Wall Street and Inequality

I want to thank everyone who sent me a copy of Steven N. Kaplan and Joshua Rauh “Wall Street and Main Street: What Contributes to the Rise in the Highest Incomes?” overnight. They make an effort to really bore down into the question of who, exactly, the superrich are. The answer turns out to be — largely finance types:

We look at hedge fund, venture capital (VC) fund, and PE or buyout fund investors. The data here are very coarse, and we make a number of assumptions to obtain estimates of income. A large number of professionals in these areas are highly compensated We estimate that the professionals in hedge, VC, and PE funds include roughly the same number of individuals in the top 0.1% of the AGI income distribution as the top nonfinancial executives. While we do not estimate precise distributional changes over time for this sector, we show that these industries are significantly larger today than ten and twenty years ago and, therefore, that their employees must represent a larger fraction of the top brackets than before.

We also find that hedge fund investors and other “Wall Street” type individuals comprise a larger fraction of the very highest end of the AGI distribution (the top 0.0001%) than CEOs and top executives. In 2004, nine times as many Wall Street investors earned in excess of $100 million as public company CEOs. In fact, the top twenty-five hedge fund managers combined appear to have earned more than all five hundred S&P; 500 CEOs combined (both realized and ex ante). This trend accelerated after 2004. In 2007, it is likely that the top five hedge fund managers earned more than all five hundred S&P; 500 CEOs combined.

They show that star athletes “represent a similar percentage of the top 0.1% AGI bracket in 2004 as in 1995 (0.8% for both years), but a larger percentage of the top 0.01% AGI bracket” and also that non-sports celebrities “comprise a substantially smaller share of the top brackets” yet another reminder of the under-acknowledged declining real wages of movie stars. They further show “that the fraction of lawyers in the 0.1% (and top 0.5%) AGI brackets rose substantially from 1994 to 2004.”


I think some of the interpretive conclusions they draw from this are a bit funny, but the clearest conclusion they offer is that this undermines accounts of inequality that focus on corporate governance, the decline of unions, or other labor market institutions. After all, increases in executive compensation at publicly traded firms have been matched or exceeded by increases in the realm of finance where these issues aren’t in play.

So what’s left? They say “theories of skill-biased technological change, greater scale, and their interaction.” Scale is easy to understand — the heads of bigger firms get paid more, as do asset managers who manage more assets, and scale has increased in both financial and non-financial sectors. But this is a pretty special kind of skill-biased technological change. In particular, it’s not the kind that would be ameliorated by boosting the high school graduation rate or improving the quality of community colleges. Instead they say technological improvements “provide part of the explanation for the increase in pay of professional athletes (technology increases their marginal product by allowing them to reach more consumers) and Wall Street investors (technology allows them to acquire information and trade large amounts more easily).”

If it were my paper, I would have discussed this under the heading of “globalization” which they instead dismiss with the odd remark that “it seems difficult for globalization to explain the increase in the top end of VC investors, PE investors, hedge fund investors, and professional athletes.” In part this becomes a question of semantics, but I think it’s quite obvious that globalization helped Tracy McGrady earn more money by becoming a celebrity in China. Similarly, globalization helped American financiers get richer by managing the money of rich people from the developing world.

Either way, I think the more granular view of what’s driving inequality helps refocus the policy conversation on questions of what it is we’re trying to do with progressive policy. If reducing high-end inequality means implementing regulations that make the very richest hedge fund managers less rich to the benefit of lesser managers of financial assets then that doesn’t seem like a particularly important goal. By contrast, if what’s happening is that finance types are getting rich off a badly flawed regulatory scheme that leaves the world economy vulnerable to catastrophic crashes and panics then that’s a problem all on its own completely apart from the impact on inequality. Last, taxes. These hedge fund and private equity guys are paying a lower marginal tax rate on their income than you or me or a teacher — that’s outrageous.

But beyond income taxes, I’m not sure that whether Stephen Schwartzman earns $400 million or “only” $100 million next year is something I really care that much about. But I do care a great deal about whether the bulk of his $4.7 billion fortune ends up going to charity or whether it sets his heirs up as a new aristocratic elite. Whether or not we have a meaningful estate tax in this country will make a big difference there.