Rising Income Inequality and Cyclicality

Has the rise of information technology led to both increased income inequality and more cyclical incomes among the wealthy?

A recent paper by Jonathan Parker and Annette Vissing-Jorgensen of Northwestern University argues “yes.” The authors explain that information technology has permitted talented people to increase the scale of their work, and this increased scale, in turn, has led the rich to garner a greater share of earnings and made their incomes more responsive economic changes.

Emmanuel Saez of the University of California at Berkeley and Thomas Piketty of L’Ecole des Hautes Etudes en Sciences Sociales have shown that the rich account for a much higher share of income today than they did in the early 1980s. Their calculations show that the top 1 percent of earners received 18 percent of income (excluding capital gains) in 2008 as compared to 8 percent at the beginning of the 1980s.

Parker and Vissing-Jorgensen found that the sensitivity of rich people’s incomes to economic fluctuations began to increase at the same time as their share of overall earnings started to rise.

The authors ruled out several explanations for the increase in the cyclicality of income among the wealthy over the past 30 years. The increased use of stock options to compensate executives isn’t responsible because the patterns exist for households where no one received any stock options. Earnings on capital and business ownership are not the cause because the patterns can be seen in just wage and salary income. Finally, changes in tax rates are not responsible because taxes have little effect on the cyclicality of income of the wealthy.

I see three interesting implications in Parker and Vissing-Jorgensen’s findings:
1. Reducing the concentration and volatility of income is going to be difficult. Policy makers can much more easily change tax or social policies that influence income than they can alter the effects of technological change on earnings.

2. We are going to experience more severe booms and busts. The economy has become more reliant on the rich, whose earnings now drop more when the economy weakens and increase more when the economy strengthens. For instance, Parker and Vissing-Jorgensen report that the average taxpayer experienced a 2.6 percent decline in income during the current downturn, as compared to 8.4 percent for the highest earning 1 percent of taxpayers and 12.7 percent for the highest earning 0.01 percent of taxpayers. With a bigger percentage of income in the hands of the rich, these outsized income changes have a larger impact on the economy than they used to.

3. Technological change isn’t increasing the concentration and cyclicality of income through the entrepreneurial sector of the economy. Rather than primarily affecting the capital gains and business incomes of entrepreneurs and business angels, information technology has increased the share and volatility of the income of the rich by influencing their salaries.

Scott Shane Scott Shane is A. Malachi Mixon III, Professor of Entrepreneurial Studies at Case Western Reserve University. He is the author of nine books, including Fool's Gold: The Truth Behind Angel Investing in America ; Illusions of Entrepreneurship: and The Costly Myths that Entrepreneurs, Investors, and Policy Makers Live By.