The L-curve: distribution of income

I had never heard of Pareto’s Law before this thread, but after running a small business for years I have a strong gut feeling that it is very reliable and that I wish I’d have known to collect the right data and used it.

I read Guinastasia’s post and I feel the need to say something. I hired women like her. They were good workers, they were single, they had one or more children and they lived paycheck to paycheck. This is the type of person (plus their children) that makes up most of the lower 20% that may not have 3% of the wealth (that’s a figure off the top of my head). I don’t have any answer as shown by the fact that I have a daughter trapped in the same situation. One difference with my daughter and I imagine with Guinastasia is that she does not have an abusive SO hanging around. My daughter straightened hers out and he has never hit her. That’s right hit, it is amazing but unfortunately true that many of these women put up with men that hit them, will not hold a job and won’t help them with the children. It got so bad once that I had the people at the local “safe house” come and talk to every woman in the plant, because every one of them needed help. I thought it helped with one, but then found out she went and got another SO just as bad.

I’m not preaching, condemning or rationalizing. I just think that everyone should know about this problem. We need to find an answer for these women, so we can help them. It will not solve the distribution of wealth because some other group will fill the lower 20%, but these women aren’t there for the classic reasons of not wanting to work and it isn’t even a question of education. They deserve better than what they are getting.

After more research, I’ve come to the conclusion that the real issue is not necessarily that wealth and income distribution is highly skewed, but that it has been getting exponentially worse in the past several decades.

Here’s a chart is from Scientific American, a source that most of us can agree is fairly reliable and unbiased. They get their data from the U.S. Census Bureau. The chart shows income before taxes.

This page analyzes after-tax income trends between 1977 and 1994, adjusted for inflation (out of date but the best I could find on short notice). Basically, income taxes have helped widen the gap between rich and poor. The lowest quintile has seen a 16% decrease in income after taxes from 1977 to 1994, and the top 1% has seen a 72% increase in after-tax income for the same period. Compare this to the Sci-Am chart which shows that the before-tax income of the bottom quintile has actually increased (albeit modestly) during the same period.

-DP

Isn’t that what business school is for? It’s unreasonable to expect kids to learn everything they need to be successful by the end of high school.

Without soldiers to lead, an officer is powerless. Everyone can’t be the boss or nothing gets done. I’m sure many of us have worked in environments where everyone was too busy nitpicking the next guy to do his own work effectively. If the schools were turning out “better employees” this country would be a much better place. I despised people in high school who were given extra credit assignments to complete to avoid failing a class when I could not have them to raise my C to a B. Deadlines are called that for a reason, if you screw up bad on a major client in the real world, its rare that you get “partial credit” , “extra credit” or retest opportunities. Many of my coworkers go to great lengths to dodge responsibility in any form. Since I take responsibility for my actions I take a lump now and then but my supervisors realize that my successes minus my failures are still significantly more than the guy next to me who is “never to blame” but rarely achieves anything significant.

Damn, how did I get on this soapbox…

Devilman Palmer, welcome to the SDMB, soapbox and all. It’s good to ask tough questions and very few people 'round these parts speak from a neutral stance. So no need to apologize for yourself.

This question of income equality has come up many times and I’m glad that you recently posted some data to show that, in the US, the issue is to do with an historical trend, with income inequality having dramatically increased since the 1970s.

This gives the lie to the notion that serious inequality is the way it always must be, always has been, etc.

Duke: “The “L-Curve” you refer to…looks pretty similar for the US, the UK, and for many Western democracies. It’s slightly worse for the US, but not by much. It’s much worse for a lot of third-world dictatorships, and, surprisingly, not much better for former communist countries in Eastern Europe.”

Duke, I must beg to differ with this sketch. Yes, the US and the UK look similar, and yes both resemble a lot of third-world countries. Yes, the gap is widening in some parts of Europe, but, NO, the differences between most of Europe and the US aren’t “slight.” France, Germany, Holland, Denmark, Sweden–all of these are countries with a much larger percentage in the middle, fewer poor, less distance between the middle and the rich, the rich and the poor, and fewer ultra-rich. I don’t have time to provide cites at the moment but I think that any you look for will bear me out on this, as I’ve seen many examples.

