The Wall Street Journal recently published a story about the concentration of wealth among the super-rich and their ability to avoid taxes. It claimed the economy is especially dependent on “rich households, whose spending is tied to the performance of the stock market.” Paul Krugman responded to the piece by highlighting the extraordinary concentration of wealth among the very wealthy, especially at the very top.

For example, he cites research by Gabriel Zucman (Paris School of Economics) and colleagues showing that the one-in-a-million people at the very top of the wealth distribution now hold nearly 2 percent of our society’s net worth. He also correctly notes that the average tax rate from all sources for the rich isn’t much different from — and is often lower than — that of the middle class. 

This tax story is not new: for decades, economists including me (see here, here and here) have pointed out how the rich realize only a tiny portion of their income — often 2 percent or less — despite likely earning a return on assets of at least 6 to 10 percent annually, and usually much more (after all, that’s how many got rich).

Misreading the Tea Leaves

Reading the WSJ and Krugman articles, one might think the main issues raised by the wealth distribution involve how to treat the rich, their spending and the taxes they pay. I have a somewhat different take, however. Our government has long promoted not just wealth for the wealthy but consumption for the masses, while overlooking wealth-building for large parts of the population, including the human capital that is the main source of income for most families.

The reliance on the wealthy is not on their spending, as The Wall Street Journal suggests. Just as the wealthy accrue most income as capital gains and recognize only a small fraction of it as taxable, they also consume a much smaller portion of their income than other wealth classes. You can spend a lot on new assets — even islands — but how much can you really consume if your wealth surpasses a hundred million, let alone a billion, dollars?

Where dependence on the wealthy has increased, therefore, is through the savings they accumulate from their higher levels of wealth and income. Their ever-increasing shares of the nation’s savings and investment then further contribute to wealth inequality.

At the same time, much of the population has become increasingly reliant on the government to support their consumption. In the figure, I used Congressional Budget Office data to compare growth from 1979 to 2021 in inflation-adjusted market incomes (such as wages, dividends and interest) and total income across five income groups. The change in total income adds to market income the change in net transfers, or transfers minus taxes. Transfers include Social Security, health care, food subsidies, unemployment compensation and other supports. (Note: while 2021 was an unusual year because of Covid-19 and the government response to it, I found quite similar trends, though of a somewhat smaller magnitude, before the Covid-19 period began.)

The groups are ranked by market income, from the poorest 20 percent of the population (the lowest quintile) to the wealthiest 20 percent (the highest quintile). If market incomes, transfers and taxes had all increased proportionally across all groups — that is, if the share of each had remained constant — every bar in this figure would have been the same length. Total income, market income and net transfers (transfers less taxes) for all groups would have grown at the same rate.

As you can see, however, the rate of growth in market income is much, much higher for the top quintile than for all other quintiles. Not surprisingly, increases in market income inequality are positively associated with increases in market wealth inequality. However, the story of growing market wealth and income inequality remains incomplete without acknowledging the extraordinary increase in reliance of most income groups on net government transfers for much of their income growth. The figure shows how intertwined the two are.

Now You See It …

It’s hard to believe that these trends in market income inequality and dependence on government are sustainable. Two complications add to the threat. First, in recent decades, both political parties have increasingly tried to subsidize both the wealthy and the non-wealthy through deficit spending, leaving the accumulating national debt hanging like a Damocles sword over everyone, rich and poor alike. 

The growth in net transfers for the bottom 80 percent of the population hasn’t been funded by higher taxes on the highest income quintile but by ever more debt passed on to future generations. In fact, the average net tax rate (tax minus transfer rate) for the highest income quintile declined from 1979 to 2021. The higher-income group does shoulder a larger share of the total tax burden, but mainly because they have a much bigger share of income.

Second, probably because of extremely low interest rates — and thus low borrowing costs — for many years, wealth valuations like the value of a house or stock have grown significantly faster than income since about 1990. That wealth bubble has also likely added to market wealth inequality. It seems the middle and lower-upper wealth classes have found it easier to use those valuation windfalls to consume — for instance, by spending down housing gains when moving. In contrast, the wealthy have found it advantageous to use low borrowing costs to leverage their wealth accumulation further.

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I realize I’ve presented a lot of information in this brief space. I discuss it in much more detail in my Substack. But there is a straightforward economic takeaway: the rise in wealth and market-income inequality on the one hand, and the ever-increasing reliance on government on the other, (a) reinforce each other, (b) are unsustainable and (c) must be addressed in parallel with our unsustainable budget deficit.

For now, I’ll let you speculate on the political takeaway. It’s also not pretty.