOs [inactive].

  In 2016, the highest-paid CEO made $98.0 million and the two-hundredth-highest-paid made $13.0 million. Jon Huang and Karl Russell, “The Highest-Paid C.E.O.s in 2016,” New York Times, May 26, 2017, accessed August 21, 2018, www.nytimes.com/interactive/2017/05/26/business/highest-paid-ceos.html.

  In 2017, the highest-paid CEO made $103.2 million and the two-hundredth-highest-paid made $13.8 million. “The Highest-Paid C.E.O.s in 2017,” New York Times, May 25, 2018, accessed August 21, 2018, www.nytimes.com/interactive/2018/05/25/business/ceo-pay-2017.html.

  collective profits: A 2005 analysis of compensation for top five highest-paid officers in the ExecuComp database (which includes “all the S&P 500, Mid-Cap 400, and Small-Cap 600 companies . . . also known as the S&P 1,500”) found that, between 2001 and 2003, the “ratio of aggregate [top-five] executive compensation to aggregate [S&P 1500] earnings” was 9.8 percent. See Lucian Bebchuk and Yaniv Grinstein, “The Growth of Executive Pay,” Oxford Review of Economic Policy 21, no. 2 (2005): 283–303, 284, 297, accessed August 26, 2018, www.law.harvard.edu/faculty/bebchuk/pdfs/Bebchuk-Grinstein.Growth-of-Pay.pdf.

  a war that talent is winning: See Roger L. Martin and Mihnea C. Moldoveanu, “Capital Versus Talent: The Battle That’s Reshaping Business,” Harvard Business Review, July 2003, accessed August 26, 2018, https://hbr.org/2003/07/capital-versus-talent-the-battle-thats-reshaping-business (concluding that talent has “started taking more of the profits from capital”).

  nine-tenths of their income from capital: Thomas Piketty, Emmanuel Saez, and Gabriel Zucman, “Distributional National Accounts: Methods and Estimates for the United States,” NBER Working Paper No. 22945 (2016), 26, 49, Figure 8, http://gabriel-zucman.eu/files/PSZ2016.pdf. Hereafter cited as Piketty, Saez, and Zucman, “Distributional National Accounts.”

  reaching bottom in 2000: Piketty, Saez, and Zucman, “Distributional National Accounts,” 26, 49, Figure 8.

  (roughly 49 percent and 53 percent, respectively): Thomas Piketty, Emmanuel Saez, and Gabriel Zucman, “Distributional National Accounts: Methods and Estimates for the United States,” Quarterly Journal of Economics 133, no. 2 (May 2018): 553–609, Figure viii.

  (when the data series runs out): Piketty, Saez, and Zucman, “Distributional National Accounts,” 26, 49, Figure 8. In calculating these shares the authors allocated 70 percent of the income received by owners of unincorporated businesses to labor and 30 percent to capital. Piketty, Saez, and Zucman, “Distributional National Accounts,” 42n.

  Other sources tell a compatible tale. For example, tax data from 2015 suggest that an average member of the top 1 percent owed 56.4 percent of his total fiscal income to labor. Facundo Alvaredo et al., World Inequality Database, distributed by WID.world, accessed July 3, 2018, https://wid.world/data/ (see “Average Fiscal Labour Income,” wid.world code afilin992t, and “Average Fiscal Income,” wid.world code afiinc992t).

  on their tax returns: Either directly, as restricted stock grants, or through the exercise of stock options.

  pensions and owner-oc
cupied housing: Employers fund pensions as payment for workers’ labor, and the payment anticipates that the pensions will accumulate between when the contributions are made and when the funds are withdrawn. The entire accumulated pensions therefore represent, both economically and morally, wages deferred until retirement, which is to say labor income. And at least insofar as a worker pays for her house with her wages (often, over time, facilitated by a mortgage), any economic return that the house generates again stems ultimately from labor.

  the founders who built the firms: Luisa Kroll and Kerry A. Dolan, eds., “Forbes 400: The Definitive Ranking of the Wealthiest Americans,” Forbes, October 3, 2018, www.forbes.com/forbes-400/#7de6813e7e2f. Hereafter cited as Kroll and Dolan, “Forbes 400.” The founders who hold these shares include: Jeff Bezos (1), Bill Gates (2), Warren Buffett (3), Mark Zuckerberg (4), Larry Ellison (5), Larry Page (6), and Sergey Brin (9). Others among the top one hundred—for example, George Soros (60) and Carl Icahn (31)—owe their fortunes to carried interest.