It’s arguable that, say, Denmark’s level of income equality is as good as it gets in a market economy. If so, I’ll take it. When and only when the US reverses the current trend and moves in the direction of Denmark will I start to think, well maybe now growing inequality isn’t a major issue in today’s American society. For now, it rates super high on my list of concerns because it effects everything else–most especially, the state of our democracy.

(And I don’t, btw, think that Amartya Sen–of all people!–is arguing that inequality is inevitable and here to stay).

That said, I don’t see inheritance taxes as the only or even the main way to go about reversing the trend. It’s easy enough to evade inheritance taxes (give your money to your family before you die).

In the US, I would say reduce payroll taxes substantially for the majority of Americans who live off of their paychecks (and Guinastasia, I’d add to your post, that most Americans live off of paycheck to paycheck; most have little or no savings; most have credit card debt up to their eyeballs; only a small percentage could live for more than six weeks without a paycheck). Make up the difference by a more progressive income tax and by closing loopholes for corporations.

shagnasty: “I would argue that the average middle class American already has a perfectly acceptable amount of wealth. The poor have a different set of problems entirely that redistribution aggrevates as often as it helps. The truly wealthy have a lot of money, but, so what.”

The problem is that the percentage of people who can call themselves middle class is shrinking, while the number of poor, and especially working poor is growing. Also except at the higher end of the middle class, standard-of-living for the middle classes has also been declining slightly; so they are also feeling a kind of pinch. And, incidentally, for the people at the higher end of the middle class, whose relative income has grown by about 9% since the '70s–this has happened because they work more than they used to do (the equivalent of about one month per year).
Note: the latter stats were cited in a now defunct thread on Thomas Frank’s One Market Under God. The rest is from my memory, but, again, I think cites will bear me out.

So by and large, Americans, especially the working poor, haven’t cashed in the tremendous productivity gains of this period. Where in an ideal world productivity would translate into wage growth, R&D, and profits, in the US most has gone into profits and corporate profits disproportionately benefit the very, very, very rich.

mssmith: “The problem is that schools don’t teach people how to become wealthy. How can
they, they are government run institutions run by people who make $40,000 a year? What does a schoolteacher or even the superintendent know about accumulating wealth? Schools teach people how to become good employees. Not good entrepreneurs.”

This is a rather bizarre response to the problem of (growing) income inequality. First of all, most public schools are run by local communities, funded primarily by property taxes with some oversight and funding at the state level, a bit of oversight and funding at the national level.

The function of K-12 schools so far as I understand them is to provide students with the tools for becoming an educated, thinking citizen. In the best case this involves acquiring a wide range of basic skills (e.g. reading, writing, math, logical reasoning, arts), a store of knowledge (e.g. science, history, literature, arts, social science), and a desire to learn more as one grows towards specialized kinds of knowledge.

If your point is that schools should try to avoid conformity, and should attempt build individuality and diversity–I’m with you. On the other hand, I can’t imagine a more conformist society, this side of Brave New World, then the all-entrepreneurial-thinking-all-of-the-time world you seem to be envisioning.

Is money-making the only worthwhile goal you understand?

I would add that you should be grateful that there are still people willing to devote their lives for teaching for $40,000. Because I don’t think Bill Gates, or Sam Walton, or even–from the sound of it–you, wants to spend his time teaching kindergartners how to recognize the alphabet, or third-graders how to do fractions, or sixth-graders introductory computer sicence, or 12th-grade kids how to do calculus–or any of these kids some sense of the humanities and how important they are to the civic institutions that liberal democracies depend on.

And guess what, if there weren’t people doing that, our country would go straight down the tubes. Man, I bet even Bill Gates would feel the pain!

I’m afraid Scientific American isn’t what it used to be. This chart has the biases I pointed out in my earlier post:

  1. It’s before tax income (which it admits). Still, the author could have gotten after-tax figure.

  2. It’s household income. The poor have smaller households than the rich and their average household size has been decreasing. In fact, real per capita income has increased substantially for the poor, even though real household income has declined. Further, the difference between rich and poor per capita income is less than the difference in household income. These per capita figures are available and could have been used in the chart.

