Wealth Mobility and Class Warfare

March 31st, 2011 | Categories: economy | Tags:

Some claim that the expiration of Bush Tax Cuts, only for the rich, is class warfare, and that it punishes the rich for working hard. The argument implicitly assumes that regardless of who you are, being smart and working hard helps you grow richer. I decided to put that claim to test because we have mostly seen children of poor parents grow up to be poor and children of the rich grow up to be rich (for a number of reasons). I wondered what statistical evidence is needed to conclude with the claim. After some time, I was able to conceptualise the survey that can statistically “prove” the claim. I googled and found out that such surveys have been done. They have proved me right, i.e., how rich you will be depends strongly on how rich your parent were (there are exceptions, of course). In this post, I will explain the survey data that is needed to make any such claim and also suggest ways to strengthen the claim.

Wealth Mobility

“Wealth mobility” is an economist’s term for inter-generational movement on the economic ladder, which studies how one’s wealth is related to their parents’. Studies on wealth mobility (link, link, link) begin by categorising the parents on percentile-based income brackets, i.e., determine what percentage of people were richer than the parents in question, adjusted for inflation. Some are in top 10%, few more in top 10%-20%, more in top 20%-30%, and so on. The study also looks at the income brackets of their children. Thus, we get a table of numbers which conveys how many children, whose parents were in, say, top 10%-20% bracket, stay in the top 10-20% bracket, how many have moved to the top 10% bracket, how many to the 20%-30% bracket, and so on. We may call this ‘wealth-mobility table.’

If there is an even distribution of people moving across the income brackets, I will conclude that luck does not play a big role in being rich (for most people). If the results are skewed to show that rich children stay rich and poor children stay poor, I will conclude that luck does plays a big role and taxing the rich more is not all that unfair.

Conclusions

The studies (linked above) have concluded that upward mobility is hard, but possible. Most people stay in the same bracket as their parents did. I don’t think this is surprising because opportunities are plenty for the rich, while lacking for the poor. Thus, I wouldn’t call higher tax rate on the rich as class warfare.

Inequality Fractal

There is a small flaw in the studies linked above. They do not consider the fact that economic inequality is a fractal (link). Wealth is exponentially distributed in many countries. Top 0.1% of people are much more richer than top 1%, who are much more richer than top 10%, and so on (link). Thus, a person from any income range will find people who are 10 to 100 times poorer and people who are 10 to 100 times richer. This inequality fractal makes the studies’ linearly-distributed income brackets (Top 10%, 10-20%, 20-30% and so on) inappropriate. Better-designed income brackets will strengthen any conclusions that are drawn from the data.

Expected Results*

We expect a wealth barrier beyond which good wealth mobility is present among the rich. The rich and the super-rich children, both, have equal access to education and other opportunities. There are plenty of avenues to grow richer and plenty of risk of losing money. A dynamic equilibrium can be expected at the top. Note that there may not be just one barrier; there may be several barriers as we move down the income ladder depending of government policies.

Technology is know to be detrimental factor in economic inequality (link), i.e., it has widen the gap between haves and have-nots. But at the same time, we expect technology to move the wealth barrier towards the poorer side as technology makes in easier for everyone to avail education and other opportunities. In the next generation, technology may alleviate the economic inequality.

*Thanks to Karthik Swaminathan for inputs

  1. Manohar Seetharam
    April 1st, 2011 at 09:27
    Reply | Quote | #1

    Shankar : Can you briefly explain what exactly this tax break for the rich in US is ? Is it like a tax holiday where the rich guys pay zero tax or more like they pay the same tax as a percentage of their income as the middle class ?

  2. Coolshankin
    April 1st, 2011 at 11:05
    Reply | Quote | #2

    @Manohar Seetharam
    http://en.wikipedia.org/wiki/Income_tax_in_the_United_States This link gives you a plot of effective tax-rate as a function of the income. It goes from 10% for $1000 income per annum to 30% for 500,000 income per annum. Given the inequality is the US ( http://www.slate.com/id/2266025/entry/2266026 ) and the reasons for it, and given the fact that rich keep getting richer and poor get poorer, I believe it has to be increase for the rich. Check out the slate.com link in this comment. That gives you a very objective, statistical proof for all the claims the writer makes.