Wealth and Income

Recently released data from the 2019 Survey of Consumer Finances (SCF) show a highly unequal distribution of wealth in the US, both between and within racial groups. This is not new, but the numbers are always staggering. The typical white family has eight times the wealth of the typical black family. Within racial and ethnic groups, more than eighty percent of wealth is owned by the wealthiest twenty percent of families.

Having wealth is a huge advantage and not having wealth is a huge disadvantage, yet people argue, incorrectly in my view, that wealth statistics are not as important as they seem. I want to respond to some common arguments, which generally revolve around the connection between wealth and income.

Common argument #1: Wealth is not a good predictor of poverty

The basic argument here is that some people with low or negative net worth actually have very high income. Therefore, since poverty is defined based on income, people with low wealth are not necessarily poor. There’s nothing wrong with this argument; because wealth is measured as net worth, assets minus debts, these cases do exist. A recent medical school grad with lots of student debt and few assets will have negative wealth but a very high salary and is unlikely to be in poverty. But these are corner cases. All the argument is saying is that there exist some cases where the relationship between net worth and income falls apart.

Applying this argument to anything other than the specific corner cases is misleading. There is a strong correlation between having low wealth and having low income and nearly all poor people have low wealth. Likewise, few wealthy people are in poverty on an income basis.

More importantly, the argument does not explain differences between demographic groups. We know that the difference between black and white wealth is not in any way compensated for by black people having higher income. Overall, the story of the black-white wealth gap is an assets story, not a student debt story. Black families have substantially fewer assets, substantially less wealth, and substantially less income. We can see this by looking at net worth, financial assets, and pre-tax income:

Common argument #2: Wealth is not a permanent source of income

Again, this is an argument mostly based around corner cases. If someone has equity in their home, they may have some wealth but not necessarily have an income advantage over someone who rents. Stocks might temporarily skip paying dividends because of weak economic conditions. There are even cases where people lose money by having wealth comprised of assets that lose value. The horror.

But the bigger picture here is that assets generally do provide income or utility and having a positive net worth does mean more income when viewed from the aggregate data. I want to illustrate this in two ways. First, the pre-tax income of various groups by their wealth percentile shows a clear relationship between income and wealth. People with more wealth have higher income:

Additionally, if we look at aggregate personal income data for the US in 2019, the overall growth from 2018 is an impressive 6.8 percent after adjusting for inflation. The second largest source of that growth, explaining 1.5 percentage points, is larger payments to property owners in 2019 than in 2018:

I wouldn’t say that wealth is a permanent source of income but neither is labor. We can see this in the above chart from the change in the number of recipients of earnings (labor income). The chart shows that aggregate personal income went up 1.1 percentage points because more people were employed in 2019 than 2018. In other words, a (disproportionately black) portion of the population was still re-entering the labor force a decade after the great recession had ended. And as we’ve seen recently, people lose jobs all the time and sometimes these job losses last for many years, so what is a permanent source of income?

Perhaps a better question is whether wealth is consequential and reliable as a source of income. I’d argue that it is. Various forms of ownership income are equivalent to annualized income of more than $16,000 per person in August, despite the very severe ongoing recession.

Common argument #3: The concentration of wealth is a life cycle story

The following chart is useful for thinking about income and consumption over a person’s life:

(Source)

The argument related to the life cycle story shown in this chart goes something like “wealth is concentrated because of age and reflects peoples’ retirement savings”. People argue that wealth reflects accrued earnings–it comes from the portion of the chart where labor income exceeds consumption. If wealth is simply accrued earnings used for consumption in retirement, then its okay that some (older) people have wealth and other (younger) people don’t (yet).

But the issue here is that large gaps still exist between families in the same age group and other large differences exist in ways that age does not explain. For example, some young people receive inheritance, in-vivo transfers, or other transfers like a car, help with college tuition, or help with a home down payment. Other young people simply do not receive these things. The gap by race is very wide when it comes to these kind of inter-generational transfers–they are much more common among white families than black families.

The accrued earnings story just doesn’t hold up to the data. From the Federal Reserve, “by some estimates bequests and transfers account for at least half of aggregate wealth (Gale and Scholz 1994), have recently averaged 3 percent of total household disposable personal income (Feiveson and Sabelhaus 2018), and account for more of the racial wealth gap than any other demographic or socioeconomic indicator (Hamilton and Darity 2010)”

Also, from 2016 SCF data, a large and growing share of people nearing retirement age (those 55-64) have no or negative wealth outside of home equity, and many also have no equity stake in their home. Social Security payments are the main source of income for a large portion of the retirement-age population and this should be expected to grow as defined benefit pensions plans become more and more rare. The end result of the current system of using private wealth to resolve income and consumption differences in the life cycle is massive gaps between people in access to goods and services at all points of the life cycle.

Should we focus on wealth?

First, if we think about wealth as assets rather than net worth (because the net worth differences between and within racial groups are largely the result of differences in assets), we can easily see the advantage of having money to cushion against an unexpected drop in income or unexpected expense. Black families are less likely to have emergency savings, and those with some savings have less than 1/5th the emergency savings of white families, on average. Black families are also substantially less likely to be able to borrow money from a friend or relative. For these reasons and many others, wealth is important, not just because it can be a source of income.

That said, income is still critically important. A policy focus on full employment, increased worker bargaining power, and compressing the wage distribution would make a huge difference in reducing poverty and reducing income inequality, and eventually, in reducing wealth inequality. But increasing the share of total income that goes to labor won’t solve one major source of inequality and poverty: the unequal distribution of workers in families. Some families contain one or more people who cannot or should not be working (children, students, elderly, persons with disabilities, unpaid caregivers, etc.), while other families do not. This situation is more common than people realize (around half of the country are non-workers during full employment) and is precisely where the welfare state shines. The US could use public ownership of wealth as a supplement to taxes in funding income payments to non-workers. As many countries already demonstrate, such payments can be designed to efficiently solve the inequality caused specifically by the uneven distribution of workers in families.

Importantly, whether the US manages to redirect a portion of its capital income to new welfare programs or not, the US government should make reparation payments to American descendants of slavery. People want to believe that wealth results from accrued earnings because it is a meritocratic story. The accrued earnings of millions of black people were stolen during slavery. Just because the victims died does not mean the wealth wasn’t stolen from their descendants. The theft of these earnings has contributed greatly to the massive racial wealth gap and this gap should be closed through both policies that close the racial income gap and through reparations and increased public ownership of assets.