  reported by one-percenters: Victor Fleischer, “How a Carried Interest Tax Could Raise $180 Billion,” New York Times, June 5, 2015, http://nytimes.com/2015/06/06/business/dealbook/how-a-carried-interest-tax-could-raise-180-billion.html. Fleischer reaches this result by inference from the legal structures typically employed by investment funds. In particular, investment funds are generally organized as partnerships, and the fund managers of investment funds are themselves also organized as partnerships. Income reported to the IRS as accruing to “partnership general partners”—that is, to general partners in one partnership that are themselves organized as a second partnership—therefore overwhelmingly goes to fund managers of investment funds. This is the “carried interest” that receives capital gains treatment, although it is, economically, just a return on the labor of the investment fund managers. The precise share is difficult to determine, because the IRS breaks its data into overlapping categories, which raises a specter of double counting. Fleischer, “Alpha”; Internal Revenue Service, “SOI Tax Stats—Partnership Statistics by Sector or Industry,” last modified June 20, 2018, www.irs.gov/statistics/soi-tax-stats-partnership-statistics-by-sector-or-industry; www.treasury.gov/resource-center/tax-policy/Documents/OTP-CG-Taxes-Paid-Pos-CG-1954-2009-6-2012.pdf [inactive]; “SOI Tax Stats—Individual Statistical Tables by Size of Adjusted Gross Income,” last modified November 5, 2018, www.irs.gov/statistics/soi-tax-stats-individual-statistical-tables-by-size-of-adjusted-gross-income; Victor Fleischer, email correspondence with author, October 30, 2018.

  Moreover, simulations of the investment structures deployed by the Blackstone Group suggest that perhaps three-quarters of the capital gains income taxed to individual taxpayers (as opposed to firms, foundations, or investment funds) through these structures in fact constitutes a return to labor. Blackstone manages over $250 billion, including (by investing for public pension funds) portions of the retirement holdings of more than half of all retirees in the United States. Fleischer, “Alpha,” 15–17.

  stock or stock options: K. J. Martijn Cremers, Saura Masconale, and Simone N. Sepe, “CEO Pay Redux,” Texas Law Review 96 (2017): 242, Figure 2. Hereafter cited as Cremers, Masconale, and Sepe, “CEO Pay Redux.” Not all of this income is taxed as capital gains, of course.

  in the 1960s: In recent years, returns to pensions and imputed rents from owner-occupied housing together have constituted about 12 percent of the top 1 percent’s income and 6 percent of the top 0.1 percent’s income, compared to about 6 and 3 percent of income, respectively, in the 1960s. For the 1 percent, these shares have held roughly steady since the late 1980s; for the 0.1 percent, the shares were greater in the 1990s and fell off in the first decade of the new millennium. These numbers are calculated from the distributional series included in Piketty, Saez, and Zucman, “Distributional National Accounts,” Appendix II, http://gabriel-zucman.eu/files/PSZ2016DataAppendix.pdf. The calculations for the 1 percent are based on Table B2b (also labeled TA2b) and divide the sum of columns 20 and 22 by column 17. The calculations for the 0.1 percent are based on Table B2c (also labeled TA2c) and divide the sum of columns 12 and 14 by column 9.

  survey of elite jobs: The phenomenon is so powerful that it applies even during the life phase once devoted to “retirement.” The top quintile of earners over sixty-five today owes more than four-fifths (83.3 percent) of its income to wages, Social Security, or pensions—that is, to its own present or prior labor. Ke Bin Wu, Sources of Income for Older Americans (Washington, DC: AARP Public Policy Institute, 2013), 3, Figure 1, www.aarp.org/money/low-income-assistance/info-12-2013/sources-of-income-for-older-americans-2012-AARP-ppi-econ-sec.html.

  now literally works for a living: A recent, detailed, and sophisticated argument for this conclusion, which emphasizes nonwage labor income associated with “pass-through” business profits, appears in Matthew Smith, Danny Yagan, Owen Zidar, and Eric Zwick, “Capitalists in the Twenty-First Century” (working paper, May 15, 2019), 51–52, Figures 7 and 8.