  3. The Census definition of income excludes many benefits that the poor receive, such as food stamps, medicaid, etc. Incouding these reduces the difference between rich and poor.

After making all these corrections, the gap between rich and poor is still increasing, but not nearly as much as Scientific American’s chart would imply. The gap increased during both the Reagan and the Clinton administrations.

… a great deal of wealth in the US is simply inherited.

More than half of the richest 400 people in this country largely inherited their wealth.

Source: Somewhat dated: The New Field Guide to the US Economy (1995). They based this assertion on their reading of the annual list of richest people published by Forbes magazine. (BTW, there’s a more recent edition which I don’t have called The Ultimate Field Guide to the US Economy: A Compact and Irreverent Guide to Economic Life in Americ, New Updated Edition (2000))

Is this really true? Cite? I guess it depends on how you define “middle class”. Or is this one of those shocking statistics such as “Egad! Almost 50% of the people in this country make less than the median income!”

We’ll never have a fair economy until everyone is making above average income.:rolleyes:

Mandelstam: Sorry about intimating that Sen isn’t trying to change economic inequality…that isn’t what I meant by citing him! But now, that I don’t have the book with me, I can’t confirm the Lorenz-curve numbers (to be precise, actually the Gini co-efficient, which is derived from the L-Curve). I, like december, wonder about what numbers are included in the curve statistics. Sen’s numbers cover countries as diverse as the US, Denmark, Bulgaria and Bangladesh. Do the stats cover the same numbers for all the countries? I’m quite unsure.

I find it rather strange that David Chandler treats the scale that he has set up as “the” correct scale. He says “it is impossible to show the whole graph meaningfully on a single diagram.” How about changing the scales so that the vertical scale is comparable to the horizontal?

The problem here is that the deceased is, well, how should I phrase this delicately, sorta dead and rotting. He or she doesn’t have much use for money.

Seriously though, all those who argue for abolition for the estate tax (and, no, sleestak, it’s not really called “the death tax” except by creative conservative spin-meisters), look at things solely from the point of view of the deceased.

If you look at things from the point of view of the living, the arguments are much different. After all, why should I be rewarded for having the good fortune of being born into a well-to-do family? That ain’t a meritocracy and it certainly has nothing to do with equality of opportunity. Purely from this point of view, nothing short of total confiscation and redistribution of wealth upon death can really be justified.

Now, in reality I think you have to take a compromise point-of-view. I.e., I think it is fair to say that it is worthwhile to give people the opportunity to transfer some of their hard work and good fortune on to their heirs for, among other reasons, to provide them with incentives. On the other hand, I also think it is fair to say that these people shouldn’t be able to do this without any sort of limit above which a “cut” of it goes to the government because that makes “equality of opportunity” a complete farce. And, thus we arrive at the estate tax. One can argue about where to make the compromise but I think it is really deceptive to make the arguments solely from one point of view or the other.

You may in fact be correct here, but since you have used this argument a couple times with no cites, I think I am going to ask you to “put up or shut up”. Seriously though, the relation between family income and per capita income is actually more confusing. For example, in a previous thread, family income was used to support the claim that the Reagan era was good for the median family but it turns out that during that time period, things look considerably worse if you look at per capita income (or maybe it was real median wages) because the rise in family income at that time was in large part due to more women entering the workforce. So, in short, one needs more than just intuitive notions when considering how the two compare.

Cite, please.

Sua

Yes this is true. However the thought that gets ingrained into every students head is “you have to get good grades so you can get a good job when you graduate”. Especially at the college level. Very few schools, including the good ones, teach students the skills necessary to be anything but a successful office drone. Even at the MBA level, the traditional school of thought is “get to the top of the class so you can work for six-figures (and 100 hr work weeks) at Golman Sachs or Morgan Stanley”

I’m not advocating an all-entrepreneurial world, although I think that would be better than a world of a few super wealthy who own all the corporations while the rest of us toil away like slaves. I am simply advocating an education that provides an awareness of how wealthy people they get that way. The conventional line of reaoning goes like this: “if you work hard and get good grades, you will go to a good college and get a great job when you graduate.” This is not how most wealthy people become wealthy. This is how 99% of us enter a life of constant work. The only diference between the Harvard investment banker and the forklift guy at the factory is that the I-banker makes a little more money and has some nicer toys. Both likely live paycheck to paycheck and have to work their asses off. One just spends a lot more each month. Odds are, neither are accumulating wealth or managing their finances properly.

