Finance, Taxes and the Upper End

There are many aspects to the financialization of the economy over the past forty years or so, and it seems that nobody has put together all the pieces. A recent paper by two economists and a Treasury official (hat-tip Doug Henwood) on changes in income growth of top earners shows some striking results. The authors begin with a more or less well-known statistic – the top 0.1% are getting an increasing share of national wealth. By their calculations, the top 0.1% took home around 2% of national income in 1981, but by 2005 took home 8%. What’s new in the paper is identifying who, exactly, these super-wealthy are. According to the paper “the data demonstrate that executives, managers, supervisors, and financial professionals account for about 60 percent of the top 0.1 percent of income earners in recent years” (the period 1979-2005).  Moreover, this group accounts for “70 percent of the increase in the share of national income going to the top 0.1 percent.”

What does any of this have to do with finance? After all, that group includes more than just financial professionals. So the fast rise at the top isn’t just amongst hedge fund managers. Well, as the paper discovers, the reason lies in changes in executive compensation, ie the stock market. Even if you weren’t directly in finance, increasing compensation in stock options and the like meant that top “executives, managers and supervisors” started taking home much more income than they used to. Indirectly, then, financialization (of pay) contributes to redistribution of wealth upwards.

This is politically interesting for a number of reasons. First, as the authors show, the rapid rise at the top does not have nearly as much to do with tax cuts as one might think. In a nifty chart at the end of the paper, the authors show that the top marginal tax rates in Japan declined more or less at the same rate, and to the same level, as in the US:

However, Japan has seen nothing like the increase at the top. Indeed, the US (and English speaking countries) is somewhat unique in this trend. Another nifty chart from the paper:

This suggests marginal tax rates don’t have such a dramatic effect on distribution at the top as one might think. The authors further suggest that, since it was illegal in Japan until 1997 to compensate executives with stock options, and remains a less common practice, it is the practices of executive compensation that explain the difference. Thus the current debate in the US over taxes is extremely important (the paper also has an important discussion of why Laffer curve arguments against higher taxes on the wealthy are not well supported), but it is a small part of the overall determinants of social stratification.

Second, and following from that, these results are further evidence for the thesis we have been advancing about how regulation entails a class restructuring, not just correction of the market. Regulations, including indirect financial regulations like limiting executive compensation in stock options so that incentives are turned towards long run economic health of the company rather than short-run stock price changes, will affect not just those directly in the financial industries but those whose economic fates are directly tied to its fate.

Third, the paper bears implications for the wider political economy of the last thirty-forty years. Two arguments made in defense of a well-developed financial industry are that a) financial instruments allow business persons to hedge risk and b) they make certain kinds of production possible by concentrating capital (lots of little deposits in a bank) and making it available for loan to enterprises that otherwise couldn’t get off the ground (banks making business loans). These are sensible arguments in theory, but the actual practice seems largely to have been otherwise. Financial markets  have been a hugely effective tool – far more effective than changes in marginal taxes – at redistributing wealth and income upwards. Even as many people at the lower and middle lost pensions, not to mention houses and other sources of wealth and income, and experienced stagnating wages, incomes at the top rose dramatically. Those seem to have been the most significant results of the past decades. There are no doubt many Luddite criticisms of finance, but there are many ideological defenses of it too.