  total national income: A rough-and-ready calculation underwrites this claim. Begin by measuring the overall income shift from labor to capital. Reasonable estimates of labor’s overall share of total national income range from finding an increase since 1950, from roughly 65 to 70 percent of total income, to finding a larger but still modest decline, from 62 percent in 1950 to perhaps 56 percent today. Robert J. Gordon and Ian Dew-Becker, “Controversies About the Rise of American Inequality: A Survey,” NBER Working Paper No. 13982 (May 2008), 5; Paul Gomme and Peter Rupert, Measuring Labor’s Share of Income, Policy Discussion Paper (Cleveland: Federal Reserve Bank of Cleveland, November 2004), 8, 9, Figure 6; Brian I. Baker, The Laboring Labor Share of Income: The “Miracle” Ends (Washington, DC: U.S. Bureau of Labor Statistics, January 2016), 1, www.bls.gov/opub/mlr/2016/beyond-bls/the-laboring-labor-share-of-income-the-miracle-ends.htm; Loukas Karabarbounis and Brent Neiman, “The Global Decline of the Labor Share,” Quarterly Journal of Economics 129, no. 1 (February 2014): 61, https://doi.org/10.1093/qje/qjt032; International Labor Organization, Global Wage Report 2012/13: Wages and Equitable Growth (Geneva: International Labour Organization, 2013), 43, Figure 31.

  It is better to consider the span of responsible assessments rather than any single specific estimate because measuring these shares turns out to require judgment, and reasonable people can disagree. How should the rental value of owner-occupied housing, which is included in national income, be apportioned between treating the owner as capitalist who rents to herself and as worker who superintends her own dwelling, for example? How should the income received by proprietors of owner-operated businesses be treated? And what return to the capital stock of the government should be included as a counterbalance to the labor income of public employees? Note that the global trend—which spans countries with vastly different political systems and domestic policy regimes—strongly implies that labor’s decline stems from economic fundamentals rather than shallow political or policy choices.

  Next, ask what share of capital is owned by top earners. Serious estimates of the share of total wealth held by the wealthiest 1 percent of Americans range from 20 percent to 42 percent, and the top 1 percent of Americans sorted by income can own no greater share of capital than this. The 20 percent estimate, which tabulates individuals rather than households, comes from Wojciech Kopczuk and Emmanuel Saez, “Top Wealth Shares in the United States, 1916–2000: Evidence from Estate Tax Returns,” National Tax Journal 57, no. 2 (June 2004): 453. The 42 percent estimate, which uses household data, comes from Emmanuel Saez and Gabriel Zucman, “Wealth Inequality in the United States Since 1913: Evidence from Capitalized Income Tax Data,” Quarterly Journal of Economics 131, no. 2 (May 2016): 520. Hereafter cited as Saez and Zucman, “Wealth Inequality in the United States.”

  Finally, combine these facts. The overall shift in income from labor to capital amounts to at most 6 percent of total income, and the richest 1 percent of households measured by inco
me own at most two-fifths of the capital. This entails that the labor-to-capital shift can have augmented the 1 percent’s income share by about 2.5 percent (which is a little more than two-fifths times 6 percent) of total national income. (This approach assumes that the rich do not enjoy materially higher rates of return on their wealth than the rest of the population. The best evidence supports this assumption and reveals only modest differences in the overall performance of investments held by wealthy versus ordinary Americans. Saez and Zucman, “Wealth Inequality in the United States Since 1913,” Appendix, Figures B29–B31, B33, Tables B30–B31, http://gabriel-zucman.eu/files/SaezZucman2016QJEAppendix.pdf.)

  roughly 20 percent today: See World Top Incomes Database, United States / Pre-tax national income / P99-P100 / Share, October 29, 2018, https://wid.world/country/usa/.

  rising top income shares: Some studies appear to show a more modest labor contribution to rising overall inequality. For example, see Congressional Budget Office, Trends in the Distribution of Household Income Between 1979 and 2007 (Washington, DC: U.S. Government Printing Office, October 2011), www.cbo.gov/publication/42729. Hereafter cited as Congressional Budget Office, “Trends in the Distribution of Household Income.” But these studies reach their conclusions by failing to attribute any business income or capital gains to labor, and the studies even so conclude that labor is the dominant cause of rising top incomes.