Yes. I wish I had a loftier purpose in life, but in the end, it’s about the money. All other goals are irrelevant if you are unable to feed, clothe and house yourself and your family.

No, that would be a waste of their talents and skills. But I am gratefull that I went to a business school that is taught by former CEOs and entrepreneurs instead of ivory-tower intellectuals. I just think that some of those lessons could be taught earlier in life. After all, IIRC, Gates dropped out of college to start his business. Why should most people have to wait until they are MBAs in their late 20s to learn that owning their own business is a possible option?

Just to clarify, I’m not advocating every person start their own company. It is very risking and it’s not for everyone. All I am saying is that we should educate our kids that acquiring wealth and managing their finances is something that can be learned, planned and executed and is not just reserved for a lucky few who are born into it.

IIRC these points were discussed in Sowell’s book “Basic Economics” In addition he addressed some of them in this column.

A real problem with wealth distribution in western economies is how quickly meritocracy becomes winner takes all.

A meritocracy is a noble goal. If you are successful, intelligent, talented and create wealth you should be rewarded for it. This encourages hard work and improves the country’s overall wealth.

But at some point you have to stop and think: what about the people who simply aren’t talented, intelligent and successful? Do we just abandon them? If, say, 20% of the population are not able to keep up, do we just throw them on the scrapheap to rot?

To my mind this would not seem fair. Many of this 20% will still be providing services that the rest of us want or need - sanitation, fast food, whatever it might be. They deserve a reasonable standard of living for their efforts. Punishing them harshly because they are fundamentally not as talented in business is like punishing people who are short or who can’t run fast.

This is where our current income disparity comes in. The gap between rich and poor is growing astonshingly. msmith compares the rich and poor wage-slaves, but the fact still remains that one is rich and the other poor. And the $400k p.a. banker will go to $500k and $800k and the next generation of bankers will start at even higher levels but the $20k p.a. dustman will, in real terms, stay there and his successor won’t be on any more either. And then you have the truly wealthy. Whooo boy.

I’ve heard it suggested that this closest that my country (the UK) came to a true “meritocracy” was in the 1960s. These days we most definitely have “winner take all”. I don’t think that is healthy.

pan

I agree that it is not beneficial to society to have a significant portion of the population living in substandard conditions. The problem is how do you distribute the wealth from the wealthy to the poor? Simply taxing the wealthy takes money from them easily enough, but how should that money find its way to the poor. Should the government simply cut checks to everyone below a certain income? That would be big disentive to even go to work.

The problem is that most poor people are in unskilled jobs where market forces don’t allow them to make a decent wage. Minimum Wage laws and unions have been unable to solve this problem.

Yes, solving the problem is a whole lot harder than recognising it. But recognising it is the first step. I too often hear denial that the problem exists at all.

Mind you, I’m not convinced that minimum wage laws are an utter failure. As part of an integrated solution, they could be a factor. Certainly the predicted mass unemployment and inflation predicted when the current UK government introduced a minimum wage a few years ago failed to materialise, so it seems that they do go some way to achieving a mimimum living standard without screwing everything else up.

Similarly, unions like minimum wages have been unable to solve the problem but I do suspect that they have been instrumental in retarding it.

Beyond that - I don’t have much I’m afraid. As you say, overtaxing and setting maximum wages have been frequently shown to be a negative factor. And yet we do have the “winner takes all” problem of a meritocracy that has gone too far.

What I will do is identify three areas which help to perpetuate the problem - indeed to spiral it upwards: [list=1]
[li] Inheritance[/li]This has been discussed elsewhere in the thread, so I won’t say much more. But I would note that from a strictly societal point of view it is a big factor in the perpetuation of the gulf between rich and poor.

(Also: from a strictly economic point of view inheritance is fairly disasterous since it discourages personal output. As such I think it gets sandwiched from both directions - fiscal and sociological. Throw in the fact that society needs tax revenue and this is money they owner doesn’t need any more and personally I see a big argument from extremely penal inheritance taxes. But I digress.)

[li]Education[/li]If you really want a meritocracy then everyone needs to start from the same level. This is clearly not the case when the rich can afford to buy a much higher quality of education for their children.

Furthermoremsmith has already pointed out some discrepancy in the style differences of some facets of education too - those who can afford a good education are encouraged to think in terms of leaders whilst those who cannot afford a good education are encouraged to think in terms of followers.

[li] Health[/li]Even given the same level of education, it is very difficult for children to succeed in that education if they are malnourished and/or ill due to lack of quality medical care. Children who are fed fresh fruit and vegetables as their staple diet have an immediate advantage compared to those who are fed overprocessed food.

Yet processed food is invariably cheaper than fresh. And you frequently find that awareness of the importance of nutrition is correlated with wealth.

So inequalities in levels of health between rich and poor also prevent a level playing field and serve to disturb a meritocracy.[/list=1]The three points above lead to one end: you end up with a new class structure. The rich find it easy to perpetuate the wealth within family lines whilst the poor find it increasingly difficult to break out of the cycle. Successive generations find the problem exacerbated more and more. In the 1960s, for various reasons, the divide was far less oppressive than it is today. It was easier for my father’s generation to break out of their socioeconomic group than it is for people of my generation.

As such any solution has to involve two steps:[list=1][li] Seek to nullify the advantages the children of the rich have over their poor brethren. I hope that it goes without saying that the aim is to bring the levels of health and education up to that the rich enjoy and not down to the lowest common denominator.[/li]
This is clearly a pipe dream. But recognising that health and education are two vital elements of a meritocracy would be a start. This is one reason I am so in favour of a national health service and state education. But the budget needs to be quintupled.

[li]Ensure that for those who do not succeed in the meritocracy:[/li]
a) Their children do not suffer as a result (see point 1); and
b) They are not cast onto life’s scrapheap as a result. The only way I can see to do this is via some form of income support or minimum wage, but I’m open to alternatives[/list=1]

I see the ultimate result of a winner-take-all society as taking us back to a stratified class structure. Indeed, to support this I’d note that the levels of employment for domestic staff in the UK has been increasing in the last ten years after years of decline prior to this. The servers and the served. I think we need to address the problem before it gets too late.

pan

I find this article somewhat interesting, though offhand I dunno how accurate it is.

Unfortunately this is only a link to a summary of an article, but still, it sounds reasonable enough. They simply argue that you either have a wage gap and low unemployment, or higher benefits and higher unemployment. That, in some way, the two are mutually exclusive.

But what I find interesting is that if there is higher unemployment due to better unemployment benefits, then does it all average out? After all, they might get more when they work (or more when they don’t), but they work statistically less (which is ok, I suppose, until you’re the one looking for a job).

Anyone care to expound on this tidbit for me? It seems terribly interesting and totally germane to the discussion.

That is interesting eris. The old convention was that unemployment and inflation were inversely correlated, but that has been blown out of the water in recent years with the US and the UK enjoying both their lowest unemployment rates AND lowest inflation rates for many years.

So maybe we have a new relationship instead: unemployment rates are inversely correlated with the gap between rich and poor.

This intuitively might make sense if we consider that when Joe Schlub works, most of the wealth generated from his employment does not end up in his pocket, but rather the pocket of the capital’s owners. Thus the higher the level of employment, the more the rich are raking it in. But to those at the bottom of society, the benefits of a minimum wage income are not particularly better than that of welfare anyway.

Worth some thought, that.

pan

The bottom line is that 20% of the people hold most of the wealth because 20% of the people drive most of the production. 20% of the people manage their finances better. 20% of the people work the hardest, etc.

If you want to correct that, the only way to do it is to redistribute their income, but that has the nasty side effect of punishing the very people that you want to be rewarded. In many companies, the pareto principle is used to reward the top 20% of employees with bigger raises and benefits. The government wants to do the opposite.